UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
[ ] 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 issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell Company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
The number of shares outstanding of the registrant's only class of common stock,
$.01 par value, was 19,117,154 on November 11, 2005.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
PART I
FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the Three and
Six Months Ended September 30, 2005 and 2004 (unaudited)........... 3
Condensed Consolidated Balance Sheets as of
September 30, 2005 (unaudited) and March 31, 2005.................. 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended September 30, 2005 and 2004 (unaudited)........... 5
Notes to Condensed Consolidated Financial Statements (unaudited)... 7
Item 2. Management's Discussion and Analysis or Plan of Operation..........20
Item 3. Controls and Procedures ...........................................32
PART II
OTHER INFORMATION
Item 1. Legal Proceedings..................................................34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........34
Item 3. Defaults Upon Senior Securities....................................34
Item 4. Submission of Matters to a Vote of Security Holders................34
Item 5. Other Information..................................................34
Item 6. Exhibits ..........................................................35
Signatures....................................................................36
Exhibits Filed with this Report on Form 10-QSB................................37
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share and per share amounts)
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Net revenues:
Collaborative software products and
services $ 172 $ 185 $ 380 $ 268
IT services 744 1,034 1,517 2,109
------------- ------------- ------------- -------------
Total net revenues 916 1,219 1,897 2,377
Cost of revenues:
Collaborative software products and
services 1 1 2 71
IT services 570 657 1,175 1,388
------------- ------------- ------------- -------------
Total cost of revenues 571 658 1,177 1,459
------------- ------------- ------------- -------------
Gross profit 345 561 720 918
------------- ------------- ------------- -------------
Operating expenses:
Selling, general and administrative 737 722 1,344 1,397
Research and development 138 135 291 273
Bad debt expense 165 -- 221 156
Depreciation 48 71 95 139
------------- ------------- ------------- -------------
Total operating expenses 1,088 928 1,951 1,965
------------- ------------- ------------- -------------
Operating loss (743) (367) (1,231) (1,047)
------------- ------------- ------------- -------------
Other expense (income):
Interest, net 127 98 250 216
Other (11) (24) (6) (58)
------------- ------------- ------------- -------------
Total other expense 116 74 244 158
------------- ------------- ------------- -------------
Loss from continuing operations before
income taxes (859) (441) (1,475) (1,205)
Income tax (benefit) expense (3) 3 7 8
------------- ------------- ------------- -------------
Loss from continuing operations (856) (444) (1,482) (1,213)
(Loss) income from discontinued operations
(Note 14) (138) 371 154 522
------------- ------------- ------------- -------------
Net loss $ (994) $ (73) $ (1,328) $ (691)
============= ============= ============= =============
Basic and diluted loss per common share:
Loss per common share from continuing
operations $ (0.04) $ (0.02) $ (0.08) $ (0.07)
(Loss) income from discontinued operations (0.01) 0.02 0.01 0.03
------------- ------------- ------------- -------------
Basic and diluted loss per common share $ (0.05) $ (0.00) $ (0.07) $ (0.04)
============= ============= ============= =============
Common shares used in computing basic and
diluted loss per common share: 19,117,154 18,833,350 19,117,154 18,730,323
============= ============= ============= =============
See accompanying notes to condensed consolidated financial statements.
3
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
SEPTEMBER 30, MARCH 31,
2005 2005
(UNAUDITED)
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 2,753 $ 3,681
Accounts receivable (net of allowance for doubtful accounts of $166 and
$199, as of September 30, 2005 and March 31, 2005, respectively) 806 1,491
Income tax receivable 12 15
Notes and related party loans receivable 12 12
Deposits 38 54
Prepaid expenses and other current assets 773 967
Current assets held for sale (Note 14) 3,549 4,274
--------- ---------
Total current assets 7,943 10,494
Property, plant and equipment, net 895 924
Goodwill 2,929 2,931
Other assets 135 144
--------- ---------
$ 11,902 $ 14,493
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt, net of discount of $209 and $222 as
of September 30, 2005 and March 31, 2005, respectively $ 1,361 $ 1,297
Related party loans payable -- 100
Current portion of capital lease obligations 16 15
Accounts payable 405 179
Accrued expenses 410 469
Income taxes payable 24 19
Deferred revenues 317 579
Other liabilities 157 179
Liabilities held for sale (Note 14) 2,976 3,530
--------- ---------
Total current liabilities 5,666 6,367
Long-term debt, net of current portion and net of discount of $99 and $200,
as of September 30, 2005 and March 31, 2005, respectively 1,644 2,108
Capital lease obligations, net of current portion 47 55
Deferred gain on sale-leaseback 643 678
--------- ---------
Total liabilities 8,000 9,208
--------- ---------
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
shares outstanding as of September 30, 2005 and March 31, 2005) 191 191
Additional paid-in capital 36,869 36,869
Accumulated deficit (32,560) (31,232)
Accumulated other comprehensive loss:
Cumulative foreign currency translation adjustments (598) (543)
--------- ---------
Total stockholders' equity 3,902 5,285
--------- ---------
$ 11,902 $ 14,493
========= =========
See accompanying notes to condensed consolidated financial statements.
4
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
SIX MONTHS SIX MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
-------- --------
Cash flows from operating activities:
Net loss $(1,328) $ (691)
Income from discontinued operations 154 522
-------- --------
Loss from continuing operations (1,482) (1,213)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 95 208
Bad debt expense 221 156
Amortization of discount on loan 113 111
Expense recognized on issuance of warrants and common stock -- 48
Changes in operating assets and liabilities:
Accounts receivable 462 (246)
Notes and related party loans receivable -- 4
Income tax receivable 4 14
Prepaid expenses and other current assets 187 (94)
Deposits 15 (33)
Other assets 9 (9)
Accounts payable 227 (124)
Accrued expenses (55) (105)
Income taxes payable 6 (2)
Other current liabilities (10) 43
Deferred revenues (255) 113
Deferred gain on sale-leaseback (35) (35)
-------- --------
Net cash used in operating activities (498) (1,164)
-------- --------
Cash flows from investing activities:
Purchase of property, plant and equipment (67) (106)
Sale of short-term investments -- 100
Proceeds from sale of division -- 191
-------- --------
Net cash (used in) provided by investing activities (67) 185
-------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt -- 2,032
Repayment of long-term debt (604) (1,294)
Repayment of capital lease obligations (7) (4)
Issuance of common stock -- 50
-------- --------
Net cash (used in) provided by financing activities (611) 784
-------- --------
Effect of exchange rate changes on cash and cash equivalents (46) 98
-------- --------
Net cash used in continuing operations (1,222) (97)
Net cash provided by (used in) discontinued
operations 294 (9)
-------- --------
Cash and cash equivalents, beginning of period 3,681 1,646
-------- --------
Cash and cash equivalents, end of period $ 2,753 $ 1,540
======== ========
(continued on the following page)
5
NETGURU, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(In thousands)
SIX MONTHS SIX MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
------------ -------------
Supplemental disclosure of cash flow information: Cash paid for:
Interest $ 165 $ 157
============ ============
Income taxes $ 8 $ 4
============ ============
Supplemental disclosure of non-cash investing and financing activities:
Acquisition of equipment under capital leases $ - $ 78
Repayment of convertible debt with common stock $ - $ 910
Acquisition of a company:
Net assets acquired $ - $ 54
Net liabilities assumed $ - $ 29
Promissory note issued toward consideration, net of discount $ - $ 142
Common stock issued toward consideration $ - $ 29
See accompanying notes to condensed consolidated financial statements.
