UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended JUNE 30, 2004
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from __________ to __________
Commission file number: 000-28560
NETGURU, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 22-2356861
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
22700 SAVI RANCH PARKWAY, YORBA LINDA, CA 92887
(Address of principal executive offices)
(714) 974-2500
(Issuer's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the registrant's only class of common stock,
$0.01 par value, was 18,837,154 on August 18, 2004.
Transitional Small Business Disclosure Format (check one) Yes[ ] No [X]
PART I
FINANCIAL INFORMATION
PAGE
Item 1. Financial Statements............................................... 3
Condensed Consolidated Statements of Operations for the three
months ended June 30, 2004 and 2003 (unaudited).................... 3
Condensed Consolidated Balance Sheets as of
June 30, 2004 (unaudited) and March 31, 2004....................... 4
Condensed Consolidated Statements of Cash Flows for the
three months ended June 30, 2004 and 2003 (unaudited).............. 5
Notes to Condensed Consolidated Financial Statements (unaudited)... 6
Item 2. Management's Discussion and Analysis or Plan of Operation..........15
Item 3. Controls and Procedures............................................27
PART II
OTHER INFORMATION
Item 1. Legal Proceedings..................................................28
Item 2. Changes in Securities and Small Business Issuer Purchases of
Equity Securities..................................................28
Item 3. Defaults Upon Senior Securities....................................28
Item 4. Submission of Matters to a Vote of Security Holders................28
Item 5. Other Information..................................................28
Item 6. Exhibits and Reports on Form 8-K...................................29
Signatures....................................................................30
Exhibits Filed with this Quarterly Report on Form 10-QSB......................31
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
($ in thousands except share and per share amounts)
THREE MONTHS ENDED
JUNE 30,
----------------------------------
2004 2003
--------------- ---------------
Net revenues:
Engineering and collaborative software products and services $ 2,444 $ 2,722
IT services 1,075 1,207
Web-based telecommunications services 222 326
--------------- ---------------
Total net revenues 3,741 4,255
--------------- ---------------
Cost of revenues:
Engineering and collaborative software products and services 245 241
IT services 756 917
Web-based telecommunications services 133 194
--------------- ---------------
Total cost of revenues 1,134 1,352
--------------- ---------------
Gross profit 2,607 2,903
--------------- ---------------
Operating expenses:
Selling, general and administrative 2,290 2,314
Research and development 415 540
Bad debt expense 165 11
Depreciation 244 253
--------------- ---------------
Total operating expenses 3,114 3,118
--------------- ---------------
Operating loss (507) (215)
--------------- ---------------
Other expense (income):
Interest, net 125 151
Other income (33) -
Loss on substantial modification of debt 133 -
--------------- ---------------
Total other expense 225 151
--------------- ---------------
Loss before income taxes (732) (366)
Income tax expense 6 37
--------------- ---------------
Net loss $ (738) $ (403)
=============== ===============
Basic and diluted loss per common share $ (0.04) $ (0.02)
=============== ===============
Common shares used in computing net loss per common share 18,626,165 17,325,150
=============== ===============
See accompanying notes to condensed consolidated financial statements.
3
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
JUNE 30, MARCH 31,
2004 2004
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,341 $ 1,646
Short-term investment 100 100
Accounts receivable (net of allowance for doubtful accounts of $707 and
$615, as of June 30, 2004 and March 31, 2004, respectively) 3,051 3,352
Income tax receivable 16 16
Notes and related party loans receivable 33 35
Deposits 103 67
Prepaid expenses and other current assets 1,201 1,183
Assets of subsidiary held for sale -- 258
------------- -------------
Total current assets 6,845 6,657
Property, plant and equipment, net 2,088 2,215
Goodwill 3,154 2,941
Other assets 147 217
------------- -------------
$ 12,234 $ 12,030
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term bank debt $ 1,014 $ 975
Current portion of capital lease obligations 120 109
Accounts payable 533 629
Accrued expenses 1,007 1,160
Income taxes payable 63 55
Deferred revenues 1,940 1,888
Other liabilities 164 208
Liabilities of subsidiary held for sale -- 103
------------- -------------
Total current liabilities 4,841 5,127
Long-term bank debt, net of current portion 1,562 1,382
Capital lease obligations, net of current portion 403 368
Deferred gain on sale-leaseback 730 747
------------- -------------
Total liabilities 7,536 7,624
------------- -------------
Stockholders' equity:
Preferred stock, par value $.01 (Authorized 5,000,000 shares; no shares
issued and outstanding) -- --
Common stock, par value $.01; authorized 150,000,000 shares; 18,812,154
shares outstanding as of June 30, 2004 and 18,087,154 shares
outstanding as of March 31, 2004 188 181
Additional paid-in capital 36,380 33,352
Accumulated deficit (31,182) (30,444)
Accumulated other comprehensive loss:
Cumulative foreign currency translation adjustments (688) (683)
------------- -------------
Total stockholders' equity 4,698 4,406
------------- -------------
$ 12,234 $ 12,030
============= =============
See accompanying notes to condensed consolidated financial statements.
4
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, 2004 JUNE 30, 2003
------------- -------------
Cash flows from operating activities:
Net loss $ (738) $ (403)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 313 325
Loss on substantial modification of debt 133 --
Bad debt expense 165 11
Amortization of debt discount 51 --
Consulting expense recognized on issuance of warrants and stock 35 --
Changes in operating assets and liabilities:
Accounts receivable 48 220
Notes and related party loans receivable 2 44
Prepaid expenses and other current assets (73) (120)
Deposits (40) 591
Other assets -- (15)
Accounts payable (76) (78)
Accrued expenses (176) (405)
Income taxes payable 9 30
Accrued restructuring costs -- (188)
Other current liabilities (41) (49)
Deferred revenues 62 (232)
Deferred gain on sale-leaseback (18) (17)
Changes in assets and liabilities held for sale 155 (20)
------------- -------------
Net cash used in operating activities (189) (306)
------------- -------------
Cash flows from investing activities:
Purchase of property, plant and equipment (98) (12)
Proceeds from sale of property, plant and equipment 1 --
Payments to acquire companies, net of cash acquired (24) --
------------- -------------
Net cash used in investing activities (121) (12)
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of bank debt 1,703 43
Repayment of bank debt (781) (310)
Repayment of capital lease obligations (32) (111)
Issuance of common stock 25 --
------------- -------------
Net cash provided by (used in) financing activities 915 (378)
------------- -------------
Effect of exchange rate changes on cash and cash equivalents 90 46
------------- -------------
Increase (decrease) in cash and cash equivalents 695 (650)
Cash and cash equivalents, beginning of period 1,646 2,772
------------- -------------
Cash and cash equivalents, end of period $ 2,341 $ 2,122
============= =============
Supplemental disclosure of cash flow information:
Amounts paid for:
Interest $ 80 $ 107
Income taxes $ 4 $ 8
Supplemental disclosure of non-cash investing and financing activities:
Acquisition of equipment under capital lease $ 78 $ --
Repayment of convertible debt with common stock $ 910 $ --
Acquisition of a company $ 150 $ --
See accompanying notes to condensed consolidated financial statements.
5
NETGURU, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
(UNAUDITED)
1. REPORT BY MANAGEMENT
The condensed consolidated financial statements include the accounts of
netGuru, Inc. and its wholly owned subsidiaries (the "Company"). All significant
transactions among the consolidated entities have been eliminated upon
consolidation.
