UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1 TO
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 DECEMBER 31, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission file number: 0-28560
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 registrant (1) has 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,
$.01 par value, was 19,117,154 on April 19, 2005.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
EXPLANATORY NOTE
----------------
netGuru, Inc. (the "Company") is filing this Amendment No. 1 to Form
10-QSB for the quarter ended December 31, 2004 to reflect the restatement of its
condensed consolidated financial statements for the three and nine months
December 31, 2004. The restatement arises from an interpretation of accounting
for modification of convertible debt. Specifically, in its original filing for
the quarter ended June 30, 2004, the Company had recorded the amendment to one
of its convertible secured notes as a substantial modification of debt and,
therefore, wrote off the $133,000 unamortized debt discount rather than
continuing to amortize this amount over the remaining term of the debt. Upon
further interpretation of Emerging Issues Task Force ("EITF") No. 96-19,
"Debtor's Accounting for a Modification or Exchange of Debt Instruments," the
Company determined the modification was not substantial. Refer to Note 15 for a
description and quantification of the restatement.
The information in this Amendment No. 1 to Form 10-QSB has not been
updated from the original filing of the Form 10-QSB except as required to
reflect the effects of the restatement. The restatement includes changes to Part
I Items 1 and 2. Items included in the original Form 10-QSB that are not
included herein are not amended and remain in effect as of the date of the
original filing. Additionally, this Amendment No. 1 to Form 10-QSB does not
purport to provide an update or a discussion of any other developments at the
Company subsequent to the original filing.
PART I
FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the Three and
Nine Months Ended December 31, 2004 and 2003 (unaudited) ........................ 3
Condensed Consolidated Balance Sheets as of
December 31, 2004 (unaudited) and March 31, 2004................................. 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended December 31, 2004 and 2003 (unaudited)......................... 5
Notes to Condensed Consolidated Financial Statements ............................ 7
Item 2. Management's Discussion and Analysis or Plan of Operation.......................... 21
PART II
OTHER INFORMATION
Item 6. Exhibits .......................................................................... 35
Signatures.................................................................................. 36
Exhibits Filed with this Amendment No. 1 to Quarterly Report on Form 10-QSB................. 37
3
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 THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2004 2003 2004 2003
(RESTATED) (RESTATED)
-------------- -------------- -------------- --------------
Net revenues:
Engineering and collaborative software
products and services $ 2,704 $ 2,664 $ 7,981 $ 8,060
IT services 1,016 1,218 3,162 3,721
-------------- -------------- -------------- --------------
Total net revenues 3,720 3,882 11,143 11,781
Cost of revenues:
Engineering and collaborative software
products and services 145 246 577 710
IT services 684 969 2,128 2,934
-------------- -------------- -------------- --------------
Total cost of revenues 829 1,215 2,705 3,644
-------------- -------------- -------------- --------------
Gross profit 2,891 2,667 8,438 8,137
-------------- -------------- -------------- --------------
Operating expenses:
Selling, general and administrative 2,353 3,139 6,972 7,889
Research and development 390 538 1,216 1,580
Bad debt expense 4 15 169 49
Depreciation 244 231 720 715
-------------- -------------- -------------- --------------
Total operating expenses 2,991 3,923 9,077 10,233
-------------- -------------- -------------- --------------
Operating loss (100) (1,256) (639) (2,096)
-------------- -------------- -------------- --------------
Other expense (income):
Interest, net (Note 7A) 123 246 376 529
Other (4) (26) (61) (109)
Loss on substantial modification of debt -- -- --
-------------- -------------- -------------- --------------
Total other expense 119 220 315 420
-------------- -------------- -------------- --------------
Loss from continuing operations before
income taxes (219) (1,476) (954) (2,516)
Income tax expense 16 53 38 165
-------------- -------------- -------------- --------------
Loss from continuing operations (235) (1,529) (992) (2,681)
(Loss) gain from discontinued operations
(Note 14) -- (489) 67 (507)
-------------- -------------- -------------- --------------
Net loss $ (235) $ (2,018) $ (925) $ (3,188)
============== ============== ============== ==============
Basic and diluted loss per common share:
Loss per common share from continuing
operations $ (0.01) $ (0.09) $ (0.05) $ (0.15)
(Loss) gain from discontinued
operations -- (0.02) -- (0.02)
-------------- -------------- -------------- --------------
Basic and diluted net loss per common
share $ (0.01) $ (0.11) $ (0.05) $ (0.13)
============== ============== ============== ==============
Common shares used in computing basic and
diluted net loss per common share 18,865,523 17,701,176 18,775,554 17,456,417
============== ============== ============== ==============
See accompanying notes to condensed consolidated financial statements.
4
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
DECEMBER 31, MARCH 31,
2004 2004
(UNAUDITED)
(RESTATED)
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,942 $ 1,646
Short-term investment -- 100
Accounts receivable (net of allowance for doubtful accounts of $700 and
$615, as of December 31, 2004 and March 31, 2004, respectively) 3,915 3,340
Income tax receivable 2 16
Notes and related party loans receivable 29 35
Deposits 97 67
Prepaid expenses and other current assets 1,331 1,174
Assets of subsidiary held for sale -- 327
-------------- --------------
Total current assets 8,316 6,705
Property, plant and equipment, net 1,865 2,215
Goodwill (net of accumulated amortization of $3,652) 3,116 2,892
Other assets 189 218
-------------- --------------
$ 13,486 $ 12,030
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt, net of discount of $239 and $186,
as of December 31, 2004 and March 31, 2004, respectively $ 1,123 $ 975
Current portion of capital lease obligations 141 109
Accounts payable 436 600
Accrued expenses 1,045 1,160
Income taxes payable 25 55
Deferred revenues 2,228 1,834
Other liabilities 263 208
Liabilities of subsidiary held for sale -- 186
-------------- --------------
Total current liabilities 5,261 5,127
Long-term debt, net of current portion and net of discount of $269 and $185,
as of December 31, 2004 and March 31, 2004, respectively 1,936 1,382
Capital lease obligations, net of current portion 381 368
Deferred gain on sale-leaseback 695 747
-------------- --------------
Total liabilities 8,273 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; 19,117,154
and 18,087,154 shares issued and outstanding as of December 31, 2004
and March 31, 2004, respectively) 191 181
Additional paid-in capital 36,887 35,352
Accumulated deficit (31,369) (30,444)
Accumulated other comprehensive loss:
Cumulative foreign currency translation adjustments (496) (683)
-------------- --------------
Total stockholders' equity 5,213 4,406
-------------- --------------
$ 13,486 $ 12,030
============== ==============
See accompanying notes to condensed consolidated financial statements.