6
NETGURU, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
1. BASIS OF PRESENTATION
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 normal and recurring adjustments which are, in the
opinion of management, necessary for a fair presentation of the financial
position at September 30, 2005 and the results of operations and the cash flows
for the three and six months ended September 30, 2005 and 2004, pursuant to the
rules and regulations of the Securities and Exchange Commission. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for annual
consolidated financial statements. Results of operations for the three and six
months ended September 30, 2005 are not necessarily indicative of the results to
be expected for the full year ending March 31, 2006 or any other period. It is
suggested that the accompanying condensed consolidated financial statements be
read in conjunction with the Company's audited consolidated financial statements
included in the Company's annual report on Form10-KSB for the year ended March
31, 2005.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP") 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.
On August 19, 2005, the Company entered into an Asset Purchase
Agreement with privately held Bentley Systems, Incorporated to sell the
Company's Research Engineers International ("REI") business and STAAD product
lines. As of that date, the Company met the criteria required to account for the
REI segment as a discontinued operation. As such, unless otherwise noted, all
amounts presented, including all note disclosures, contain only information
related to the Company's continuing operations. See note 14 for additional
discontinued operations disclosures.
Certain reclassifications have been made to the fiscal 2005 condensed
consolidated financial statements to conform to the fiscal 2006 presentation.
The primary reclassifications relate to the separate reporting for the
discontinued operations of the REI business and STAAD product lines (note 14).
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 September 30, 2005, the Company's
management believed the carrying amounts of cash and cash equivalents,
receivable and payable amounts, and accrued expenses approximated fair value
because of the short maturity of these financial instruments. The Company's
management also believed that the carrying amounts of its capital lease
obligations approximated their fair values, as the interest rates approximated a
7
rate that the Company could have obtained under similar terms at the balance
sheet date. In addition, the Company's management also believed that the
carrying amounts of its long-term debt obligations approximated their fair
values, as the borrowing rates are consistent with those of other lending
sources. The estimated fair value of the Company's long-term debt at September
30, 2005, was approximately $3.0 million.
3. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
EXCHANGES OF NONMONETARY ASSETS
In December 2004, the Financial Accounting Standards Board (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
nonmonetary 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, became effective for the Company beginning with the second
quarter of fiscal 2006. The adoption of SFAS No. 153 has not had a material
effect on the Company's consolidated financial condition or results of
operations.
SHARE-BASED PAYMENT
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based
Payment." 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 first quarter of the first
fiscal year beginning after December 15, 2005 and, thus, will be effective for
the Company for the interim periods beginning with 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 the Company's management believes the
adoption of SFAS No. 123(R), will have a material effect on the Company's
consolidated results of operations, similar to the pro forma results described
in "Stock-Based Compensation" in note 1 to the Company's consolidated financial
statements included in the Company's annual report on Form 10-KSB for fiscal
2005 and note 8 of this quarterly report. However, management has not yet
determined the actual effect of the accounting for stock option and related
income tax components.
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 September 30,
2005, there were no unamortized capitalized software costs.
The Company amortizes capitalized software development costs and
purchased technology using the straight-line method over two to five years, or
the ratio of actual sales to anticipated sales, whichever is greater.
Amortization of software development costs and purchased technology charged to
operations was approximately $0 and $69,000 for the six months ended September
30, 2005 and 2004, respectively. Accumulated amortization on capitalized
software was $544,000 as of September 30, 2005 and 2004.
8
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 reasonably assured. The Company's revenues
arise from the following segments: 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 reasonably assured. 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.
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 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
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 reasonably assured 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 September 30, 2005.
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.
9
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 prime rate
plus 1%, payable in arrears; (2) the amortization period was extended from 20
months ending on November 13, 2004 to 24 months ending on July 31, 2005; (3) the
penalty for repayments of the outstanding balance in cash was removed; and (4)
the fixed conversion price, upon which potential issuances of the Company's
common stock to satisfy the obligations of the convertible note are based, was
reduced from $1.60 to $1.30.
In April 2004, Laurus converted $650,000 of principal balance on the
2002 Note into 500,000 shares of the Company's common stock. In December 2004,
Laurus converted the remaining balance of $80,000 into 61,358 shares of the
Company's common stock. At September 30, 2005, 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, if any, outstanding on the 2002 Note and the Amended and Restated 2003
Note (defined below).
Borrowings under the Facility accrued interest, initially, at an annual
rate equal to the greater of 5% or the prime rate plus 1%. 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 7.75% in September
2005 as a result of increases in the prime rate. 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 and other terms, 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. It is anticipated that this
termination fee will be waived when all outstanding borrowings from Laurus are
Repaid. 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
10
conversion price based upon how much of the outstanding obligation under the
Facility is converted to equity. As of September 30, 2005, 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 September 30,
2005, 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 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. On April 27, 2004, the Company amended and restated
the 2003 Note to reflect an additional $1,000,000 that it borrowed on April 27,
2004, so that the principal amount of the 2003 Note was increased to $2,400,000
from $1,400,000 (the "Amended and Restated 2003 Note"). The net proceeds from
the additional principal under the Amended and Restated 2003 Note were used for
working capital.
The Amended and Restated 2003 Note requires monthly principal payments
of $50,000 plus accrued interest (payable in arrears) on the first business day
of each month, commencing August 1, 2004, with the entire remaining principal
balance becoming due on December 3, 2006. Monthly payments under the original
2003 Note had been scheduled to begin in April 2004. The amount of monthly
principal payment was increased from $30,000 to $50,000. The Company is required
to pay any remaining balance of principal, including any accrued and unpaid
interest, on the maturity date. The final payment due at maturity was increased
from $440,000 to $710,000. 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 feature 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 September 30, 2005, the Company had an
outstanding balance of $1,410,000, 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 September 30, 2005, the Company was in compliance with this covenant.