These condensed consolidated financial statements have been prepared by
the Company and include all adjustments which are, in the opinion of management,
necessary for a fair presentation of the financial position at June 30, 2004 and
the results of operations and the cash flows for the three months ended June 30,
2004 and 2003, pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for annual consolidated financial statements. Results of
operations for the three months ended June 30, 2004 are not necessarily
indicative of the results to be expected for the full year ending March 31,
2005. It is suggested that the accompanying condensed consolidated financial
statements be read in conjunction with the Company's audited consolidated
financial statements included in the Company's annual report on Form10-KSB for
the year ended March 31, 2004.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
Certain reclassifications have been made to the fiscal 2004
consolidated financial statements to conform to the fiscal 2005 presentation.
2. FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards ("SFAS") No. 107,
"Disclosures About Fair Value Of Financial Instruments," requires management to
disclose the estimated fair value of certain assets and liabilities defined by
SFAS No. 107 as financial instruments. At June 30, 2004, the Company's
management believed the carrying amounts of cash and cash equivalents,
receivable and payable amounts, and accrued expenses approximated fair value
because of the short maturity of these financial instruments. The Company's
management also believed that the carrying amounts of its capital lease
obligations approximated their fair values, as the interest rates approximated a
rate that the Company could have obtained under similar terms at the balance
sheet date. The estimated fair value of the Company's long-term debt at June 30,
2004, was approximately $2.9 million.
3. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
REVENUE RECOGNITION
The Emerging Issues Task Force, or EITF, reached a consensus for EITF
No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF No. 00-21
provides accounting guidance for allocation of revenue where delivery or
performance of products or services may occur at different points in time or
6
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
over different periods. The Company adopted this consensus on July 1, 2003.
Under EITF No. 00-21, revenue must be allocated to all deliverables regardless
of whether an individual element is incidental or perfunctory. The adoption of
EITF No. 00-21 did not materially impact the Company's consolidated financial
condition or results of operations.
In July 2003, the EITF reached a consensus on EITF 03-5, "Applicability
of AICPA SOP 97-2 to Non-Software Deliverables." EITF 03-5 provides accounting
guidance on whether non-software deliverables (for example, non-software related
equipment or services) included in an arrangement that contains software are
within the scope of SOP 97-2. In general, any non-software deliverables are
within the scope of SOP 97-2 if the software deliverable is essential to the
functionality of the non-software deliverables. The Company adopted the
consensus in October 2003. The adoption of EITF 03-5 did not materially impact
the Company's consolidated financial condition or results of operations.
FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments that have characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that is within its
scope as a liability (or as an asset in some circumstances). Many of those
instruments were previously classified as equity. This statement is effective
for financial instruments entered into or modified after May 31, 2003. The
adoption of SFAS No. 150 did not materially impact the Company's consolidated
financial condition or results of operations.
4. SOFTWARE DEVELOPMENT COSTS AND PURCHASED TECHNOLOGY
The Company capitalizes costs related to the development of certain
software products in accordance with SFAS No. 86, "Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed." Capitalization of
costs begins when technological feasibility has been established and ends when
the product is available for general release to customers. As of June 30, 2004,
there were no unamortized capitalized software costs.
The Company amortizes capitalized software development costs and
purchased technology using the straight-line method over two to five years, or
the ratio of actual sales to anticipated sales, whichever is greater.
Amortization of software development costs and purchased technology charged to
operations was approximately $69,000 and $70,000 for the quarters ended June 30,
2004 and 2003, respectively. Accumulated amortization on capitalized software
was $982,000 and $703,000 as of June 30, 2004 and 2003, respectively.
5. REVENUE RECOGNITION
The Company recognizes revenue when the following criteria are met: (1)
persuasive evidence of an arrangement, such as agreements, purchase orders or
written or online requests, exists; (2) delivery has been completed and no
significant obligations remain; (3) the Company's price to the buyer is fixed or
determinable; and (4) collection is probable. The Company's revenues arise from
the following segments: engineering and collaborative software products and
services; IT services; and Web-based telecommunications services.
7
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
Revenue from software sales is recognized when persuasive evidence of
an arrangement exists, delivery has been completed and if no significant
post-contract support obligations remain outstanding, the price to the Company's
buyer is fixed or determinable and collection of the resulting receivable is
probable. Since the second quarter of fiscal 2003, the Company has provided a
15-day right of return (from the date of purchase) on the purchase of a product
during which time the customer may return the product subject to a $50
restocking fee per item returned. Since the Company's product returns have
historically not been material, the Company does not make any provisions for
such returns. Customers may choose to purchase maintenance contracts that
include telephone, e-mail and other methods of support, and the right to receive
upgrades. Revenue from these maintenance contracts is deferred and recognized
ratably over the life of the contract, usually twelve months.
In October 1997, the Accounting Standards Executive Committee ("AcSEC")
of the AICPA issued Statement of Position ("SOP") 97-2, "Software Revenue
Recognition." SOP 97-2 distinguishes between significant and insignificant
vendor obligations as a basis for recording revenue, with a requirement that
each element of a software licensing arrangement be separately identified and
accounted for based on relative fair values of each element. The Company
determines the fair value of each element in multi-element transactions based on
vendor-specific objective evidence ("VSOE"). VSOE for each element is based on
the price charged when the same element is sold separately.
In 1998, the AICPA issued SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions," which modifies SOP
97-2 to allow for use of the residual method of revenue recognition if certain
criteria have been met. If evidence of fair value of all undelivered elements
exists but evidence does not exist for one or more delivered elements, then
revenue is recognized using the residual method. Under the residual method, the
fair value of the undelivered elements is deferred and the remaining portion of
the transaction fee is recognized as revenue.
The Company sells its engineering and collaborative software along with
a maintenance package. This constitutes a multiple element arrangement. The
price charged for the maintenance portion is the same as when the maintenance is
sold separately. The fair values of the maintenance contracts sold in all
multiple element arrangements are recognized over the terms of the maintenance
contracts. The engineering and collaborative software portion is recognized when
persuasive evidence of an arrangement exits, price is fixed and determinable,
when delivery is complete, collection of the resulting receivable is probable
and no significant obligations remain.
Revenues from providing IT services are recognized primarily on a time
and materials basis, with time at a marked-up rate and materials and other
reasonable expenses at cost, once the services are completed and no significant
obligations remain. Certain IT services contracts are fixed price contracts
where progress toward completion is measured by mutually agreed upon
pre-determined milestones for which the Company recognizes revenue upon
achieving such milestones. Fixed price IT contracts are typically for a short
duration of one to three months. The Company did not have any fixed price
contracts at June 30, 2004.
Revenues from call termination services are recognized at gross sales
value, with the applicable cost separately stated in the cost of revenues.
Revenues from the Company's own phone card sales are deferred and recognized
based on usage, whereas revenues from resale of third-party phone cards are
recognized net of returns since no significant obligations remain once the
product is delivered. Other products and services sold via Internet portals,
where the Company is an agent, are recognized net of purchase costs when the
products and services are delivered and collection is probable.