5
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
NINE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
2004 2003
(RESTATED)
-------------- --------------
Cash flows from operating activities:
Net loss $ (925) $ (3,188)
Income (loss) from discontinued operations 67 (507)
-------------- --------------
Loss from continuing operations (992) (2,681)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 795 932
Bad debt expense 169 50
Amortization of discount on loan 157 --
Expense recognized on issuance of warrants and common stock 68 212
Expense recognized on issuance of stock-based compensation -- 410
Loss on disposal of property 19 --
Changes in operating assets and liabilities:
Accounts receivable (695) (287)
Notes and related party loans receivable 6 51
Income tax receivable 15 (7)
Prepaid expenses and other current assets (247) (166)
Deposits (29) 587
Other assets (25) (8)
Accounts payable (168) (122)
Accrued expenses (153) 15
Income taxes payable (34) 116
Accrued restructuring costs -- (199)
Other liabilities 41 (2)
Deferred revenues 370 (199)
Deferred gain on sale-leaseback (52) (52)
-------------- --------------
Net cash used in operating activities (755) (1,350)
-------------- --------------
Cash flows from investing activities:
Purchase of property, plant and equipment (286) (78)
Proceeds from sale of property, plant, and equipment 37 150
Sale of short term investments 100 --
Payments to acquire companies, net of cash acquired (58) --
Proceeds from sale of division 271 --
-------------- --------------
Net cash provided by investing activities 64 72
-------------- --------------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 3,627 2,101
Financing fees (21) --
Repayment of long-term debt (1,730) (1,371)
Repayment of capital lease obligations (98) (182)
Issuance of common stock upon exercise of warrant 100 --
-------------- --------------
Net cash provided by financing activities 1,878 548
-------------- --------------
Effect of exchange rate changes on cash and cash equivalents 235 163
-------------- --------------
Net cash provided by (used in) continuing operations 1,422 (567)
Net cash used in discontinued operations (126) (538)
Cash and cash equivalents, beginning of period 1,646 2,772
-------------- --------------
Cash and cash equivalents, end of period $ 2,942 $ 1,667
============== ==============
(Continued)
6
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(In thousands)
NINE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
2004 2003
(RESTATED)
-------------- --------------
Supplemental disclosure of cash flow information: Cash paid for:
Interest $ 267 $ 262
============== ==============
Income taxes $ 75 $ 53
============== ==============
Supplemental disclosure of non-cash investing and financing activities:
Acquisition of equipment under capital leases $ 119 $ --
Repayment of convertible debt with common stock $ 1,209 $ 715
Issuance of warrants $ 103 $ --
Acquisition of a company:
Net assets acquired $ 54 $ --
Net liabilities assumed $ 29 $ --
Promissory Note issued toward consideration, net of discount $ 135 $ --
Common stock issuable toward consideration $ 41 $ --
See accompanying notes to condensed consolidated financial statements.
7
NETGURU, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 December 31,
2004, the results of operations for the three and nine months ended December 31,
2004 and 2003, and the cash flows for the nine months ended December 31, 2004
and 2003, pursuant to the rules and regulations of the Securities and Exchange
Commission (the "SEC"). 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 and nine months ended December 31, 2004 are not
necessarily indicative of the results to be expected for the full fiscal year
ending March 31, 2005.
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 December 31, 2004, 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 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 December 31, 2004, excluding capital leases,
determined by using the effective rate of interest on this indebtedness, was
approximately $3,567,000.
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
over different periods. The Company adopted this consensus on July 1, 2003.
8
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 affect 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 affect
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 affect the Company's consolidated
financial condition or results of operations.
EXCHANGES OF NONMONETARY ASSETS
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets," an Amendment of Accounting Principles Board ("APB") Opinion
No. 29, "Accounting for Nonmonetary Transactions." SFAS No. 153 requires
companies to measure exchanges of nommonetary assets, including similar
productive assets that have commercial substance, based on the fair value of the
assets exchanged, recognizing a gain or loss. SFAS No. 153 is effective for
interim periods beginning after June 15, 2005 and, thus, will be effective for
the Company beginning with the third quarter of fiscal 2006. Early adoption is
encouraged but not required. The Company believes that adoption of SFAS No. 153
will not have a material effect on its consolidated financial condition or
results of operations.
SHARE-BASED PAYMENTS
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based
Payment: an Amendment of FASB Statements No. 123 and 95." SFAS No. 123(R)
requires companies to measure and recognize compensation expense for all
stock-based payments at fair value. For small businesses, SFAS No. 123(R) is
effective for the fiscal years beginning after December 15, 2005 and, thus,
will be effective for the Company beginning with the first quarter of fiscal
2007. Early adoption is encouraged and retroactive application of the provisions
of SFAS No. 123(R) to the beginning of the fiscal year that includes the
effective date is permitted, but not required. The Company is currently
evaluating the effect of adopting SFAS No. 123(R) and believes the adoption of
SFAS No. 123(R) will have a material effect on its consolidated results of
operations, similar to the pro forma results described in Note 8 "Stockholders'
Equity" of the Notes to Condensed Consolidated Financial Statements, but has not
yet determined whether the adoption of SFAS No. 123(R) will have a material
effect on its consolidated financial condition.
9
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 December 31,
2004, capitalized software costs of approximately $54,000 were included in other
assets, all of which represents software developed in-house. Additions to
capitalized software were $54,000 and $0 during the nine months ended December
31, 2004 and 2003, respectively.
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 $0 and $69,000 for the three months ended December
31, 2004 and 2003, respectively, and $69,000 and $208,000 for the nine months
ended December 31, 2004 and 2003, respectively. Accumulated amortization on
capitalized software was $1,005,000 and $848,000 as of December 31, 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, and IT services.
Revenue from software sales is recognized upon shipment if no
significant post-contract support obligations remain outstanding and collection
of the resulting receivable is deemed probable. Since July 1, 2002, the Company
has provided at the time of sale a 15-day right of return on the purchase of a
product during which time the customer may return the product subject to a $50
restocking fee per item returned. 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.
10
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 six months. The Company did not have any fixed price
contracts at December 31, 2004.
During September 2004, the Company sold its Web-based
telecommunications services division and therefore, the results of the
operations of this division are excluded from continuing operations and are
reported under "Discontinued Operations." Of the total sale price of $130,000,
the Company has received $100,000 in cash as of December 31, 2004 with the
balance to be received in consecutive monthly installments through April 15,
2005 (Note 14).
6. DEFERRED REVENUES
The Company defers revenues for its maintenance contracts and for its
collaborative software sales 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.
7. LONG-TERM DEBT
2002 NOTE
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 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 was amended from 6% to the greater of 5% or the 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
11
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 of the
2002 Note into 500,000 shares of the Company's common stock. In December 2004,
Laurus converted the remaining balance of $80,000 into 61,538 shares of the
Company's common stock. At December 31, 2004, the Company had no principal
balance outstanding under the 2002 Note.