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
11
$5,000 of expenses in connection with the offering. The net proceeds from the
sale of the 2004 Note were 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 September
30, 2005, the outstanding principal balance of the 2004 Note was $910,000.
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 Securities and Exchange Commission, (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 the Company 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. 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, unbonded or unstayed for
ninety days;
12
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.
On June 28, 2005, the Company and Laurus entered into a waiver and
extension, pursuant to which they agreed to amend the definition of
"Effectiveness Date" contained in a Registration Rights Agreement (the
"Agreement") dated December 23, 2004 that they entered into simultaneously with
the issuance of the 2004 Note and the 2004 Warrant. Pursuant to the Agreement,
the Company was required to file by a January 22, 2005 initial filing date a
resale registration statement with the SEC covering the shares of common stock
issuable upon conversion of the 2004 Note and upon exercise of the 2004 Warrant.
The Company was also required to obtain effectiveness of the registration
statement by a May 22, 2005 initial Effectiveness Date.
The Agreement provides that:
o if a registration statement is not filed on or prior to the
initial filing date, or
o if the registration statement is not declared effective by the
SEC by the Effectiveness Date, or
o if after the registration statement is filed with and declared
effective by the SEC, the registration statement ceases to be
effective as to all registrable securities to which it is
required to relate at any time prior to the time that all of
the registrable securities have been sold or may be sold
without volume restrictions under Rule 144(k) of the
Securities Act of 1933, as amended, or
o if trading of our common stock is suspended for more than
three trading days, then subject to certain grace periods,
until the event described above is cured, the Company must pay
to Laurus cash liquidated damages equal to 1.0% for each
30-day period (prorated for partial periods) of the original
principal amount of the 2004 Note.
The Company was unable to meet either the initial filing deadline or
the initial Effectiveness Date. Accordingly, the Company and Laurus entered into
the June 28, 2005 waiver and extension. The waiver and extension provides that
the January 22, 2005 initial filing deadline is waived. The waiver and extension
also provides that the amended Effectiveness Date for the initial registration
statement filed under the Agreement is September 1, 2005, and with respect to
each additional registration statement that may be required to be filed in the
future, a date no later than 30 days following the applicable filing date. The
Company paid $10,000 in liquidated damages for the delay in the registration
statement being declared effective by the SEC. The $10,000 liquidated
damage payment was recorded as a penalty expense under other expense in July
2005. The registration statement was declared effective by the SEC on
August 12, 2005.
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.
13
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 is being charged to interest expense, ratably, over the term of the
2004 Note.
In connection with the Company's entry into the Asset Purchase
Agreement described in note 14, Laurus and the Company entered into a Stand
Still Agreement as of August 19, 2005. Under the Stand Still Agreement, Laurus
consented to the Company's entry into and consummation of the transactions
contemplated by the Asset Purchase Agreement and agreed to release its security
interest in the assets being sold, subject to Laurus being paid in full at the
closing all of the Company's obligations under the convertible promissory notes
held by Laurus. In anticipation of the consummation of the asset sale described
in note 14, Laurus has agreed to release all UCC filings against assets of the
Company immediately upon receiving payment in full for all principal and accrued
interest. Laurus also agreed not to exercise any of its warrants to purchase the
Company's common stock until the earlier to occur of the closing of the Asset
Purchase Agreement, the termination of the Asset Purchase Agreement or February
15, 2006. In addition, Laurus agreed not to interfere with the transactions
contemplated by the Asset Purchase Agreement through involvement in any merger,
sale of assets, sale of equity or similar transaction involving the Company or
any of its divisions or any other transaction that would involve the transfer or
potential transfer of control of the Company. The Stand Still Agreement does
not, however, limit the right of Laurus to transfer or vote shares of the
Company's common stock.
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):
14
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- --------------------------------
2005 2004 2005 2004
--------------- --------------- --------------- ----------------
Net loss - as reported $ (994) $ (73) $ (1,328) $ (691)
Deduct: Stock-based compensation
expense determined under the fair
value based method for all awards,
net of tax (36) (145) (72) (290)
--------------- --------------- --------------- ----------------
Net loss - pro forma $ (1,030) $ (218) $ (1,400) $ (981)
=============== =============== =============== ================
Basic and diluted net loss per share -
As reported $ (0.05) $ (0.00) $ (0.07) $ (0.04)
Pro forma $ (0.05) $ (0.01) $ (0.07) $ (0.05)
Weighted average fair value of
options granted $ 1.02 $ 1.45 $ 1.02 $ 1.45
SIX MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2005 2004
-------------- -------------
Black-Scholes option pricing model
Assumptions:
Dividend yield - -
Expected volatility 81.0% 80.7%
Risk-free interest rate 4.26 3.56%
Expected option lives (in years) 7.01 6.93
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 half of fiscal 2005
and 2006.
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 $1,383,000 and $681,000 for the six months ended September 30, 2005 and
2004, 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.
15
The following table illustrates the computation of basic and diluted
net loss per share (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ----------------------------
2005 2004 2005 2004
------------- -------------- ------------- -------------
Numerator:
Net loss and numerator for basic and diluted
loss per share $ (994) $ (73) $(1,328) $(691)
============= ============== ============= =============
Denominator:
Denominator for basic net loss per share -
average number of common shares
outstanding during the period 19,117 18,833 19,117 18,730
Incremental common shares attributable to
exercise of outstanding options, warrants
and other common stock equivalents - - - -
------------- -------------- ------------- -------------
Denominator for diluted net loss per
share 19,117 18,833 19,117 18,730
============= ============== ============= =============
Basic and diluted net loss per share $ (0.05) $ (0.00) %(0.07) $(0.04)
============= ============== ============= =============
Options, warrants and other common stock equivalents amounting to
1,790,000 potential common shares for the three and six month periods ended
September 30, 2005 (all of which are potential common shares from the possible
conversion of the convertible notes issued to Laurus for each of the same
periods), and 1,615,000 and 1,664,000 potential common shares for the three and
six month periods ended September 30, 2004, 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. The Company's operating segments are:
o Collaborative software products and services; and
o IT services
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 Company's
management monitors unallocable expenses related to the Company's corporate
activities in a separate "Center," which is reflected in the tables below.