8
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
6. DEFERRED REVENUES
The Company defers revenues for its maintenance contracts, for its
collaborative software sales and for its phone card revenues that are not
considered earned. The Company defers its maintenance revenues when the
maintenance contracts are sold, and then recognizes the maintenance revenues
over the term of the maintenance contracts. The Company defers its collaborative
software sales revenues if it invoices or receives payment prior to the
completion of a project, and then recognizes these revenues upon completion of
the project when no significant obligations remain. The Company defers revenues
from the sales of its own phone cards when the cards are sold, and then
recognizes revenues from these phone card sales based on usage. Revenues from
any unused portion of phone card minutes are recognized upon expiration of the
phone cards.
7. LONG-TERM DEBT
On December 13, 2002, the Company entered into a Securities Purchase
Agreement ("Agreement") with Laurus Master Fund, Ltd. ("Laurus"). Pursuant to
the Agreement, the Company issued to Laurus a 6% Convertible Note ("2002 Note")
in the principal amount of $2,000,000 maturing on December 12, 2004 and a
five-year warrant to purchase up to 200,000 shares of the Company's common stock
at exercise prices ranging from $1.76 to $2.40 per share.
On August 4, 2003, the terms of the 2002 Note were amended as follows:
(1) the interest rate on the convertible note was amended from 6% to the greater
of 5% or prime rate plus 1%, payable in arrears; (2) the amortization period was
extended from 20 months ending on November 13, 2004 to 24 months ending on July
31, 2005; (3) the penalty for repayments of the outstanding balance in cash was
removed; and (4) the fixed conversion price, upon which potential issuances of
the Company's common stock to satisfy the obligations of the convertible note
are based, was reduced from $1.60 to $1.30.
In April 2004, Laurus converted $650,000 of principal balance on the
2002 Note into 500,000 shares of the Company's common stock. At June 30, 2004,
the Company had a principal balance of $80,000, excluding unamortized fees and
beneficial conversion adjustments, under the 2002 Note.
On July 31, 2003, the Company obtained a three-year, renewable,
$4,000,000 revolving accounts receivable credit facility from Laurus
("Facility"). The amount available under this Facility is reduced by the
balances outstanding on the 2002 Note and the Amended 2003 Note (defined below).
Borrowings under the Facility accrued interest, initially, at an annual
rate equal to the greater of 5% or the prime rate plus 1%. Beginning November 1,
2003, the interest rate may be adjusted every month based on certain
registration requirements and on the volume weighted average price of the
Company's common stock. No adjustments were made to the interest rate during the
period ended June 30, 2004. Obligations owed under this Facility may be repaid
at the Company's option in cash or through the issuance of shares of the
Company's common stock at the fixed conversion price of $1.30 per share, subject
to volume limitations, as described in the Facility. The Facility has a
three-year term. An early termination fee of up to $120,000 will be payable if
the Facility is terminated prior to August 1, 2006. The Facility also provides
the Company, under certain conditions, the flexibility to borrow additional
amounts up to $1,000,000 above what is available based upon eligible accounts
receivable. Any such additional borrowings will accrue interest at a rate of
0.6% per month, payable monthly.
9
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
In connection with this Facility, the Company issued to Laurus a
five-year warrant to purchase 180,000 shares of the Company's common stock,
exercisable at various prices. Laurus may also receive additional five-year
warrants to purchase up to 400,000 shares of our common stock at an exercise
price equal to 125% of the fixed conversion price based upon how much of the
outstanding obligation under the Facility is converted to equity. As of June 30,
2004, none of the additional five-year warrants had been issued. The Facility is
secured by a general security interest in the assets of the Company and its
subsidiaries and prohibits the Company from paying any dividends on its common
stock without Laurus' permission.
On December 4, 2003, the outstanding balance of $900,000 under the
Facility was refinanced with Laurus along with $500,000 of additional borrowings
into a three-year, 5% secured convertible note ("2003 Note"). At June 30, 2004,
the Company had no borrowings under the Facility.
The interest rate on the 2003 Note is equal to the greater of 5% or the
prime rate plus 1.0%. The 2003 Note matures on December 3, 2006. The fixed
conversion price, upon which potential issuances of the Company's common stock
to satisfy the obligations of the 2003 Note are based, is $1.30. In April 2004,
the 2003 Note was amended ("Amended 2003 Note") to include $1,000,000 in
additional borrowings. The Amended 2003 Note requires monthly principal payments
of $50,000 plus accrued interest (payable in arrears) commencing August 1, 2004,
with the entire remaining principal balance becoming due on December 3, 2006.
The Company recorded this amendment as a substantial modification of debt and
wrote off approximately $133,000 in unamortized discount on the original 2003
Note as a loss on substantial modification of debt pursuant to EITF 96-19. The
Company recorded approximately $173,000 as a discount to the Amended 2003 Note,
which included the $11,000 in fees it paid to an affiliate of Laurus and the
$162,000 it recorded in April 2004 due to the beneficial conversion rate of the
debt related to the additional borrowings. The discount is being amortized to
interest expense over the remainder of the term of the Amended 2003 Note. In
April 2004, Laurus also converted $260,000 of the principal balance into 200,000
shares of the Company's common stock. At June 30, 2004, the Company had an
outstanding balance of $2,110,000, excluding unamortized fees and unamortized
beneficial conversion adjustments, under the Amended 2003 Note.
The 2002 Note and the Amended 2003 Note are secured by a general
security interest in the assets of the Company and its domestic subsidiaries.
The Company was required to use the net proceeds from the 2002 Note and the
Amended 2003 Note for general corporate purposes only. The Company is also
required not to permit for any fiscal quarter commencing April 1, 2003, the net
operating cash flow deficit to be greater than $500,000, excluding extraordinary
items, as determined by Laurus. At June 30, 2004, the Company was in compliance
with this covenant.
8. STOCKHOLDERS' EQUITY
The Company continues to follow the guidance of APB No. 25. Pursuant to
APB No. 25, compensation related to stock options is measured as the difference
between the grant price and the fair market value of the underlying common
shares at the grant date. Generally, the Company issues options to employees
with a grant price equal to the market value of its common stock on the grant
date. Accordingly, the Company has recognized no compensation expense on its
grants of employee stock options.
10
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
The following represents pro forma information as if the Company
recorded compensation cost using the fair value of the issued compensation
instrument under SFAS No. 123 (in thousands, except amounts per share):
THREE MONTHS ENDED JUNE 30,
2004 2003
------------------ -----------------
Net loss - as reported $ (738) $ (403)
Deduct: Stock-based compensation expense
determined under the fair value based
method for all awards, net of tax 34 55
------------------ -----------------
Net loss - pro forma $ (772) $ (458)
================== =================
Basic and diluted net loss per share -
as reported $ (0.04) $ (0.02)
================== =================
pro forma $ (0.04) $ (0.03)
================== =================
Weighted average fair value of options
granted $ -- $ --
================== =================
THREE MONTHS ENDED JUNE 30,
2004 2003
------------------ -----------------
Black-Scholes option pricing model
assumptions:
Dividend yield -- --
Expected volatility 60.2% 111.9%
Risk-free interest rate 3.9% 2.9%
Expected option lives (in years) 6.4 6.8
9. FOREIGN CURRENCY TRANSLATION
The financial condition and results of operations of the Company's
foreign subsidiaries are accounted for using the local currency as the
functional currency. Assets and liabilities of the subsidiaries are translated
into United States dollars (the reporting currency) at the exchange rate in
effect at the end of the interim period. Statements of operations accounts are
translated at the average rate of exchange prevailing during the respective
interim periods. Translation adjustments arising from the use of differing
exchange rates from period to period are included in accumulated other
comprehensive income (loss) in the consolidated balance sheet. Gains and losses
resulting from foreign currency transactions are included in operations and were
not material to the first quarters of fiscal 2005 and 2004.