REVOLVING CREDIT FACILITY
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 Amended and Restated 2003 Note (defined below) and
the 2004 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%. Since 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. The interest rate was adjusted up to 6.25% during the
quarter ended December 31, 2004 as a result of five increases of 25 basis points
each in the prime rate from 4% to 5.25% during the nine months ended December
31, 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. 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.
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 ranging from $1.50 to $1.89 per share. Laurus may
also receive additional five-year warrants to purchase up to 400,000 shares of
the Company's 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 December 31, 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 December 31,
2004, the Company had no borrowings under the Facility.
2003 NOTE
The interest rate on the 2003 Note was equal to the greater of 5% or
the prime rate plus 1%. The 2003 Note was to mature 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 were based, was $1.30. In
April 2004, the 2003 Note was amended and restated ("Amended and Restated 2003
Note") to include $1,000,000 in additional borrowings. The Amended and Restated
12
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
approximately $173,000 as additional discount to the Amended and Restated 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. This additional discount, along
with approximately $133,000 in unamortized discount remaining at the time of the
amendment for a total discount of $306,000, is being amortized to interest
expense over the remainder of the term of the Amended and Restated 2003 Note. In
April 2004 and December 2004, Laurus converted $260,000 and $219,000 of the
principal balance under the Amended and Restated 2003 Note into 200,000 and
168,462 shares of the Company's common stock, respectively. At December 31,
2004, the Company had an outstanding balance of $1,641,000, excluding
unamortized fees and unamortized beneficial conversion adjustments, under the
Amended and Restated 2003 Note.
The Amended and Restated 2003 Note is 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 Amended and Restated 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 December 31, 2004, the Company was in compliance with this covenant.
13
2004 NOTE
On December 23, 2004 ("Closing Date"), the Company entered into a
Securities Purchase Agreement ("2004 Agreement") with Laurus. Pursuant to the
2004 Agreement, the Company sold to Laurus a secured convertible note in the
original principal amount of $1,000,000 ("2004 Note") that is scheduled to
mature on December 23, 2007 ("Maturity Date"). The Company paid Laurus Capital
Management, LLC, an affiliate of Laurus, a $5,000 fee, and reimbursed Laurus for
$5,000 of expenses in connection with the offering. The net proceeds from the
sale of the 2004 Note are being used for working capital. In connection with the
2004 Note, we issued to Laurus a warrant to purchase up to 130,000 shares of the
Company's common stock at any time or from time to time on or before December
23, 2009 at an exercise price of $1.56 per share ("2004 Warrant"). On December
31, 2004, the outstanding principal balance of the 2004 Note was $1,000,000.
The 2004 Note bears an annual interest rate equal to the greater of 5%
or prime rate plus 1% based on a 360-day year, and requires monthly interest
payments in arrears on the first business day of each month beginning February
1, 2005 through the Maturity Date. The interest rate may be adjusted downward
(but not below 0%) following effective registration of the shares underlying the
2004 Note with the SEC if certain increases occur in the closing price of the
Company's common stock. The 2004 Note requires monthly principal repayments of
$30,000 along with any related accrued but unpaid interest (together the
"Monthly Payment") beginning July 1, 2005 and through the Maturity Date. The
remaining balance of principal including any accrued and unpaid interest is due
on the Maturity Date. The Monthly Payment must be paid through conversion into
shares of the Company's common stock at the initial fixed conversion price of
$1.29 per share (subject to anti-dilution adjustments in connection with
mergers, acquisitions, stock splits, dividends and the like, and in connection
with future issuances of the Company's common stock at prices per share below
the then-applicable conversion price) if the following conversion criteria are
met:
(1) the shares are registered with the SEC for public
resale;
(2) the average closing price of the Company's common
stock for the 5 trading days preceding a repayment
date is at least 110% of the fixed conversion price;
and
(3) the amount of such conversion does not exceed 25% of
the aggregate dollar trading volume of the Company's
common stock for the 30-day trading period
immediately preceding the applicable repayment date.
Any amount of Monthly Payment that cannot be converted into common
stock due to failure to meet the conversion criteria must be paid in cash at a
rate of 102% of the monthly principal amount. Laurus may convert at the fixed
conversion price amounts due under the 2004 Note if the underlying shares are
registered for resale or an exemption from registration is available and no
event of default under the 2004 Note remains uncured or remains unwaived by
Laurus.
The Company may also prepay the amount of the 2004 Note in cash by
paying 104% of the principal balance together with any accrued but unpaid
interest.
In the event of a default and continuation of a default, Laurus may
accelerate the payment of the principal balance requiring us to pay 115% of the
entire principal balance of the 2004 Note outstanding on that date. In the event
of a default and continuation of default, the interest rate will increase by 5%
per annum on the unpaid principal balance until the default is cured or waived.
14
Events of default that would give rise to automatic acceleration of payment of
the principal balance and an increase in annual interest rate on unpaid
principal balance include:
o A failure to pay principal, interest or fees;
o Breach of covenant, representations and warranties;
o A receiver or trustee for the Company is appointed;
o Any judgment against the Company or any of its assets
in excess of $250,000 remains unvacated, umbonded or
unstayed for ninety days;
o Bankruptcy, insolvency, liquidation or reorganization
proceedings against the Company are not resolved
within 30 days;
o Trading stop in the Company's common stock is in
effect for more than five days;
o Failure to deliver the Company's common stock or
replacement note;
o Occurrence of default or continuation of default in
related or other agreements with Laurus; and
o Change in control of ownership of the Company.
As security for payment of the 2004 Note, the Company granted to Laurus
a continuing general security interest in the Company's assets.
The registration obligations require, among other things, that the
Company cause a registration statement to be filed with the SEC by March 11,
2005 and declared effective no later than May 22, 2005. If the Company is unable
to meet these obligations or is unable to maintain the effectiveness of the
registration in accordance with the requirements of the Registration Rights
Agreement, then the Company will be required to pay to Laurus monthly liquidated
damages equal to 1% of the original principal amount of the 2004 Note.
With the exception of previously disclosed issuances of stock and the
exception of stock options granted to employees and directors, the Company is
prohibited from issuing any securities with a continuously variable/floating
conversion feature that could become free-trading prior to the full repayment or
conversion of the 2004 Note together with all related accrued and unpaid
interest and fees.
The five-year 2004 Warrant permits Laurus to purchase up to 130,000
shares of common stock, at any time or from time to time, at the exercise price
of $1.56 per share. The exercise price and the number of shares underlying the
2004 Warrant are fixed but are subject to anti-dilution adjustments in
connection with mergers, acquisitions, stock splits, dividends and the like.