16
The significant components of worldwide operations by reportable
operating segment are:
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2005 2004 2005 2004
-------- -------- -------- --------
NET REVENUE
Collaborative software products
and services $ 172 $ 185 $ 380 $ 268
IT services 744 1,034 1,517 2,109
-------- -------- -------- --------
Consolidated $ 916 $ 1,219 $ 1,897 $ 2,377
======== ======== ======== ========
GROSS PROFIT
Collaborative software products
and services $ 171 $ 184 $ 378 $ 197
IT services 174 377 342 721
-------- -------- -------- --------
Consolidated $ 345 $ 561 $ 720 $ 918
======== ======== ======== ========
OPERATING (LOSS)/INCOME
Collaborative software products
and services $ 15 $ 22 $ 45 $ (274)
IT services (286) 50 (440) 77
Center (472) (439) (836) (850)
-------- -------- -------- --------
Consolidated $ (743) $ (367) $(1,231) $(1,047)
======== ======== ======== ========
The Company's operations are based worldwide through foreign and
domestic subsidiaries and branch offices in the United States, India, Germany
and Asia-Pacific. The following are significant components of worldwide
operations by geographic location:
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2005 2004 2005 2004
-------- -------- -------- --------
NET REVENUE
United States $ 627 $ 856 $1,398 $ 1,691
Europe 52 167 104 242
Asia-Pacific 237 196 395 444
------- ------- ------- -------
Consolidated $ 916 $1,219 $1,897 $2,377
====== ====== ====== ======
EXPORT SALES
United States $ 24 $ 57 $ 110 $ 309
====== ====== ====== ======
17
SEPTEMBER 30, MARCH 31,
2005 2005
----------------- ------------------
(IN THOUSANDS)
LONG-LIVED ASSETS
United States $ 2,929 $ 2,897
Europe 109 113
Asia-Pacific 921 989
----------------- ------------------
Consolidated $ 3,959 $ 3,999
================= ==================
13. CONTINGENCIES
The Company is a named defendant in a civil action commenced against it
by plaintiffs Ash Brahma ("Brahma"), Sujit Kumar ("Kumar"), and Venture
International ("Venture") (collectively, "Plaintiffs") on August 18, 2005, in
the Commonwealth of Massachusetts, Essex County, Superior Court Department of
the Trial Court, Civil Action No. 05-1446 B, entitled, Ash Brahma, et al. v.
netGuru, Inc. (the "Action").
In the Action, Plaintiffs allege breach of contract and fraud on the
part of the Company, and they seek alleged damages of $4,885,000. On October 5,
2005, the Company timely filed a Notice of Removal of the Action to the United
States District Court, District of Massachusetts, where the Action is currently
pending.
On October 13, 2005, the Company filed its answer and counterclaim in
the Action. The Company has denied any breach of contract or other wrongdoing on
its part, and has denied that Plaintiffs are entitled to equitable relief or
damages. The Company's counterclaim seeks recission of contract and/or breach of
contract, restitution and/or damages for consulting fees paid to Plaintiffs,
damages for time and money spent pursuant to the contracts alleged objectives,
(plus interest, costs and attorneys' fees.
The Company is also 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
On August 19, 2005, the Company entered into an Asset Purchase
Agreement with privately held Bentley Systems, Incorporated ("Bentley"). The
Asset Purchase Agreement provides for the sale of the Company's its REI business
and STAAD product lines to Bentley for approximately $23.5 million in cash. The
sale is subject to various closing conditions, including approval by the
Company's stockholders and compliance with regulatory requirements. If approved
By stockholders at the Annual Meeting on November 17, 2005, the Company
anticipates the sale will close on during the quarter ended December 31, 2005.
Bentley will acquire the worldwide operations associated with REI, including the
STAAD structural analysis and design product line, software and product
development, customer support and relationships, and offices associated with the
worldwide business.
The Company's condensed consolidated financial statements have been
reclassified for all periods presented to reflect the REI business segment as
discontinued operations. In accordance with GAAP, the revenues, costs, and
expenses directly associated with the REI business have been reclassified as
discontinued operations on the condensed consolidated statements of operations
for all periods presented. Corporate expenses such as general corporate overhead
and interest have not been allocated to discontinued operations. Additionally,
assets and liabilities of the REI business segment have been reclassified as
held for sale on the Company's condensed consolidated balance sheets for all
periods presented, and the Company's condensed consolidated statements of cash
flows have been reclassified to reflect the operations of the REI business
segment as discontinued operations for all periods presented.
Separately, in September 2004, the Company sold its Web-based
telecommunications services division in its continuing efforts to focus on its
core software products and IT services businesses. Accordingly, the results of
the operations of the Web-based telecommunications services division is excluded
from continuing operations and reported as "Discontinued Operations" for the
three and six months ended September 30, 2004. The total sales price was
$130,000 for the sale of the Web-based telecommunications services division in
September 2004. The Company received the entire proceeds from the sale of the
Web-based telecommunications services division prior to March 31, 2005.
18
The carrying value of the assets and liabilities held for sale of the
discontinued REI business segment included in the consolidated balance sheets
are as follows:
SEPTEMBER 30, MARCH 31,
2005 2005
---------------- -----------------
ASSETS HELD FOR SALE
Accounts receivable, net $ 2,212 $ 2,843
Deposits 47 42
Prepaid expenses and other current assets 341 376
---------------- -----------------
Total current assets 2,600 3,261
Property, plant and equipment, net 588 758
Goodwill 157 157
Other assets 204 98
---------------- -----------------
$ 3,549 $ 4,274
================ =================
LIABILITIES HELD FOR SALE
Current portion of capital lease obligations $ 142 $ 129
Accounts payable 215 285
Accrued expenses 499 667
Income taxes payable 10 10
Deferred revenues 1,817 2,118
Other liabilities 33 33
--------------- -----------------
Total current liabilities 2,716 3,242
Capital lease obligations, net of current portion 237 288
Other long term liabilities 23 --
--------------- -----------------
Total liabilities $ 2,976 $ 3,530
=============== =================
The net revenues and net income of the Company's discontinued
operations were as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
Net revenues:
Web-based telecommunications
services business $ -- $ 109 $ -- $ 327
REI business 2,952 2,680 5,821 5,047
------- ------- ------- -------
$ 2,952 $ 2,789 $ 5,821 $ 5,374
------- ------- ------- -------
Net (loss) income:
Web-based telecommunications
services business $ -- $ 38 $ -- $ 67
REI business (138) 333 154 455
------- ------- ------- -------
$ (138) $ 371 $ 154 $ 522
------- ------- ------- -------
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. 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 complete the proposed sale of a substantial
portion of our assets;
o our ability to achieve and maintain profitability and obtain
additional working capital, if required;
o our ability to re-pay our debt and service our interest cost;
o our ability to successfully implement our business plans,
including our engineering business process outsourcing
initiatives;
o our ability to attract and retain strategic partners and
alliances;
o our ability to hire and retain qualified personnel;
o the risks of uncertainty of protection of our intellectual
property;
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 Collaborative software products and services for businesses
worldwide; and
o Embedded information technology, or IT, services (including
engineering business process outsourcing, or EBPO).