10. COMPREHENSIVE INCOME (LOSS)
The Company applies the provisions of SFAS No. 130, "Reporting
Comprehensive Income," which prescribes rules for the reporting and display of
comprehensive income (loss) and its components. SFAS No. 130 requires foreign
currency translation adjustments, which are reported separately in stockholders'
equity, to be included in other comprehensive income (loss). Total comprehensive
loss was $743,000 and $321,000 for the quarters ended June 30, 2004 and 2003,
respectively.
11
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
11. NET LOSS PER SHARE
Basic earnings (loss) per share ("EPS") is calculated by dividing net
income (loss) by the weighted-average common shares outstanding during the
period. Diluted EPS reflects the potential dilution to basic EPS that could
occur upon conversion or exercise of securities, options, or other such items,
to common shares using the treasury stock method based upon the weighted-average
fair value of the Company's common shares during the period.
The following table illustrates the computation of basic and diluted
net loss per share (in thousands, except per share amounts):
THREE MONTHS ENDED
JUNE 30,
----------------------------------
2004 2003
--------------- ----------------
Numerator:
Net loss and numerator for basic and diluted loss per
share $ (738) $ (403)
=============== ===============
Denominator:
Denominator for basic net loss per share - average
number of
common shares outstanding during the period 18,626 17,325
Incremental common shares attributable to exercise of
outstanding options, warrants and other common stock
equivalents -- --
--------------- ----------------
Denominator for diluted net loss per share 18,626 17,325
=============== ================
Basic and diluted net loss per share $ (0.04) $ (0.02)
=============== ================
Options, warrants and other common stock equivalents amounting to
1,847,000 and 1,179,000 potential common shares were excluded from the
computations of diluted EPS for the quarters ended June 30, 2004 and 2003,
respectively, because the Company reported net losses and, therefore, the effect
would have been anti-dilutive. Potential common shares amounting to 1,685,000
from the possible conversion of the convertible notes issued to Laurus were
excluded from the computation of diluted loss per share for the quarter ended
June 30, 2004, as their effect would have been anti-dilutive.
12. SEGMENT AND GEOGRAPHIC DATA
The Company is an integrated Internet and IT technology and services
company. The Company's operating segments are: o Engineering and collaborative
software products and services; o IT services; and o Web-based
telecommunications services.
The Company's management reviews unallocable expenses related to the
Company's corporate activities in a separate "Center."
The Company applies the provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 requires
segments to be determined and reported based on how management measures
performance and makes decisions about allocating resources.
12
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
The significant components of worldwide operations by reportable
operating segments are:
THREE MONTHS ENDED JUNE 30,
----------------------------------
2004 2003
--------------- ---------------
(IN THOUSANDS)
NET REVENUE
Engineering and collaborative software
products and services $ 2,444 $ 2,722
IT services 1,075 1,207
Web-based telecommunications services 222 326
Center - -
--------------- ---------------
Consolidated $ 3,741 $ 4,255
=============== ===============
GROSS PROFIT
Engineering and collaborative software
products and services $ 2,199 $ 2,481
IT services 319 290
Web-based telecommunications 89 132
Center - -
--------------- ---------------
Consolidated $ 2,607 $ 2,903
=============== ===============
OPERATING (LOSS) INCOME
Engineering and collaborative software
products and services $ (113) $ 379
IT services 29 (5)
Web-based telecommunications services 27 (60)
Center (450) (529)
--------------- ---------------
Consolidated $ (507) $ (215)
=============== ===============
The Company's operations are based worldwide through foreign and
domestic subsidiaries and branch offices in the United States, India, the United
Kingdom, France, Germany and Asia-Pacific. The following are significant
components of worldwide operations by geographic location:
THREE MONTHS ENDED
JUNE 30,
----------------------------------
2004 2003
--------------- ---------------
(IN THOUSANDS)
NET REVENUE
United States $ 1,801 $ 2,331
The Americas (other than U.S.) 165 158
Europe 770 1,126
Asia-Pacific 1,005 640
--------------- ---------------
Consolidated $ 3,741 $ 4,255
=============== ===============
EXPORT SALES
United States $ 405 $ 663
=============== ===============
13
NetGuru, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (cont'd)
AS OF
----------------------------------
JUNE 30, MARCH 31,
2004 2004
--------------- ---------------
(IN THOUSANDS)
LONG-LIVED ASSETS
United States $ 3,886 $ 4,084
Europe 220 204
Asia-Pacific 1,283 1,085
--------------- ---------------
Consolidated $ 5,389 $ 5,373
=============== ===============
13. CONTINGENCIES
The Company is party to various litigation matters arising in the
normal course of business. Management believes the resolution of these matters
will not have a material adverse effect on the Company's consolidated results of
operations or financial condition.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities Exchange Act
of 1934, as amended, (the "Exchange Act)." We intend that the forward-looking
statements be subject to the safe harbors created by those sections. The
forward-looking statements generally include the plans and objectives of
management for future operations, including plans and objectives relating to our
future economic performance, and can generally be identified by the use of the
words "believe," "intend," "plan," "expect," "forecast," "project," "may,"
"should," "could," "seek," "pro forma," "goal," "estimates," "continues,"
"anticipate" and similar words. The forward-looking statements and associated
risks may include, relate to, or be qualified by other important factors,
including, without limitation:
o our ability to achieve and maintain profitability and obtain
additional working capital, if required;
o our ability pay down our debt;
o our ability to successfully implement our business plans,
including our business process outsourcing (BPO) plans;
o our ability to attract and retain strategic partners,
alliances and advertisers;
o our ability to hire and retain qualified personnel;
o the risks of uncertainty of trademark protection;
o risks associated with existing and future governmental
regulation to which we are subject; and
o uncertainties relating to economic conditions in the markets
in which we currently operate and in which we intend to
operate in the future.
These forward-looking statements necessarily depend upon assumptions
and estimates that may prove to be incorrect. Although we believe that the
assumptions and estimates reflected in the forward-looking statements are
reasonable, we cannot guarantee that we will achieve our plans, intentions or
expectations. The forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause actual results to differ in
significant ways from any future results expressed or implied by the
forward-looking statements. We do not undertake to update, revise or correct any
forward-looking statements.
Any of the factors described above or in the "Risk Factors" section of
our latest annual report on Form 10-KSB could cause our financial results,
including our net income (loss) or growth in net income (loss) to differ
materially from prior results, which in turn could, among other things, cause
the price of our common stock to fluctuate substantially.
OVERVIEW
We operate in three business segments. They are:
o Engineering and collaborative software products and services
for businesses worldwide;
o Information technology, or IT, services (including value-added
IT services); and
o Web-based telecommunications services (including long-distance
communication services that include call termination services
and prepaid phone cards).
15
Our net revenues during the three months ended June 30, 2004 were
$3,741,000, a decrease of 12.1% over the corresponding prior year period, of
which engineering and collaborative software products and services net revenues
declined $278,000 (10.2%), IT services net revenues declined $132,000 (10.9%),
and Web-based telecommunications services declined $104,000 (31.9%).