Laurus has contractually agreed to two separate beneficial ownership
limitations that restrict conversion of the 2004 Note and the exercise of the
2004 Warrant. Laurus has agreed that the 2004 Note shall not be converted and
the 2004 Warrant shall not be exercised to the extent such conversion would
result in Laurus, together with its affiliates, beneficially owning in excess of
4.99% of the number of shares of the Company's common stock outstanding at that
time. Laurus may cause this 4.99% limitation to expire by providing the Company
with 75 days' advance notice of its intention to do so. This 4.99% limitation
does not preclude conversion of the 2004 Note or exercise of the 2004 Warrant
over time, so long as Laurus' beneficial ownership of the Company's common
stock, together with its affiliates, does not exceed the limitation amount. This
4.99% limitation automatically becomes void upon an event of default under the
2004 Note.
The Company recorded a debt discount as a result of the issuance of
the 2004 Warrant of approximately $103,000 and a debt discount as a result of
$10,000 in fees paid to Laurus and its affiliate. The total debt discount of
$113,000 will be charged to interest expense, ratably, over the term of the 2004
Note.
15
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.
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss - as reported $ (235) $(2,018) $ (925) $(3,188)
Deduct: Stock-based compensation
expense determined under the fair
value based method for all awards,
net of tax (68) (92) (204) (276)
======== ======== ======== ========
Net loss - pro forma $ (303) $(2,110) $(1,129) $(3,464)
======== ======== ======== ========
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Basic and diluted net loss per share -
As reported $ (0.01) $ (0.11) $ (0.05) $ (0.18)
Pro forma $ (0.02) $ (0.12) $ (0.06) $ (0.20)
Weighted average fair value of
options granted $ -- 1.44 $ 1.45 1.37
NINE MONTHS ENDED
DECEMBER 31,
-----------------------
2004 2003
-------- --------
Black-Scholes option pricing model
Assumptions:
Dividend yield - -
Expected volatility 83.9% 115.7%
Risk-free interest rate 3.81% 3.51%
Expected option lives (in years) 6.85 6.84
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 statements of stockholders'
equity. Gains and losses resulting from foreign currency transactions are
included in operations and were not material to the first nine months of fiscal
2005 and 2004.
16
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 $59,000 and $1,954,000 for the three months ended December 2004 and
2003, respectively, and was $738,000 and $3,048,000 for the nine months ended
December 31, 2004 and 2003, respectively.
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Numerator:
Net loss and numerator for basic and
diluted loss per share (235) (2,018) (925) (3,188)
======== ======== ======== ========
Denominator:
Denominator for basic net loss per share-
average number of common shares 18,866 17,701 18,776 17,456
outstanding during the period
Incremental common shares attributable to
exercise of outstanding options,
warrants and other common
stock equivalents -- -- -- --
-------- -------- -------- --------
Denominator for diluted net loss per
share 18,866 17,701 18,776 17,456
======== ======== ======== ========
Basic and diluted net loss per share $ (0.01) $ (0.11) $ (0.04) $ (0.18)
======== ======== ======== ========
Options, warrants and other common stock equivalents amounting to
1,377,000 and 1,360,000 potential common shares for the three and nine month
periods ended December 31, 2004, respectively (including potential common shares
from the possible conversion of the convertible notes issued to Laurus amounting
to 1,329,000 and 1,285,000 for the same periods, respectively), and 1,540,000
and 1,133,000 potential common shares for the three and nine month periods ended
December 31, 2003, respectively (including potential common shares from the
possible conversion of the convertible notes issued to Laurus amounting to
1,520,000 and 1,110,000 for the same periods, respectively), were excluded from
the computation of diluted EPS for the periods presented because the Company
reported net losses and, therefore, the effect would be antidilutive.
12. SEGMENT AND GEOGRAPHIC DATA
The Company is an integrated Internet and IT technology and services
company. Prior to December 31, 2003, the Company reported the results of its
travel subsidiary, e-Destinations, and its Web-based telecommunications services
division in a separate segment called the "Web-based travel and
telecommunications services" segment. In its continuing efforts to focus on its
core software products and IT services businesses, the Company sold
e-Destinations in April 2004.
17
During the quarter ended March 31, 2004, the Company reported the
results of its telecommunications services division in a separate segment called
Web-based telecommunications services. During the quarter ended September 30,
2004, the Company sold its telecommunications services division (see
"Discontinued Operations"). Therefore, beginning with the quarter ended
September 30, 2004, the Company operates in two segments - (1) engineering and
collaborative software products and services and (2) IT services.
The Company's management reports unallocable expenses related to the
Company's corporate activities in a separate "Center." Prior period presentation
has been revised to provide comparable information.
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.
The significant components of worldwide operations by reportable
operating segments are:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------- -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
NET REVENUE
Engineering and collaborative
software products and services $ 2,704 $ 2,664 $ 7,981 $ 8,060
IT services 1,016 1,218 3,162 3,721
Center -- -- -- --
--------- --------- --------- ---------
Consolidated $ 3,720 $ 3,882 $ 11,143 $ 11,781
========= ========= ========= =========
GROSS PROFIT
Engineering and collaborative
software products and services $ 2,559 $ 2,418 $ 7,404 $ 7,350
IT services 332 249 1,034 787
Center -- -- -- --
--------- --------- --------- ---------
Consolidated $ 2,891 $ 2,667 $ 8,438 $ 8,137
========= ========= ========= =========
OPERATING (LOSS)/INCOME
Engineering and collaborative
software products and services $ 291 $ (901) $ 534 $ (1,129)
IT services (32) (54) 76 (144)
Center (359) (301) (1,249) (824)
--------- --------- --------- ---------
Consolidated $ (100) $ (1,256) $ (639) $ (2,097)
========= ========= ========= =========
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:
18
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
NET REVENUE
United States $ 1,508 $ 1,800 $ 4,906 $ 5,772
The Americas (other than U.S.) 248 238 519 543
Europe 821 930 2,466 2,868
Asia-Pacific 1,143 914 3,252 2,598
-------- -------- -------- --------
Consolidated $ 3,720 $ 3,882 $11,143 $11,781
======== ======== ======== ========
EXPORT SALES
United States $ 517 $ 507 $ 1,454 $ 1,483
======== ======== ======== ========
DECEMBER 31 MARCH 31,
2004 2004
------------- -------------
(IN THOUSANDS)
LONG-LIVED ASSETS
United States $ 3,603 $ 4,036
Europe 216 204
Asia-Pacific 1,351 1,085
------------- -------------
Consolidated $ 5,170 $ 5,325
============= =============
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 materially affect the Company's consolidated results of operations or
financial condition.
14. DISCONTINUED OPERATIONS
In its continuing efforts to focus on its core software products and IT
services businesses, the Company finalized the sale of its travel services
subsidiary, "e-Destinations," in April 2004 and its Web-based telecommunications
services division in September 2004. Accordingly, the results of the operations
of the Web-based telecommunications services division are excluded from
continuing operations and reported as "Discontinued Operations."