Our net revenues during the six months ended September 30, 2005 were
$1,897,000, a decrease of $480,000 (20.2%) over the corresponding prior year
period, of which IT services net revenue decreased $592,000 (28.1%), and
collaborative software products and services net revenues increased $112,000
(41.8%).
20
Currently, our EBPO services address the production of structural steel
detailing drawings. Although we believe our EBPO 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.
On August 19, 2005, we entered into an Asset Purchase Agreement with
privately held Bentley Systems, Incorporated ("Bentley"). The Asset Purchase
Agreement provides for the sale of our Research Engineers International ("REI")
business and STAAD product lines to Bentley for approximately $23.5 million in
cash. The sale is subject to various closing conditions, including approval by
our stockholders and compliance with regulatory requirements. If approved by
stockholders at the Annual Meeting on November 17, 2005, we anticipate the sale
will close during the quarter ended December 31, 2005. Bentley will acquire the
worldwide operations associated with REI, including the STAAD structural
analysis and design product line, software and product development, customer
support and relationships, and offices associated with the worldwide business.
As of that date, we met the criteria required to account for the REI business as
a discontinued operation. As such, the MD&A results of operations discussion is
broken up into discussions of continuing operations and discontinuing
operations.
As of September 30, 2005, our indebtedness under our convertible notes
totaled approximately $2,320,000 out of a total availability of $4,000,000. We
anticipate that the remaining indebtedness under our convertible notes will be
paid off with the proceeds from the sale of our REI business to Bentley.
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 doubtful accounts receivable; and
o impairment of long-lived assets, including goodwill.
REVENUE RECOGNITION
We derive revenues from:
o 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 reasonably assured.
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. 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.
In 1997, the Accounting Standards Executive Committee ("AcSec") of the
American Institute of Certified Public Accountants ("AICPA") issued Statement of
Position ("SOP") 97-2, "Software Revenue Recognition." SOP 97-2 distinguishes
between significant and insignificant vendor obligations as a basis for
recording revenue and requires that each element of a software licensing
arrangement be separately identified and accounted for based on relative fair
values of each element. We determine the fair value of each element in
multi-element transactions based on vendor-specific objective evidence ("VSOE").
VSOE for each element is based on the price charged when the same element is
sold separately.
21
In 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2, "Software
Revenue Recognition, With Respect to Certain Transactions," which modified SOP
97-2 to allow for use of the residual method of revenue recognition if certain
criteria are met. If evidence of fair value of all undelivered elements exists
but evidence does not exist for one or more delivered elements, then we
recognize revenue using the residual method. Under the residual method, the fair
value of the undelivered elements is deferred, and the remaining portion of the
transaction fee is recognized as revenue.
We recognize revenues from our IT services primarily on a time and
materials basis, with time at a marked-up rate and materials and other
reasonable expenses at cost, as we perform IT services. Certain IT services
contracts are fixed price contracts where we measure progress toward completion
by mutually agreed upon pre-determined milestones and recognize revenue upon
reaching those milestones. Our fixed price IT contracts typically are for a
short duration of one to six months. We did not have any uncompleted fixed price
IT contracts at September 30, 2005.
ALLOWANCE FOR DOUBTFUL 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. 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, we record bad debt expense and increase the allowance for accounts
receivable by an amount equal to the amount estimated to be unrecoverable. If
the historical data we use to calculate the allowance provided for doubtful
accounts does not reflect our future ability to collect outstanding receivables,
additional provisions for doubtful accounts may be needed and our future results
of operations could be materially affected.
IMPAIRMENT OF LONG-LIVED ASSETS INCLUDING GOODWILL
We apply the provisions of SFAS No. 86, "Accounting for the Cost of
Computer Software to be Sold, Leased, or Otherwise Marketed," to software
development costs. At each balance sheet date, we compare the unamortized
software development cost of each product to the net realizable value of the
product. We write off to cost of revenues the amount by which the unamortized
software development cost exceeds the net realizable value of the product.
On April 1, 2002, we adopted the provisions of SFAS No. 142, "Goodwill
and Other Intangible Assets." SFAS No. 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead be
tested at least annually for impairment.
We consider the following operating segments- 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.
22
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. We have no indication during the interim period ended September 30,
2005 that goodwill has been impaired, this we have not updated our annual test.
As of September 30, 2005, our goodwill balance was $2,929,000.
23
CONSOLIDATED RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED SEPTEMBER 30,
2005 VERSUS THREE AND SIX MONTHS ENDED SEPTEMBER 30, 2004
CONTINUING OPERATIONS
NET REVENUES
The following table presents our net revenues by segment (dollars in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2005 2004 2005 2004
------- ------- ------- -------
NET REVENUES
Collaborative
software products and services $ 172 $ 185 $ 380 $ 268
% of total net revenues 18.8% 15.2% 20.0% 11.3%
IT services 744 1,034 1,517 2,109
% of total net revenues 81.2% 84.8% 80.0% 88.7%
------- ------- ------- -------
Total net revenues $ 916 $1,219 $1,897 $2,377
======= ======= ======= =======
Total net revenues for the three and six months ended September 30,
2005 decreased by $303,000 (24.8%) and $480,000 (20.2%), respectively, compared
to the three and six months ended September 30, 2004.
COLLABORATIVE SOFTWARE PRODUCTS AND SERVICES
Net revenues from collaborative software products and services for the
three months ended September 30, 2005 decreased by $13,000 (7.0%) compared to
the three months ended September 30, 2004. Net revenues from collaborative
software products and services for the six months ended September 30, 2005
increased by $112,000 (41.8%) compared to the six months ended September 30,
2004 due to the completion and recognition of one large project in the amount of
$196,000 during the six months ended September 30, 2005, compared to $75,000 for
the same period in the prior year, an increase of $121,000. The timing of
completion and recognition of revenue from our large projects creates
variability in our collaborative software net revenues between quarters.