We anticipate growth in both domestic and international sales of
engineering and collaborative software in the quarter ending September 30, 2004,
and for fiscal 2005. Although historically our software sales and revenues have
increased during the second half of the fiscal year, we offer no assurance that
increases in software sales and revenues will materialize since our sales and
revenues depend upon, among other factors, our customers' continued acceptance
of our products and services as well as our customers' economic conditions.
We believe our IT services business will see growth in revenues due to
our expansion into the BPO market. Currently, our
BPO services address the production of structural steel detailing drawings.
Although we believe our BPO
services will contribute additional revenues to the IT services segment, we
offer no assurance as to the amount of additional revenues that may materialize
since we have a limited history in this segment of the business, competition for
such services is intense as there are relatively few barriers to entry.
As of June 30, 2004, our indebtedness under our convertible notes
totaled approximately $2,190,000, out of a total availability of $4,000,000.
During the three months ended June 30, 2004, we converted a portion of the
outstanding convertible debt into equity. We anticipate that additional
convertible debt will be converted to equity in the coming months.
CRITICAL ACCOUNTING POLICIES
We have identified the following as accounting policies that are the
most critical to aid in understanding and evaluating our financial results:
o revenue recognition;
o allowance for accounts receivable; and
o impairment of long-lived assets, including goodwill.
REVENUE RECOGNITION
We derive revenues from:
o engineering and collaborative software products and services;
o IT services; and
o Web-based telecommunications services.
We recognize revenues when the following criteria are met:
o Persuasive evidence of an arrangement, such as agreements,
purchase orders or written or online requests, exists;
o Delivery has been completed and no significant obligations
remain;
o Our price to the buyer is fixed or determinable; and
o Collection is probable.
16
At the time of sale, we provide a 15-day right of return on the
purchase of the product during which time the customer may return the product to
us subject to a $50 restocking fee on each returned item. Customers may choose
to purchase ongoing maintenance contracts that include telephone, e-mail and
other methods of support, and the right to receive upgrades. Revenue from the
maintenance contracts is deferred and recognized ratably over the life of the
contract, usually twelve months.
We recognize revenues from software we customize to fit a customer's
requirements based on satisfactory completion of pre-determined milestones
(evidenced by written acceptance from the customer) and delivery of the product
to the customer, provided no significant obligations remain and collection of
the resulting receivable is probable.
In 1997, the Accounting Standards Executive Committee ("AcSec") of the
American Institute of Certified Public Accountants ("AICPA") issued Statement of
Position ("SOP"), 97-2, "Software Revenue Recognition." SOP 97-2 distinguishes
between significant and insignificant vendor obligations as a basis for
recording revenue and requires that each element of a software licensing
arrangement be separately identified and accounted for based on relative fair
values of each element. We determine the fair value of each element in
multi-element transactions based on vendor-specific objective evidence ("VSOE").
VSOE for each element is based on the price charged when the same element is
sold separately.
In 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2, "Software
Revenue Recognition, With Respect to Certain Transactions," which modified SOP
97-2 to allow for use of the residual method of revenue recognition if certain
criteria are met. If evidence of fair value of all undelivered elements exists
but evidence does not exist for one or more delivered elements, then we
recognize revenue using the residual method. Under the residual method, the fair
value of the undelivered elements is deferred, and the remaining portion of the
transaction fee is recognized as revenue.
We recognize revenues from our IT services primarily on a time and
materials basis, with time at a marked-up rate and materials and other
reasonable expenses at cost, as we perform IT services. Certain IT services
contracts are fixed price contracts where we measure progress toward completion
by mutually agreed upon pre-determined milestones and recognize revenue upon
reaching those milestones. Our fixed price IT contracts typically are for a
short duration of one to three months.
We recognize revenues from call termination services at gross sales
value, with the applicable cost separately stated in cost of revenues. We
recognize revenues from sales of our own phone cards based on usage. We
recognize revenues from our resale of third-party phone cards net of returns
because no significant obligations remain once the phone cards are delivered. We
recognize revenues from products and services sold via Internet portals net of
purchase costs when the products and services are delivered and collection is
probable.
ALLOWANCE FOR ACCOUNTS RECEIVABLE
We sell to our customers on credit and grant credit to those who are
deemed credit worthy based on our analysis of their credit history. Our standard
payment terms are net 30 days. We review our accounts receivable balances and
the collectibility of these balances on a periodic basis. Based on our analysis
of the length of time that the balances have been outstanding, the pattern of
customer payments, our understanding of the general business conditions of our
17
customers and our communications with our customers, we estimate the
recoverability of these balances. When recoverability is uncertain and the
unrecoverable amounts can be reasonably estimated, we record bad debt expense
and increase the allowance for accounts receivable by an amount equal to the
amount estimated to be unrecoverable. If the historical data we use to calculate
the allowance provided for doubtful accounts does not reflect our future ability
to collect outstanding receivables, additional provisions for doubtful accounts
may be needed and our future results of operations could be materially affected.
IMPAIRMENT OF LONG-LIVED ASSETS, INCLUDING GOODWILL
We apply the provisions of SFAS No. 86, "Accounting for the Cost of
Computer Software to be Sold, Leased, or Otherwise Marketed," to software
development costs. At each balance sheet date, we compare the unamortized
software development cost of each product to the net realizable value of the
product. We write off to cost of revenues the amount by which the unamortized
software development cost exceeds the net realizable value of the product.
On April 1, 2002, we adopted the provisions of SFAS No. 142, "Goodwill
and Other Intangible Assets." SFAS No. 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead be
tested at least annually for impairment.
We consider the following operating segments- engineering and
collaborative software products and services, IT services, and Web-based
telecommunications services - to be our reporting units for purposes of testing
for impairment.
We use a two-step test to assess potential impairment to goodwill. In
the first step, the fair value of each reporting unit is compared to its
carrying value including goodwill. If the fair value exceeds the carrying value,
then goodwill is not considered impaired, and we do not need to proceed to the
second step. If the carrying value of a reporting unit exceeds its fair value,
then we have to determine and compare the implied fair value of the reporting
unit's goodwill to the carrying value of its goodwill. If the carrying value of
the reporting unit's goodwill exceeds its implied fair value, then we have to
record an impairment loss in the amount of the excess.
The implied fair value of goodwill is determined by allocating the fair
value of the reporting unit to all of the assets (recognized and unrecognized)
and liabilities of the reporting unit in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141, "Business Combinations." The
residual fair value after this allocation is the implied fair value of the
reporting unit goodwill.
We are required to perform reviews for impairment annually, or more
frequently when events occur or circumstances change that would more likely than
not reduce the fair value of the net carrying amount.
Our annual test for impairment is performed as of March 31 every year.
The evaluation of goodwill impairment involves assumptions about the fair values
of assets and liabilities of each reporting unit. If these assumptions are
materially different from actual outcomes, the carrying value of goodwill will
be incorrect. In addition, future results of operations could be materially
impacted by the write-down of the carrying amount of goodwill to its estimated
fair value. There was no goodwill impairment write-down during the three months
ended June 30, 2004. As of June 30, 2004, our goodwill balance was $3,154,000.