Loss from discontinued operations for the three and nine months ended
December 31, 2004 was $0 and $67,000, respectively, compared to a loss from
discontinued operations of $489,000 and $507,000, respectively, for the three
and nine months ended December 31, 2003. The Company recorded no gain or loss
from the sale of e-Destinations and a $117,000 gain from the sale of the
Web-based telecommunications division during the nine months ended December 31,
2004.
The total sales price was $155,000 for the sale of e-Destinations in
April 2004 and $130,000 for the sale of the Web-based telecommunications
services division in September 2004. The entire proceeds from the sale of
e-Destinations were received in April 2004. Of the $130,000 in proceeds from the
sale of the Web-based telecommunications services division, the Company had
received $100,000 in cash as of December 31, 2004. The balance of the sales
price is receivable in consecutive monthly installments through April 15, 2005.
19
The following table summarizes financial information for the
discontinued operations (in thousands), with prior period presentation
reclassified to conform to the current period presentation:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ -------------------
2004 2003 2004 2003
------- ------- ------- -------
Net gain (loss) from operations of
e-Destinations $ -- $ (146) $ -- $ (133)
Web-based telecommunications
services -- (27) (50) (58)
Impairment loss from
e-Destinations -- (316) -- (316)
Gain on sale of tele-
communications services -- -- 117 --
------- ------- ------- -------
Total $ -- $ (489) $ 67 $ (507)
======= ======= ======= =======
15. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
In its original Form 10-QSB filing for the quarter ended June 30, 2004,
the Company had recorded the amendment to the 2003 Note as a substantial
modification of debt and had written off $133,000 in unamortized discount to
loss on substantial modification of debt. Upon further interpretation of EITF
96-19, the Company determined the modification was not substantial and a
restatement was therefore necessary. The following table shows the effect of
this restatement:
(In thousands, except share and per share THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
data) ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2004 2004 2004 2004
(PREVIOUSLY (PREVIOUSLY
REPORTED) (RESTATED) REPORTED) (RESTATED)
----------------- ----------------- ----------------- -----------------
Operating loss (100) (100) (639) (639)
----------------- ----------------- ----------------- -----------------
Other expense (income):
Interest, net 111 123 340 376
Other (4) (4) (61) (61)
Loss on substantial modification of debt -- -- 133 --
----------------- ----------------- ----------------- -----------------
Total other expense 107 119 412 315
----------------- ----------------- ----------------- -----------------
Loss from continuing operations before
income taxes (207) (219) (1,051) (954)
Income tax expense 16 16 38 38
----------------- ----------------- ----------------- -----------------
Loss from continuing operations (223) (235) (1,089) (992)
Gain from discontinued operations (Note 14) -- -- 67 67
----------------- ----------------- ----------------- -----------------
Net loss $ (223) $ (235) $ (1,022) $ (925)
================= ================= ================= =================
Basic and diluted net loss per common share:
Net loss per common share from
continuing operations $ (0.01) $ (0.01) $ (0.06) $ (0.05)
Net gain from discontinued operations -- -- 0.01 --
----------------- ----------------- ----------------- -----------------
Basic and diluted net loss per common
share $ (0.01) $ (0.01) $ (0.05) $ (0.05)
================= ================= ================= =================
Common shares used in computing basic and
diluted net loss per common share: 18,865,523 18,865,523 18,775,554 18,775,554
================= ================= ================= =================
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
EFFECTS OF RESTATEMENT AND RECLASSIFICATIONS
This Management's Discussion and Analysis or Plan of Operation
discussion has been revised to reflect the effects of the restatement described
in Note 15 and the reclassification described in Note 14 to the accompanying
condensed consolidated financial statements.
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 the following two business segments:
o Engineering and collaborative software products and
services for businesses worldwide; and
o Information technology, or IT, services (including
value-added IT services).
21
Our net revenues during the nine months ended December 31, 2004 were
$11,143,000, a decrease of 5.4% over the corresponding prior year period, of
which engineering and collaborative software products and services net revenues
declined $79,000 (1.0%) and IT services net revenues declined $559,000 (15.0%).
Although historically our engineering software sales and revenues have
increased during the second half of a fiscal year, we can 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, and competition
for such services is intense as there are relatively few barriers to entry.
We plan to continue to monitor our costs in the upcoming quarters. As
part of our cost control measures and to expedite development of our next
generation of engineering software, we have moved most of our R&D functions
related to engineering software development to our lower cost location in India.
Although we expect to be profitable in our quarter ending March 31, 2005, this
will depend upon the anticipated growth in our revenues and the anticipated cost
savings, neither of which is certain.
As of December 31, 2004, our indebtedness under our convertible notes
totaled approximately $2,641,000, out of a total availability of $4,000,000.
During the nine months ended December 31, 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; and
o IT 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.
22
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 AcSec 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 are typically for a
short duration of one to six months.
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
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.
23
IMPAIRMENT OF LONG-LIVED ASSETS, INCLUDING GOODWILL
In August 2001, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." This statement addresses financial accounting and reporting for the
impairment of long-lived assets and the accounting and reporting provisions of
APB No. 30, "Reporting the Results of Operations for a Disposal of a Segment of
a Business." In September 2004, we sold our Web-based telecommunications
services division and recorded a $50,000 loss from the discontinued operations
for the nine months ended December 31, 2004 and a $117,000 gain on sale of the
telecommunications services division. Pursuant to SFAS No. 144, these items are
excluded from continuing operations and reported under "Discontinued
Operations." Prior period presentations have been conformed to the current
period presentations.
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 and IT 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
affected by the write-down of the carrying amount of goodwill to its estimated
fair value. There was no goodwill impairment write-down during the nine months
ended December 31, 2004. As of December 31, 2004, our goodwill balance was
$3,116,000.
24
CONSOLIDATED RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED DECEMBER 31,
2004 VERSUS THREE AND NINE MONTHS ENDED DECEMBER 31, 2003
CONTINUING OPERATIONS
NET REVENUES
The following table presents our net revenues by segment (dollars in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
NET REVENUES
Engineering and collaborative
software products and services $ 2,704 $ 2,664 $ 7,981 $ 8,060
% of total net revenues 72.7% 68.6% 71.6% 68.4%
IT services $ 1,016 $ 1,218 $ 3,162 $ 3,721
% of total net revenues 27.3% 31.4% 28.4% 31.6%
-------- -------- -------- --------
Total net revenues $ 3,720 $ 3,882 $11,143 $11,781
======== ======== ======== ========
Total net revenues for the three and nine months ended December 31,
2004 decreased by $162,000 (4.2%) and $638,000 (5.4%), respectively, compared to
the three and nine months ended December 31, 2003. Our total net revenues
consisted primarily of net revenues from (1) engineering and collaborative
software products and services and (2) IT services.