IT SERVICES
The trend of decreasing IT services net revenues continued during the
three and six months ended September 30, 2005, compared to the three and six
months ended September 30, 2004. IT services net revenues decreased $290,000
(28.0%) and $592,000 (28.1%) for the three and six months ended September 30,
2005, compared to the three and six months ended September 30, 2004. Net
revenues from IT services have decreased due to the scaling back of one of our
domestic IT services offices, due to decreases in IT services revenues from
Europe, and due to lowering the prices we charge our customers in order to be
able to compete with our competitors and to retain our current customers. For
the past several years, the IT services industry has been adversely affected by
a slow economy, and many of our customers reduced, and continue to reduce,
spending on technology consulting and systems integration services. In addition,
24
the decrease is also attributable to the fact that our EBPO services business
did not bring significant revenues to the IT services segment. Although we
anticipate that our EBPO services business will bring in additional revenues for
the IT services segment, we cannot assure you that we will be successful in this
endeavor, due to competition among providers of such services and relatively few
barriers to entry since EBPO services are not capital-intensive.
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 revenues, or gross margin (dollars
in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2005 2004 2005 2004
-------------- ------------- ------------- --------------
GROSS PROFIT
Collaborative
software products and services $ 171 $ 184 $ 378 $ 197
IT services 174 377 342 721
-------------- ------------- ------------- --------------
Consolidated $ 345 $ 561 $ 720 $ 918
============== ============= ============= ==============
GROSS MARGIN
Collaborative
software products and services 99.4% 99.5% 99.4% 73.5%
IT services 23.3% 36.5% 22.6% 34.1%
-------------- ------------- ------------- --------------
Consolidated 37.7% 46.0% 38.0% 38.6%
============== ============= ============= ==============
Consolidated gross margin decreased to 37.7% and 38.0% for the three
and six months ended September 30, 2005 from 46.0% and 38.6% for the three and
six months ended September 30, 2004 due to the decreasing gross margin for IT
services.
COLLABORATIVE SOFTWARE PRODUCTS AND SERVICES
Our 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 net revenues for
the collaborative software products and services segment includes royalty fees
and software amortization expense.
Gross margin in the collaborative software products and services
segment decreased by 0.1 percentage points to 99.4% for the three months ended
September 30, 2005 from 99.5% for the three months ended September 30, 2004.
Gross margin for the six months ended September 30, 2005 increased by 25.9
percentage points to 99.4% compared to 73.5% for the six months ended September
30, 2004. The increase in gross margin for the six months was primarily due to a
$69,000 decrease in software amortization costs as a result of the completion of
amortization during June 2004.
IT SERVICES
Gross margin in the IT services segment decreased by 13.2 and 11.5
percentage points for the three and six months ended September 30, 2005,
respectively, compared to the three and six months ended September 30, 2004. IT
services segment gross margin decreased due to the increase in the number of
employees for the new estimated EBPO projects we will undertake, but have not
begun yet or have been delayed. Historically, gross margin from the IT services
25
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 net 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.
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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------ -------------------------------
2005 2004 2005 2004
---------------- -------------- ------------- -------------
OPERATING EXPENSES
Selling, general and
administrative expenses $ 737 $ 722 $ 1,344 $ 1,397
% of total net revenues 80.5% 59.2% 70.9% 58.8%
Research and development
expenses $ 138 $ 135 $ 291 $ 273
% of total net revenues 15.1% 11.1% 15.3% 11.5%
Bad debt expense $ 165 $ - $ 221 $ 156
% of total net revenues 18.0% - 11.6% 6.6%
Depreciation $ 48 $ 71 $ 95 $ 139
% of total net revenues 5.2% 5.8% 5.0% 5.8%
Total operating expenses $ 1,088 $ 928 $ 1,951 $ 1,965
% of total net revenues 118.8% 76.1% 102.8% 82.7%
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses increased by
$15,000 (2.1%) and decreased by $53,000 (3.8%) for the three and six months
ended September 30, 2005, compared to the three and six months ended September
30, 2004. As a percentage of revenues, SG&A expenses increased 21.3 percentage
points and 12.1 percentage points for the three and six months ended September
30, 2005, compared to the three and six months ended September 30, 2004. SG&A
expenses increased as a percentage of total net revenues due to the fact that
the corporate overhead costs are remaining constant yet the total amount of net
revenues from the IT segment are decreasing. The decrease in the SG&A expenses
for the six months ended September 30, 2005 was primarily due to the following:
o a $72,000 decrease in insurance expenses and other benefits
due to a decrease in the number of our employees and due to
proper allocation of insurance expenses relating to IT
consultants to cost of sales;
o a $61,000 decrease in consulting fees due to our use of fewer
outside sales consultants; and
o a $52,000 decrease in sales commission due to less IT sales, a
change in the commission structure, and a decrease in the
number of sales employees.
26
The above decreases were offset by the following increases in SG&A
expense:
o a $73,000 increase in professional fees due to additional
accounting and legal fees;
o a $23,000 increase in board compensation expense due to
monthly pay increases;
o a $23,000 increase in traveling expenses due to increased
traveling by our sales departments and upper management in
order to increase sales growth and;
o an $8,000 increase in advertising expense aimed toward to
increasing market growth for our EBPO business.
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 six
months of fiscal 2006. In addition, obtaining profitability may be difficult due
to the future decrease in sales from the sale of our REI division and to the
decreasing trend in IT services sales.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses consist primarily of software
developers' wages. R&D expenses increased by $3,000 (2.2%) and $18,000 (6.6 %)
to $138,000 and $291,000 for the three and six months ended September 30, 2005,
from $135,000 and $273,000 for the three and six months ended September 30,
2004.
BAD DEBT EXPENSE
Bad debt expense increased by $165,000 and $15,000 to $165,000 and
$221,000 for the three and six months ended September 30, 2005, respectively
from zero and $156,000 for the three and six months ended September 30, 2004,
respectively. Bad debt expense increased during the three and six months ended
September 30, 2005 due to an increase in the reserve balance for receivables at
our India subsidiary.
DEPRECIATION
Depreciation expenses (excluding amounts charged to cost of revenues)
decreased $23,000 (32.4%) and $44,000 (31.7%) for the three and six months ended
September 30, 2005, respectively, compared to the three and six months ended
September 30, 2004. We anticipate that depreciation expenses will remain at this
lower level through the end of fiscal 2006.
SEGMENT PROFITABILITY AND OPERATING INCOME (LOSS)
During the three and six months ended September 30, 2005, consolidated
operating losses were $743,000 and $1,231,000, respectively, compared to
consolidated operating losses of $367,000 and $1,047,000 during the three and
six months ended September 30, 2004, respectively. Consolidated operating losses
during the three and six months ended September 30, 2005 consisted of operating
income from the collaborative software products and services segment, offset by
an operating loss for the IT services segment and for the corporate center.