18
CONSOLIDATED RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2004 VERSUS
THREE MONTHS ENDED JUNE 30, 2003
CONTINUING OPERATIONS
NET REVENUES
The following table presents our net revenues by segment (dollars in
thousands):
THREE MONTHS ENDED
JUNE 30,
------------------------
NET REVENUE 2004 2003
------- -------
Engineering and collaborative $2,444 $2,722
software products and services
% of total net revenues 65.3% 64.0%
IT services $1,075 $1,207
% of total net revenues 28.7% 28.4%
Web-based telecommunications
services $ 222 $ 326
% of total net revenues 6.0% 7.6%
------- -------
Total net revenues $3,741 $4,255
======= =======
Net revenues for the three months ended June 30, 2004 decreased by
$514,000 (12.1%), compared to the three months ended June 30, 2003. Our revenues
consisted primarily of revenues from (1) engineering and collaborative software
products and services, (2) IT services, and (3) Web-based telecommunications
services.
Net revenues from engineering and collaborative software products and
services for the three months ended June 30, 2004 decreased by $278,000 (10.2%)
compared to the three months ended June 30, 2003. The decrease in net revenues
for the three months ended June 30, 2004 was primarily because $450,000 in
engineering software and support revenues recognized during the three months
ended June 30, 2003 in connection with a large domestic project did not recur
during the three months ended June 30, 2004. This decrease was partially offset
by increases in domestic net revenues from new products such as our 3-D
engineering design modeling software and advanced bridge design software as well
as increases in engineering software revenues from Europe and Asia. Net revenues
from Europe increased due to increased focus on higher margin products and
services. Net revenues from Asia increased due to an increase in infrastructure
projects requiring our engineering software, effective anti-piracy initiatives,
and training programs. Net revenues from collaborative software products and
services decreased $143,000 for the three months ended June 30, 2004 because no
new projects were completed during this period compared to the three months
ended June 30, 2003 when a large project was completed.
Historically, our engineering software sales during the second half of
a fiscal year have been higher than during the first half of a fiscal year. We
believe this trend will continue in the current fiscal year, provided our
customers' continued acceptance of our products and economic conditions occur as
anticipated.
19
The trend of decreasing IT services net revenues continued for the
three months ended June 30, 2004, compared to the same period in the prior
fiscal year. IT services net revenues decreased $132,000 (10.9%) for the three
months ended June 30, 2004, compared to the three months ended June 30, 2003.
Net revenues from IT services have decreased due to scaling back one of our
domestic IT services offices and to decreases in IT services revenues from
Europe. These decreases were offset by an increase in IT services net revenues
from India, primarily due to our acquisition of a small IT consulting company.
In the past several quarters, the IT services industry had been adversely
affected by a slow economy, and many of our customers reduced, and continue to
reduce, spending on technology consulting and systems integration services.
Although we do not anticipate significant recovery in the IT services sector, we
anticipate that our BPO efforts that began during the later part of last fiscal
year will contribute to a recovery in our IT services net revenues during fiscal
2005.
Web-based telecommunications services net revenues decreased $104,000
(31.9%) for the three months ended June 30, 2004, compared to the three months
ended June 30, 2003, primarily due to decreases in our phone card net revenues.
A decline in the volume of phone card sales as well as reductions in the prices
we charge our customers due to price competition contributed to this decrease.
We do not expect our Web-based telecommunications services net revenues to
improve significantly from current levels for the foreseeable future due to the
uncertainty in the telecommunications services industry.
Although the intense competition in the telecommunications industry and
the resulting pricing pressures should preclude improvement of net revenues from
current levels for the indefinite future, we intend to maintain the
telecommunications infrastructure to facilitate our BPO initiatives and our 24x7
technical support call centers.
GROSS PROFIT AND GROSS MARGIN
The following table presents our gross profit by segment and gross
profit as a percentage of each segment's net revenue, or gross margin (dollars
in thousands):
THREE MONTHS ENDED
JUNE 30,
----------------------------------
2004 2003
---------------- ---------------
GROSS PROFIT
Engineering and collaborative
software products and services $ 2,199 $ 2,481
IT services 319 290
Web-based telecommunications
services 89 132
---------------- ---------------
Consolidated $ 2,607 $ 2,903
================ ===============
GROSS MARGIN
Engineering and collaborative
software products and services 90.0 % 91.1 %
IT services 29.7 % 24.0 %
Web-based telecommunications
services 40.1 % 40.5 %
Consolidated 69.7 % 68.2 %
20
Gross margin in the engineering and collaborative software products and
services segment decreased by 1.1 percentage points for the three months ended
June 30, 2004, compared to the three months ended June 30, 2003, due to a
decrease in net revenues without a comparable decrease in cost of revenues,
since some of the costs are fixed and do not change with the volume of sales.
Absence of net revenues from a large project with minimal related costs also
contributed to the lower gross margin. Our engineering and collaborative
software products and services segment generally produces a higher gross margin
than our other segments due to the relatively lower costs associated with each
sale. The cost of revenues for the engineering and collaborative software
products and services segment includes printing services, direct supplies such
as hardware locks, which are security devices that are attached to the central
processing unit to prevent unauthorized access to licensed software, salaries
for the technical support employees, freight out, and software amortization
expense.
Gross margin in the IT services segment increased by 5.7 percentage
points for the three months ended June 30, 2004, compared to the three months
ended June 30, 2003. This increase was primarily the result of scaling back one
of the domestic offices as well as our acquisition of a higher margin IT
services company engaged in steel detailing services in India. Historically,
gross profit percentage from the IT services segment has been lower than gross
profit percentage from the engineering and collaborative software products and
services segment due to the higher cost of labor associated with IT services.
The cost of revenues for IT services includes the salaries, bonuses, and
benefits for the consulting employees. Our IT services consultants generally
receive higher salaries than our technical support employees.
Gross margin in the Web-based telecommunications services segment
stayed relatively flat, decreasing by 0.4 percentage points for the three months
ended June 30, 2004, compared to the three months ended June 30, 2003. The cost
of revenues for Web-based telecommunications services includes the cost of
buying minutes from another carrier. Pricing pressures in the telecommunications
industry may continue to negatively impact the gross profit from our Web-based
telecommunications services for the foreseeable future.
OPERATING EXPENSES
The following table presents our operating expenses in dollars and as a
percentage of total net revenues (dollars in thousands):
THREE MONTHS ENDED
JUNE 30,
--------------------------------
2004 2003
---------------- ---------------
OPERATING EXPENSES
Selling, general and
administrative expenses $ 2,290 $ 2,314
% of total net revenues 61.2% 54.4%
Research and development $ 415 $ 540
% of total net revenues 11.1% 12.7%
Bad debt expense $ 165 $ 11
% of total net revenues 4.4% 0.3%
Depreciation $ 244 $ 253
% of total net revenues 6.5% 5.9%
Total operating expenses $ 3,114 $ 3,118
% of total net revenues 83.2% 73.3%
21
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses remained
relatively flat, decreasing by $24,000 (1.0%) for the three months ended June
30, 2004, compared to the three months ended June 30, 2003. A $62,000 decrease
in salaries and related expenses due to terminations and a $38,000 decrease in
professional fees were partially offset by a $42,000 increase in dealer
commissions due to higher sales through dealers and a $19,000 increase in travel
expenses, contributing to the relatively flat SG&A expenses. We continue to
monitor our SG&A expenses but do not make any assurances that we will be able to
cut SG&A expenses from levels attained in the first three months of fiscal 2005.
In addition, obtaining profitability may be difficult even with reduced expenses
because some of the areas of expense cutting, such as sales and marketing and
research and development, involve activities that we ordinarily undertake with
the expectation that they will contribute to future revenues. Even if near-term
profitability can be achieved through cost-cutting, it will not be sustainable
if the effect of cost-cutting is to impede future revenue growth.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses consist primarily of software
developers' wages. R&D expenses decreased by $125,000 (23.2%) for the three
months ended June 30, 2004, compared to the three months ended June 30, 2003.