ENGINEERING AND COLLABORATIVE SOFTWARE PRODUCTS AND SERVICES
Net revenues from engineering and collaborative software products and
services for the three months ended December 31, 2004 increased by $40,000
(1.5%) compared to the three months ended December 31, 2003, primarily due to an
increase in net revenues from engineering software products and services in
Europe and Asia offset by decreases in the U.S. Net revenues from engineering
and collaborative software products and services for the nine months ended
December 31, 2004 decreased by $79,000 (1.0%) compared to the nine months ended
December 31, 2003 primarily due to a decrease in collaborative software net
revenues and decreases in engineering software net revenues in the U.S. offset
by increases in Europe and Asia.
Net revenues from engineering software products and services for the
three months ended December 31, 2004 increased by $83,000 (3.4%) compared to the
three months ended December 31, 2003, primarily due to a $131,000 increase in
net revenues from Asia and a $54,000 increase in net revenues from Europe offset
by a $102,000 decrease in net revenues in the U.S. Net revenues from Asia
increased due to increased direct sales efforts, and increases in purchases by
government entities and engineering colleges. Net revenues from Europe increased
due to increased emphasis on engineering software products and services sales
rather than IT services. Engineering software products and services net revenues
increased by approximately $168,000 (2.3%) during the nine months ended December
31, 2004 due to a $430,000 increase in net revenues from Asia and a $148,000
increase in net revenues from Europe offset by a $409,000 decrease in domestic
net revenues. The decrease in domestic net revenues in the U.S. was primarily
due to $450,000 in engineering software products and services revenues
recognized during the nine months ended December 31, 2003 in connection with a
large domestic project that did not recur during the nine months ended December
31, 2004. This decrease was partially offset by a $145,000 increase in domestic
net revenues from corporate sales. Our enhanced focus on larger corporate
25
clients has yielded significant customers such as Bechtel. However, the timing
of completion and recognition of our large projects creates greater variability
in our engineering software net revenues between quarters. Our efforts to
increase our maintenance sales to mitigate this variability resulted in
significantly increased maintenance billings during the three months ended
December 31, 2004, compared to the three months ended December 31, 2003.
However, most of these billings are not reflected in the net revenues from
maintenance sales recognized during the three months ended December 31, 2004,
because maintenance sales are recognized as revenues over the term of
maintenance period, usually twelve months. 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 $43,000 (20.1%) and $247,000 (36.0%) during the three and nine months
ended December 31, 2004, compared to the three and nine months ended December
31, 2003. The decrease in net revenues from collaborative software products and
services was due to the lower dollar value of a new project completed during the
nine months ended December 31, 2004, compared to the nine months ended December
31, 2003 when a larger 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.
IT SERVICES
The trend of decreasing IT services net revenues continued during the
three and nine months ended December 31, 2004, compared to the three and nine
months ended December 31, 2003. IT services net revenues decreased $202,000
(16.6%) and $559,000 (15.0%) for the three and nine months ended December 31,
2004, compared to the three and nine months ended December 31, 2003. Although
net revenues from IT services during the three and nine months ended December
31, 2004 decreased in domestic and European markets as compared to the three and
nine months ended December 31, 2003, they increased in Asia during the same
periods. Net revenues from IT services have decreased due to scaling back of one
of our domestic IT services offices and due to lesser emphasis on IT services in
Europe. These decreases were offset by a $129,000 and a $229,000 increase in IT
services net revenues from India during the three and nine months ended December
31, 2004, respectively, primarily due to our acquisition of a small IT
consulting company in April 2004. In the past several quarters, our IT services
business had been adversely affected due to competition 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 increased emphasis on the
development of higher margin IT services as well as the BPO efforts that began
during the later part of fiscal 2004 will contribute to a partial recovery in
our IT services net revenues for the year ending March 31, 2005. IT services net
revenues for the nine months ended December 31, 2004 reflect minimal revenues
related to our BPO services.
26
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------- -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
GROSS PROFIT
Engineering and collaborative
software products and services $ 2,559 $ 2,418 $ 7,404 $ 7,350
IT services 332 249 1,034 787
---------- --------- --------- ---------
Consolidated $ 2,891 $ 2,667 $ 8,438 $ 8,137
========== ========= ========= =========
GROSS MARGIN
Engineering and collaborative
software products and services 94.6% 90.8% 92.8% 91.2%
IT services 32.7% 20.4% 32.7% 21.2%
Consolidated 77.7% 68.7% 75.7% 69.1%
Consolidated gross margin increased to 77.7% and 75.7% for the three
and nine months ended December 31, 2004 from 68.7% and 69.1% for the three and
nine months ended December 31, 2003 due to the growing proportion of revenues as
well as higher gross margin from engineering and collaborative software products
and services compared to IT services.
ENGINEERING AND COLLABORATIVE SOFTWARE PRODUCTS AND SERVICES
Our engineering and collaborative software products and services
segment generally produces a higher gross margin than our IT services segment
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 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 engineering and collaborative software products and
services segment increased by 3.8 and 1.6 percentage points for the three and
nine months ended December 31, 2004, compared to the three and nine months ended
December 31, 2003. The increase in gross margin in the engineering and
collaborative software product and services segment was due to $69,000 and
$138,000 decreases in software amortization costs for the three and nine months
ended December 31, 2004, respectively, compared to the three and nine months
ended December 31, 2003, as a result of the completion of amortization during
June 2004. This decrease was offset by $30,000 and $68,000 increases in royalty
fees during the three and nine months ended December 31, 2004, respectively,
compared to the three and nine months ended December 31, 2003. Gross margin for
the nine months ended December 31, 2003 included gross margin from a large
project with minimal related costs whereas gross margin for the nine months
ended December 31, 2004 did not include any gross margin from such large
projects, resulting in a smaller 1.6 percentage point increase in gross margin
for the nine months ended December 31, 2004 as compared to the 3.8 percentage
point increase in gross margin for the three months ended December 31, 2004.
27
IT SERVICES
Historically, gross margin from the IT services segment has been lower
than gross margin 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 IT services segment increased by 12.3 and 11.5
percentage points for the three and nine months ended December 31, 2004,
compared to the three and nine months ended December 31, 2003. This increase was
primarily the result of our acquisition of a higher margin IT services company
engaged in steel detailing services in India. An increase in the emphasis on
higher margin IT services in India during the nine months ended December 31,
2004 compared to IT services that included a lower margin hardware component
during the nine months ended December 31, 2003 contributed to the improvement in
gross margin for this segment but was offset by increased costs related to our
BPO services. In addition, better utilization of consultants and scaling back of
one of the domestic offices also contributed to the increase in gross margin for
the nine months ended December 31, 2004, compared to the nine months ended
December 31, 2003.