Operating income in the engineering and collaborative software products and
services segment was $15,000 and $45,000 during the three and six months ended
September 30, 2005 compared to an operating income of $22,000 and an operating
loss of $274,000 during the three and six months ended September 30, 2004,
respectively. Operating income increased $296,000 during the six months ended
September 30, 2005 due to the following:
o a $141,000 decrease in bad debt expense due to additional
reserves needed;
o a $69,000 decrease in amortization of capitalized software due
to the completion of amortization in June 2004; and
o a $34,000 decrease in outside sales consulting expenses.
In the IT services segment, the operating loss during the three and six
months ended September 30, 2005 was $286,000 and $440,000, respectively,
compared to operating income of $50,000 and $77,000 during the three and six
months ended September 30, 2004. The decrease in operating income for both
periods was due to an increase in bad debt expense, an increase in the number of
employees for the new estimated EBPO projects we plan to undertake but have not
begun yet or have been delayed, and a decrease in the number of customers we
have resulting in a decrease in revenues.
27
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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------- -------------------------------
2005 2004 2005 2004
----------------- ---------------- ------------ -------------
OTHER EXPENSE (INCOME)
Interest expense, net $ 127 $ 98 $ 250 $ 216
% of total net revenues 13.9% 8.0% 13.2% 9.1%
Other income $ (11) $ (24) $ (6) $ (58)
% of total net revenues (1.2)% (1.9)% (0.3)% (2.5)%
Total other expense $ 116 $ 74 $ 244 $ 158
% of total net revenues 12.7% 6.1% 12.9% 6.6%
INTEREST EXPENSE, NET
Interest expense, net increased by $29,000 (29.6%) and $34,000 (15.7%%)
for the three and six months ended September 30, 2005 compared to the three and
six months ended September 30, 2004. The increase was due primarily to an
increase in interest expense from our Laurus debt resulting from the additional
convertible note issued to Laurus on December 23, 2004 and an increase in the
prime rates, which increased the stated rate on our convertible notes from 5.75%
to 7.75%. We anticipate paying off the entire Laurus debt after the close of the
REI sale to Bentley, which will decrease our interest expense in the future.
OTHER INCOME
Other income decreased by $13,000 and $52,000 for the three and six
months ended September 30, 2005, compared to the three and six months ended
September 30, 2004. During the three and six months ended September 30, 2004, we
had sold certain assets that were previously written off. We did not have any
similar transactions during the three and six months ended September 30, 2005.
INCOME TAXES
We recorded an income tax benefit of $3,000 and an income tax expense
of $7,000 for the three and six months ended September 30, 2005, respectively,
compared to income tax expenses of $3,000 and $8,000 during the three and six
months ended September 30, 2004, respectively. Tax expense for the three and six
months ended September 30, 2005 resulted from provisions for domestic and
foreign income taxes applicable to local jurisdictions.
DISCONTINUED OPERATIONS
On August 19, 2005, we entered into an Asset Purchase Agreement with
Bentley.. The Asset Purchase Agreement provides for the sale of our REI business
and STAAD product lines to Bentley for approximately $23.5 million in cash. Our
condensed consolidated financial statements have been reclassified for all
periods presented to reflect the REI business segment as discontinued
operations. In accordance with accounting principles generally accepted in the
United States, the revenues, costs, and expenses directly associated with the
REI business have been reclassified as discontinued operations on the condensed
consolidated statements of operations for all periods presented. Corporate
expenses such as general corporate overhead and interest have not been allocated
to discontinued operations.
28
Separately, in September 2004, we sold our Web-based telecommunications
services division in our continuing efforts to focus on our core software
products and IT services businesses. Accordingly, the results of the operations
of the Web-based telecommunications services division are excluded from
continuing operations and reported as "Discontinued Operations" for the three
and six months ended September 30, 2004. The total sales price was $130,000 for
the sale of the Web-based telecommunications services division in September
2004. We had received the entire proceeds from the sale of the Web-based
telecommunications services division as of March 31, 2005.
Net loss from discontinued operations for the three months ended
September 30, 2005 was $138,000 compared to a net income of $371,000 for the
same period in the prior year, a decrease of $509,000. The decrease in net
income was due to a $471,000 decrease in the REI business segment and a $38,000
decrease in the Web-based telecommunications services segment. The primary
decrease in the REI business segment was due to additional costs incurred
related to the sale of the REI division. Total costs incurred during the three
months ended September 30, 2005 were $411,000. The decrease in the Web-based
telecommunications services segment is due to the fact that this segment was
sold in September 2004, therefore there was no loss or income recorded during
the current year. Net income from discontinued operations for the six months
ended September 30, 2005 was $154,000 compared to $522,000 for the same period
in the prior year, a decrease of $368,000. The decrease in net income from
discontinued operations was due to a $301,000 decrease in the REI business
segment and a $67,000 decrease in the Web-based telecommunications services
segment. The decrease was due to $411,000 of additional costs incurred related
to the sale of the REI division, offset by an increase in sales revenue from
STAAD products.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have relied upon cash from financing activities to
fund the majority 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. Currently, we finance our operations (including capital
expenditures) primarily through existing cash and cash equivalent balances and
issuance of convertible notes. We have used debt and equity financing when
appropriate and practicable, such as by issuing to Laurus a $2,400,000
convertible note in December 2003 ("2003 Note"), as amended in April 2004, and a
$1,000,000 convertible note in December 2004 ("2004 Note"). In addition, we
expect to close the sale of our REI division during the quarter ending December
31, 2005. If the sale occurs as anticipated, the gross proceeds will be
approximately $23.5 million. We intend to allocate a portion of the sale
proceeds to transaction costs, applicable taxes and the retirement of
approximately $3.3 million of outstanding debt. We anticipate that the proceeds
will strengthen our balance sheet with a substantial cash position and therefore
provide us with the financial resources to allow management to explore proper
allocation of capital for strategic opportunities and/or the return of capital
to the stockholders.
Our principal sources of liquidity at September 30, 2005 consisted of
$2,753,000 of cash and cash equivalents. Cash and cash equivalents of our
continuing operations decreased by $1,222,000 (33.2%) during the six months
ended September 30, 2005. Cash flow from discontinued operations provided
$294,000 for the six months ended September 30, 2005, compared to total cash
used in discontinued operations of $59,000 for the six months ended September
30, 2004.