The decrease in R&D expenses is primarily related to employee terminations and a
reduction in consulting expenditures. We believe R&D expenses will remain at
current levels for the foreseeable future.
BAD DEBT EXPENSE
Bad debt expense increased by $154,000 to $165,000 for the three months
ended June 30, 2004 from $11,000 for the three months ended June 30, 2003. The
increase in bad debt expense was primarily due to one collaborative software
customer.
DEPRECIATION
Depreciation expenses (excluding amounts charged to cost of revenues)
stayed relatively flat, decreasing $9,000 (3.6%) for the three months ended June
30, 2004, compared to the three months ended June 30, 2003. As a result of our
continuing efforts to control costs, additions to capital equipment have been
minimal. We anticipate that depreciation expenses will remain at this lower
level through the end of fiscal 2005.
22
OTHER EXPENSE (INCOME)
The following table presents our other expense (income) in dollars and
as a percentage of total net revenues (dollars in thousands):
THREE MONTHS ENDED
JUNE 30,
--------------------------------
2004 2003
---------------- ---------------
OTHER EXPENSE (INCOME)
Interest, net $ 125 $ 151
% of total net revenues 3.3% 3.5%
Other (income) expense $ (33) $ -
% of total net revenues (0.9)% 0.0%
Loss on substantial modification
of debt $ 133 $ -
% of total net revenues 3.6% 0.0%
Total other expense $ 225 $ 151
% of total net revenues 6.0% 3.5%
INTEREST EXPENSE
Net interest decreased by $26,000 (1.0%) for the three months ended
June 30, 2004 compared to the three months ended June 30, 2003. The decrease in
net interest expense was primarily due to a reduction in interest rate on the
convertible debt to 5% from 6% in July 2003, pursuant to the amendment to our
2002 Note with Laurus. Interest expense in the upcoming quarters may decrease if
additional portions of debt outstanding under the 2002 Note and Amended 2003
Note are converted into equity or may increase if we borrow additional amounts.
OTHER (INCOME) EXPENSE
Other income increased by $33,000 for the three months ended June 30,
2004, compared to the three months ended June 30, 2003 primarily due to the sale
of certain assets that were previously written off.
LOSS ON SUBSTANTIAL MODIFICATION OF DEBT
In April 2004, we amended our 2003 Note and borrowed an additional
$1,000,000 under the Amended 2003 Note (see note 7 "Long-term Debt" to the
condensed consolidated financial statements). We recorded this transaction as a
substantial modification of debt. We wrote off approximately $133,000 in
unamortized discount on the original 2003 Note as a loss on substantial
modification of debt pursuant to EITF 96-19. There was no similar transaction
for the three months ended June 30, 2003.
INCOME TAXES
We recorded an income tax expense of $6,000 for the three months ended
June 30, 2004 compared to $37,000 during the same period in the prior fiscal
year. Tax expense for the three months ended June 30, 2004 resulted from
provisions for domestic income taxes.
23
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have relied upon cash from financing activities to
fund most of the cash requirements of our operating and investing activities.
Currently, we finance our operations (including capital expenditures) primarily
through existing cash and cash equivalent balances and borrowings under our
credit facilities. We have used debt and equity financing when appropriate and
practicable.
Our principal sources of liquidity at June 30, 2004 consisted of
$2,341,000 of cash and cash equivalents and a revolving credit facility
described below. Cash and cash equivalents increased by $695,000 (42.2%) during
the three months ended June 30, 2004. The primary reason for this increase was
the additional borrowing from Laurus, which was partially offset by cash used in
operations. During the three months ended June 30, 2004, our consolidated
average monthly net cash outflow from operations was approximately $63,000,
compared to approximately $102,000 per month during the three months ended June
30, 2003.
Net cash used in operations was $189,000 during three months ended June
30, 2004 compared to $306,000 during the three months ended June 30, 2003, a
decrease of $117,000. Net loss was the primary reason for cash used in
operations in both periods. The following primarily contributed to cash usage
during the three months ended June 30, 2004:
o A $176,000 decrease in accrued expenses primarily due to
payment of severance payments and professional fees;
o A $76,000 decrease in accounts payable due to payments; and
o A $73,000 increase in prepaid expenses and other current
assets due to prepayment of rent and product packaging
materials.
The above were partially offset by $155,000 in proceeds from the sale of our
travel subsidiary and a $62,000 increase in deferred revenues primarily from
collaborative software services.
The following contributed to cash usage during the three months ended
June 30, 2003:
o A $405,000 decrease in accrued expenses due to payment of a
legal settlement and professional fees;
o A $232,000 decrease in deferred revenues due to a lower level
of unrecognized revenues;
o A $188,000 decrease in accrued restructuring costs due to
payments; and
o A $120,000 increase in prepaid expenses and other current
assets primarily due to prepaid digital media costs.
The above were offset by a $591,000 decrease in deposits due to payment
of a legal settlement and a $220,000 decrease in accounts receivable due to
better collections of receivables.
Although we anticipate our cash needs will increase in the upcoming
quarters as a result of increases in expenses related to our BPO services, we
believe this increase will be more than offset by revenues we anticipate earning
from such services. However, the combined effect of such transactions may not
result in net cash provided by operations, if actual level of expenses and
revenues from our BPO services differ from anticipated levels due to
unanticipated increases in labor costs or decreased demand, competition, or
other factors.
24
Net cash used in investing activities during the three months ended
June 30, 2004 consisted of capital expenditures of $98,000 and payment to
acquire companies of $24,000, compared to $12,000 of capital expenditures during
the three months ended June 30, 2003. We expect our capital expenditures to stay
at the current level for the next twelve months.
Cash provided by financing activities during the three months ended
June 30, 2004 primarily resulted from long-term borrowings of $1,703,000
(including $990,000 in additional borrowings, net of fees, under the Amended
2003 Note) offset by $781,000 in long-term debt repayments. In addition,
repayments of capital lease obligations amounted to $32,000 for the three months
ended June 30, 2004. Proceeds from long-term borrowings during the three months
ended June 30, 2003 were $43,000. Additionally, we repaid $310,000 of long-term
debt and $111,000 in capital lease obligations during the three months ended
June 30, 2003.
We incurred net losses from continuing operations of $738,000 and
$403,000 and used cash in operations of $189,000 and $306,000 during the three
months ended June 30, 2004 and 2003, respectively. Our future capital
requirements will depend upon many factors, including sales and marketing
efforts, the development of new products and services, possible future strategic
acquisitions, the progress of research and development efforts, and the status
of competitive products and services.
The following table summarizes our contractual obligations and
commercial commitments at June 30, 2004 (in thousands of dollars):
-------------------------------------------------------------------------------
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------------
LESS THAN AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
- ----------------------- ----- ------ --------- --------- -----
Long-Term Debt* 2,916 968 1,936 9 3
Capital Lease Obligations 523 120 264 139 -
Operating Leases 3,829 499 872 733 1,725
--------------------------------------------------------------------------
Total Contractual Cash Obligations 7,268 1,587 3,072 881 1,728
==========================================================================
OTHER COMMERCIAL COMMITMENTS TOTAL AMOUNTS LESS THAN
COMMITTED 1 YEAR 1-3 YEARS 4-5 YEARS OVER 5 YEARS
--------- ------ --------- --------- ------------
Letter of Credit $ 100 100 - - -
--------------------------------------------------------------------------
Total Commercial Commitments $ 100 100 - - -
==========================================================================
* Excludes debt discount of $340.