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------- --------------------------
2004 2003 2004 2003
---------- ----------- ----------- -----------
OPERATING EXPENSES
Selling, general and
administrative expenses $ 2,353 $ 3,139 $ 6,972 $ 7,889
% of total net revenues 63.3% 80.9% 62.6% 67.0%
Research and development
expenses $ 390 $ 538 $ 1,216 $ 1,580
% of total net revenues 10.4% 13.9% 10.9% 13.4%
Bad debt expense $ 4 $ 15 $ 169 $ 49
% of total net revenues 0.1% 0.4% 1.5% 0.4%
Depreciation $ 244 $ 231 $ 720 $ 715
% of total net revenues 6.6% 6.0% 6.5% 6.1%
Total operating expenses $ 2,991 $ 3,923 $ 9,077 $ 10,233
% of total net revenues 80.4% 101.1% 81.5% 86.9%
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses decreased by
$786,000 (25.0%) and $917,000 (11.6%) for the three and nine months ended
December 31, 2004 compared to the three and nine months ended December 31, 2003.
The primary reasons for the decrease in SG&A expenses during the three
months ended December 31, 2004 compared to the three months ended December 31,
2003 are as follows: a $406,000 decrease in strategic and investor relations
services expense relating to warrants issued during the three months ended
December 31, 2003. No warrants were issued during the three months ended
December 31, 2004 for similar purposes. Additionally, a $232,000 decrease in
28
severance payments and expenses related to stock options granted as part of a
severance package, a $102,000 decrease in professional fees, a $79,000 decrease
in salaries and related expenses due to terminations and a $52,000 decrease in
rent due to lease renegotiations, facility closure and entry into three-year
sub-leases for portions of our headquarters facility also contributed to the
decrease in SG&A expenses.
The primary reasons for the decrease in SG&A expenses during the nine
months ended December 31, 2004 compared to the nine months ended December 31,
2003 are as follows: a $403,000 decrease in strategic and investor relations
services expense, a $232,000 decrease in severance payments and expenses related
to stock options granted as part of a severance package, a $294,000 decrease in
salaries and related expenses due to terminations and a $270,000 decrease in
professional fees partially offset by a $60,000 increase in consulting fees and
a $33,000 increase in user sales commissions, resulting in an overall decrease
in 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 nine 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.
The requirements of section 404 of the Sarbanes-Oxley Act of 2002 (the
"Act") are effective for us beginning with the fiscal year ending March 31,
2006. We anticipate that the expenses related to the implementation of the
requirements of the Act will be significant to our results of operations and
cash flows for the fiscal year ending March 31, 2006. However, we are unable to
quantify the extent of the effect of the Act on our results of operations and
cash flows.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses consist primarily of software
developers' wages. R&D expenses decreased by $148,000 (27.6%) and $364,000
(23.0%) to $390,000 and $1,216,000 for the three and nine months ended December
31, 2004, from $538,000 and $1,580,000 for the three and nine months ended
December 31, 2003. The decrease in R&D expenses is primarily related to employee
terminations and reorganization and due to capitalization of $54,000 in software
development expenses related to STAAD X. We believe R&D expenses may not
decrease further from current levels.
BAD DEBT EXPENSE
Bad debt expense decreased by $11,000 (73.3%) to $4,000 for the three
months ended December 31, 2004 from $15,000 for the three months ended December
31, 2003. Bad debt expense increased by $120,000 to $169,000 for the nine months
ended December 31, 2004 from $49,000 for the nine months ended December 31,
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, increasing $13,000 (5.6%) and $5,000 (0.7%) for the
three and nine months ended December 31, 2004, respectively, compared to the
three and nine months ended December 31, 2003. We anticipate that depreciation
expenses will remain at this lower level through the end of fiscal 2005.
29
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ----------------------------
2004 2003 2004 2003
---------- ----------- ----------- -------------
OTHER EXPENSE (INCOME)
Interest expense, net $ 123 $ 246 $ 376 $ 529
% of total net revenues 3.3% 6.3% 3.4% 4.5%
Other income $ (4) $ (26) $ (61) $ (109)
% of total net revenues (0.1)% (0.7)% (0.6)% (0.9)%
Total other expense $ 119 $ 220 $ 315 $ 420
% of total net revenues 3.2% 5.7% 2.8% 3.6%
INTEREST EXPENSE, NET
Interest expense, net decreased by $123,000 (49.9%) and $152,000
(28.8%) for the three and nine months ended December 31, 2004 compared to the
three and nine months ended December 31, 2003. The decrease in interest expense,
net was primarily due to a reduction in principal balance due to conversions of
portions of our convertible debt into equity as well as a reduction in interest
due to refinancing of a bank debt owed by one of our subsidiaries. Annual
interest rate on the convertible notes with Laurus is based on the greater of 5%
or the prime rate plus 1%. The Federal Reserve has increased interest rates five
times since August 2004, which increased the stated rate on our convertible
notes issued to Laurus from 5% to 6.25%. Interest expense in the upcoming
quarters may increase if the prime rate increases further or if we borrow
additional amounts, but may decrease if additional portions of debt outstanding
under the Amended and Restated 2003 Note and the 2004 Note are converted into
equity.
OTHER INCOME
Other income decreased by $22,000 and $48,000 for the three and nine
months ended December 31, 2004, compared to the three and nine months ended
December 31, 2003 primarily due to the sale of certain assets in the prior year
that were previously written off or fully depreciated.
INCOME TAXES
We recorded an income tax expense of $16,000 and $38,000 for the three
and nine months ended December 31, 2004 compared to $53,000 and $165,000 during
the three and nine months ended December 31, 2003. The decrease in income tax
expense for the three and mine months ended December 31, 2004 as compared to the
income tax expense for the three and nine months ended December 31, 2003, was
due to the transfer pricing agreements we established with our subsidiaries in
the United Kingdom and Singapore in March 2004. Tax expense for the three and
nine months ended December 31, 2004 resulted from provisions for domestic and
foreign income taxes applicable to local jurisdictions.
30
DISCONTINUED OPERATIONS
In our continuing efforts to focus on our core software products and IT
services businesses, we sold our travel services subsidiary, "e-Destinations,"
in April 2004 for its approximate fair value of $155,000 and our Web-based
telecommunications services division in September 2004 for $130,000, which
amount was $117,000 greater than its book value. Accordingly, the results of the
operations of the travel services subsidiary and Web-based telecommunications
services division are excluded from continuing operations and reported as
discontinued operations.
Loss from discontinued operations for the three and nine months ended
December 31, 2004 was $0 and $67,000, respectively, compared to a loss from
discontinued operations of $489,000 and $507,000 for the three and nine months
ended December 31, 2003, respectively. We recorded no gain or loss from the sale
of e-Destinations since it was written down to its potential recoverable value
at the end of March 31, 2004, and a $117,000 gain from the sale of the Web-based
telecommunications services division during the nine months ended December 31,
2004.
The total sales price was $155,000 for the sale of e-Destinations in
April 2004 and $130,000 for the sale of the Web-based telecommunications
services division. We received the entire proceeds from the sale of
e-Destinations in April 2004. Of the total sales price of $130,000 for the
Web-based telecommunications services division, we received $100,000 in cash
through December 31, 2004. The balance of the sales price is receivable in
consecutive monthly installments through April 15, 2005.
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.
During the nine months ended December 31, 2004, we financed 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 December 31, 2004 consisted of
$2,942,000 of cash and cash equivalents and a revolving credit facility
described below. Cash and cash equivalents increased by $1,296,000 (78.7%)
during the nine months ended December 31, 2004. The primary reason for this
increase was net cash provided by additional borrowings. To a lesser extent,
investing activities also provided cash. Net cash provided by borrowings and
investing activities were offset by net cash used in operating activities.
31
Net cash used in operations was $755,000 during the nine months ended
December 31, 2004 compared to $1,350,000 during the nine months ended December
31, 2003, a decrease of $595,000. Net loss from continuing operations of
$992,000 during the nine months ended December 31, 2004 and net loss from
continuing operations of $2,681,000 during the nine months ended December 31,
2003 were the primary reasons for cash used in operations in both periods.
The following contributed to cash usage during the nine months ended
December 31, 2004:
o A $695,000 increase in accounts receivable primarily
due to annual maintenance billed toward the end of
December 2004 and due to slower collection of
receivables in Asia;
o A $247,000 increase in prepaid expenses and other
current assets primarily due to $103,000 in prepaid
dealer commissions for sales not yet recognized, a
$90,000 increase in deposits related to our BPO
operations and a $54,000 increase in capitalized
software development;
o A $153,000 decrease in accrued expenses primarily due
to payment of severance payments and professional
fees; and
o A $168,000 decrease in accounts payable due to
payments.
The above were partially offset by a $370,000 increase in deferred revenues
primarily due to a higher level of new maintenance billings and a lower level of
recognized revenues from previously deferred billings.
The following contributed to cash usage during the nine months ended December
31, 2003:
o A $287,000 increase in accounts receivable primarily
due to a higher proportion of sales on credit toward
the end of December 2003;
o A $199,000 decrease in deferred revenues primarily
due to a lower level of new maintenance billings and
a higher level of recognized revenues from previously
deferred billings;
o A $199,000 decrease in accrued restructuring
obligations due to payment;
o A $166,000 increase in prepaid expenses and other
current assets primarily due to increases in advance
payments to vendors in Asia; and
o A $122,000 decrease related in accounts payable due
to payments.
The above were offset by a $587,000 decrease in deposits due to payment
of a legal settlement and a $116,000 increase in income taxes payable.
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 positive cash generation, if actual levels of expenses and revenues
from our BPO services differ from anticipated levels due to unanticipated
increases in labor costs, decreased demand, competition, or other factors.
32
Net cash used in investing activities during the nine months ended
December 31, 2004 consisted of capital expenditures of $286,000 and payment to
acquire a company of $58,000, offset by $100,000 from the sale of short-term
investments, $271,000 of proceeds from the sale of our travel subsidiary and our
Web-based telecommunications services division, and $37,000 of proceeds from the
sale of equipment. Capital expenditures during the nine months ended December
31, 2003 were $78,000 and were offset by $150,000 of proceeds from the sale of
our telecommunications switch. We expect our capital expenditures to stay at or
near the current level for the next twelve months.
Cash provided by financing activities during the nine months ended
December 31, 2004 primarily resulted from long-term borrowings of $3,627,000
(including $990,000 in additional borrowings, net of fees, under the Amended and
Restated 2003 Note and $990,000 in borrowings, net of fees under the 2004 Note)
and $100,000 of proceeds from warrant exercises, offset by $1,730,000 in
long-term debt repayments. In addition, repayments of capital lease obligations
amounted to $98,000 for the nine months ended December 31, 2004. Proceeds from
long-term borrowings during the nine months ended December 31, 2003 were
$2,101,000. Additionally, we repaid $1,371,000 of long-term debt and $182,000 in
capital lease obligations during the nine months ended December 31, 2003.
We incurred net losses from continuing operations of $992,000 and
$2,681,000 and used cash in operations of $755,000 and $1,350,000 during the
nine months ended December 31, 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 December 31, 2004 (in thousands of dollars):
PAYMENTS DUE BY PERIOD
--------------------------------------------------------------------------------
LESS THAN 1 AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL YEAR 3-4 YEARS 4-5 YEARS YEARS
Long-Term Debt* $ 3,567 $ 1,362 $ 2,189 $ 13 $ 3
Capital Lease Obligations 522 141 293 88 --
Operating Leases 3,409 536 790 527 1,556
------------ ------------ ------------ ------------ ------------
Total Contractual Cash Obligations $ 7,498 $ 2,039 $ 3,272 $ 628 $ 1,559
============ ============ ============ ============ ============
* Excludes debt discount of $508 primarily related to warrants and beneficial
conversion adjustments.
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
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.
33
On July 31, 2003, we obtained a $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 Amended and Restated 2003 Note and the
2004 Note (collectively, the "Laurus Notes"). At December 31, 2004, we had no
borrowings under the revolving credit facility, $2,641,000 in principal balance,
excluding $386,000 of fees and beneficial conversion adjustments, under the
Laurus Notes, and availability of $1,359,000.
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 our 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 December 31, 2004.
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 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.
34
ITEM 6. EXHIBITS .
EXH. NO. DESCRIPTION
-------- -----------
10.1 Security Agreement dated December 23, 2004 by and
between netGuru, Inc. and Laurus Master Fund, Ltd.
(1)
10.2 Common Stock Purchase Warrant dated December 23, 2004
issued by netGuru, Inc. in favor of Laurus Master
Fund, Ltd.
10.3 Registration Rights Agreement dated December 23, 2004
by and between netGuru, Inc. and Laurus Master Fund,
Ltd. (1)
10.4 Securities Purchase Agreement dated December 23, 2004
by and between netGuru, Inc. and Laurus Master Fund,
Ltd. (1)
10.5 Secured Convertible Note dated December 23, 2004 in
the principal amount of $1,000,000 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 current report on Form 8-K
that was filed with the SEC on December 30, 2004, and
incorporated herein by reference.
(2) Attached as an exhibit to this Amendment No. 1 to
Form 10-QSB.
35
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: April 20, 2005
NETGURU, INC.
By: /s/ BRUCE K. NELSON_
----------------------------------
Bruce K. Nelson
Chief Financial Officer (principal
financial officer and
duly authorized officer)
36
EXHIBITS FILED WITH THIS AMENDMENT NO. 1 TO 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
37