As indicated above, historically we have relied upon cash from
financing activities to fund most of the cash requirements of our operating and
investing activities. We have not been able to generate sufficient cash from our
operating activities in the past, and there is no assurance we will be able to
do so in the future. However, we believe that current and future available
capital resources, including amounts available under the revolving credit
facility from Laurus, will be adequate to fund our operations for the next
twelve months, because we are continuing to implement cost containment measures
25
in an effort to reduce net cash outflow both domestically and abroad and are
working to increase sales of our software products and to develop our BPO
services. The results of these combined efforts have reduced our consolidated
monthly net cash outflow from operations to approximately $63,000 per month
during the three months ended June 30, 2004 from $102,000 per month during the
three months ended June 30, 2004. We expect this level of cash outflow to
continue for the next twelve months.
On July 31, 2003, we obtained $4,000,000 revolving credit facility from
Laurus. The availability of funds under this credit facility is limited by the
amount of the unpaid balances on the 2002 Note and the Amended 2003 Note
(collectively, the "Laurus Notes"). At June 30, 2004, we had no borrowings under
the revolving credit facility, $2,190,000 in principal balance, excluding fees
and beneficial conversion adjustments, under the 2002 Note and the Amended 2003
Note, and availability of $1,810,000.
We are required to use the net proceeds from this financing for general
corporate purposes only. We are also required not to permit for any fiscal
quarter commencing April 1, 2003, the net operating cash flow deficit to be
greater than $500,000, excluding extraordinary items, as determined by Laurus.
We were in compliance with such covenant as of June 30, 2004.
We believe we will be able to generate sufficient cash from operations
or through additional sources of debt and equity financing, including
availability under the revolving credit facility. If adequate funds from
operating or financing activities are not available, we may be required to
delay, scale back or eliminate portions of our operations and product
development efforts or to obtain funds through arrangements with strategic
partners or others that may require us to relinquish rights to certain of our
technologies or potential products or other assets. Accordingly, our inability
to generate sufficient cash from operations or obtain any needed financing could
result in a significant loss of ownership and/or control of our proprietary
technology and other important assets and could hinder our ability to fund our
continued operations and our product development efforts that historically have
contributed significantly to our competitiveness.
We believe that our current cash and cash equivalents balances, along
with the availability under the revolving credit facility mentioned above, will
be sufficient to meet our working capital needs at currently anticipated levels
for the next twelve months. We have implemented, and will continue to implement,
cost containment measures to maintain adequate capital reserves. However, if we
are unable to execute our operational plan for the next twelve months, we may be
required to raise additional funds through public or private equity or debt
financing. We cannot be certain that additional financing will be available, if
needed, or, if available, will be on terms favorable to us. In addition, any
future financing may cause significant dilution to existing stockholders. Any
debt financing or other financing of securities senior to our common stock
likely will include financial and other covenants that may restrict our
flexibility. At a minimum, we expect these covenants to include restrictions on
our ability to pay dividends on our common stock.
We may borrow additional amounts under the revolving credit facility
from time to time, which would increase the principal balance that could
potentially be converted into shares of our common stock in the future. As a
result, if the entire principal balances of the Laurus Notes and/or any
additional amounts we may borrow under the revolving credit facility were
converted at their initial fixed conversion prices, substantial dilution of the
voting power of our stockholders' investments and of our earnings per share
would occur.
26
ITEM 3. CONTROLS AND PROCEDURES.
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of June 30, 2004, that the design and operation of
our "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended ("Exchange Act")) are effective to
ensure that information required to be disclosed by us in the reports filed or
submitted by us under the Exchange Act is accumulated, recorded, processed,
summarized and reported to our management, including our Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
whether or not disclosure is required.
During the quarter ended June 30, 2004, there were no changes in our
"internal controls over financial reporting" (as defined in Rule 13a-15(f) under
the Exchange Act) that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting.
27
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY
SECURITIES
On April 27, 2004, we borrowed an additional $1,000,000 from Laurus and
issued the Amended 2003 Note in replacement of the 2003 Note, bringing the total
outstanding principal balance under the Amended 2003 Note to $2,400,000, of
which we repaid $30,000 in cash and converted $260,000 into common stock as
described below. If not converted into common stock, we are required to pay
monthly principal payments of $50,000 plus accrued interest, in arrears,
beginning August 1, 2004 until December 1, 2006, when we are required to pay the
entire remaining principal balance along with accrued interest. Borrowings under
the Amended 2003 Note accrue interest at an annual rate equal to the greater of
5% or the prime rate plus 1%. The credit facility with Laurus prohibits us from
paying any dividends on our common stock without Laurus' permission. We are
required to use the net proceeds from this financing for general corporate
purposes only. We are also required not to permit for any fiscal quarter
commencing April 1, 2003, the net operating cash flow deficit to be greater than
$500,000, excluding extraordinary items, as determined by Laurus. At June 30,
2004, we were in compliance with this covenant.
During the quarter ended June 30, 2004, we converted $650,000 of
outstanding indebtedness under the 2002 Note and $260,000 of outstanding
indebtedness under the 2003 Note into shares of common stock. As a result, we
issued to Laurus 700,000 shares of common stock at the fixed conversion price of
$1.30 per share.
Exemption from the registration provisions of the Securities Act of
1933 for the transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transactions did
not involve any public offering and the purchaser was accredited and had access
to the kind of information registration would provide. Appropriate investment
representations were obtained, and the securities were issued with restricted
securities legends.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended June 30, 2004, no matters were submitted to a
vote of our common stockholders.
ITEM 5. OTHER INFORMATION
None.
28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
--------
10.1 Amended and Restated Convertible Note dated December 4, 2003
in the principal amount of $2,400,000 made by netGuru, Inc. in
favor of Laurus Master Fund, Ltd. (1)
31 Certifications required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (2)
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2)
- ----------
(1) Filed as an exhibit to our Form 8-K that was filed with the Securities
and Exchange Commission on June 3, 2004 (File No. 000-28560) and
incorporated herein by reference
(2) Attached as an exhibit to this Form 10-QSB
(b) Reports on Form 8-K
On April 28, 2004, we filed a Form 8-K for April 16, 2004
that contained Item 5-Other Events and Item 7-Financial
Statements, Pro Forma Financial Information and Exhibits.
The Form 8-K contained a press release announcing the
completion of the sale of our travel subsidiary,
eDestinations, Inc.
On June 3, 2004, we filed a Form 8-K for April 27, 2004
that contained Item 5-Other Events and Item 7-Financial
Statements, Pro Forma Financial Information and Exhibits.
The Form 8-K contained information on the amendment and
restatement of our convertible note issued to Laurus Master
Fund on December 4, 2003.
29
SIGNATURES
----------
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: August 23, 2004
NETGURU, INC.
By: /s/ BRUCE K. NELSON_
-------------------
Bruce K. Nelson
Chief Financial Officer (principal
financial officer and duly
authorized officer)
30
EXHIBITS FILED WITH THIS QUARTERLY REPORT ON FORM 10-QSB
Exh. No. Description
-------- -----------
31 Certifications required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
31