29
Net cash used in continuing operations was $498,000 during six months
ended September 30, 2005 compared to $1,164,000 for the six months ended
September 30, 2004, an increase of $666,000. Net loss from continuing
operations of $1,328,000 during the six months ended September 30, 2005 and net
loss from continuing operations of $691,000 during the six months ended
September 30, 2004 were the primary reasons for cash used in operations in both
periods.
The following contributed to cash usage during the six months ended
September 30, 2005:
o A $55,000 decrease in accrued expenses due primarily to
payments of year-end audit and other professional fees; and
o A $255,000 decrease in deferred revenues primarily due to a
lower level of new maintenance billings and the recognition of
revenues from one large collaborative software contract that
was deferred at year-end.
The above cash usages were partially offset by the following
contributors to cash during the six months ended September 30, 2005:
o A $462,000 decrease in accounts receivable due to a few large
payments received for large contracts and due to one of our
larger IT customers paying on a net 15-day basis instead of
net 60 days;
o A $227,000 increase in accounts payable due to larger
professional fee invoices being held for payment until the
sale of the REI division goes through; and
o A $187,000 decrease in prepaid expenses and other current
assets due to the write-off of the remaining capitalized film
costs, the write-off of tax deducted at source amounts that
are not recoverable, and a decrease in prepaid insurance fees.
The following contributed to cash usage during the six months ended
September 30, 2004:
o A $246,000 increase in accounts receivable primarily due to a
higher proportion of sales on credit toward the end of
September 2004;
o A $105,000 decrease in accrued expenses primarily due to
payment of severance payments and professional fees;
o A $124,000 decrease in accounts payable due to payments; and
o A $94,000 increase in prepaid expenses and other current
assets due primarily to a receivable resulting from the sale
of our Web-based telecommunications services division.
Although we anticipate our cash needs will increase in the upcoming
quarters as a result of increases in expenses related to our EBPO 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 EBPO services differ from anticipated levels due to unanticipated
increases in labor costs, decreased demand, competition, or other factors.
Net cash used in investing activities during the six months ended
September 30, 2005 consisted of capital expenditures of $67,000. Net cash used
in investing activities during the six months ended September 30, 2004 consisted
of capital expenditures of $106,000, offset by $100,000 from the sale of
short-term investments and $191,000 of proceeds from the sale of e-destinations
and our Web-based telecommunications services division.
30
Cash used in financing activities during the six months ended September
30, 2005 primarily resulted from $604,000 in long-term debt repayments. Cash
provided by financing activities during the six months ended September 30, 2004
primarily resulted from long-term borrowings of $2,032,000 (including $990,000
in additional borrowings, net of fees, under the Amended and Restated 2003 Note)
and $50,000 of proceeds from warrant exercises, offset by $1,294,000 in
long-term debt repayments.
We incurred net losses from continuing operations of $1,328,000 and
$691,000 and used cash in operations of $498,000 and $1,164,000 during the six
months ended September 30, 2005 and 2004, 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.
We believe that the additional proceeds from the proposed sale of our
REI division, which we anticipate will close during the quarter ending December
31, 2005, will be adequate to fund our operations for the next twelve months.
However, to the extent we are in need of any additional financing, we cannot
assure you that any such additional financing will be available to us on
acceptable terms, or at all. 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 will restrict our flexibility. At a minimum, we expect
these covenants to include restrictions on our ability to pay dividends on our
common stock.
The following table summarizes our contractual obligations and
commercial commitments at September 30, 2005 (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* $ 3,005 $ 1,361 $ 1,496 $ 145 $ 3
Capital Lease Obligations 63 16 35 12 -
Operating Leases 125 98 27 - -
------------- ------------- ------------- ------------ -----------
Total Contractual Cash Obligations $ 3,193 $ 1,475 $ 1,558 $ 157 $ 3
============= ============= ============= ============ ===========
* Excludes debt discount of $308
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 2002 Note and the Amended 2003 Note
(collectively, the "Laurus Notes"). At September 30, 2005, we had no borrowings
under the revolving credit facility and we had a total availability of
$1,680,000 under the revolving credit facility. We anticipate that this
revolving credit facility will be terminated after the remaining indebtedness
under our convertible notes is paid off with the proceeds from the sale of our
REI business to Bentley.
We are required to use the net proceeds from this financing for general
corporate purposes only. We are also required not to permit for any fiscal
quarter commencing April 1, 2003, the net operating cash flow deficit to be
greater than $500,000, excluding extraordinary items, as determined by Laurus.
We were in compliance with such covenant as of September 30, 2005.
31
ITEM 3. CONTROLS AND PROCEDURES.
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of September 30, 2005, that the design and
operation of our "disclosure controls and procedures" (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange
Act")) are effective to ensure that information required to be disclosed by us
in the reports filed or submitted by us under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
SEC's rules and forms, including to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding whether or not disclosure is required.
During the quarter ended September 30, 2005, there were no changes
in our "internal controls over financial reporting" (as defined in Rule
13a-15(f) under the Exchange Act) that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
Under current SEC guidelines, the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002 (the "Act") will be effective for our fiscal year
ending March 31, 2007. In order to comply with the Act, we have begun a
comprehensive effort, which includes documentation and testing of the design and
operation of our internal controls using the guidelines established by Internal
Control -Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. During the course of these activities,
we may identify certain internal control matters that our management believes
should be improved. These improvements, if necessary, will likely include
further formalization of existing policies and procedures, improved segregation
of duties, additional information technology system controls and additional
monitoring controls. Although our management does not believe that any of these
matters will result in material weaknesses being identified in our internal
controls as defined by the Public Company Accounting Oversight Board (United
States), no assurances can be given regarding the outcome of these efforts at
the present time.
32
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are named defendant in a civil action commenced against us by
plaintiffs Ash Brahma ("Brahma"), Sujit Kumar ("Kumar"), and Venture
International ("Venture") (collectively, "Plaintiffs") on August 18, 2005, in
the Commonwealth of Massachusetts, Essex County, Superior Court Department of
the Trial Court, Civil Action No. 05-1446 B, entitled, ASH BRAHMA, ET AL. V.
NETGURU, INC. (the "Action").
In the Action, Plaintiffs allege breach of contract and fraud on our
part, and they seek alleged damages of $4,885,000. On October 5, 2005, we timely
filed a Notice of Removal of the Action to the United States District Court,
District of Massachusetts, where the Action is currently pending.
On October 13, 2005, we filed our answer and counterclaim in the
Action. netGuru denies any breach of contract or other wrongdoing on our part,
and have denied that Plaintiffs are entitled to equitable relief or damages.
Our Counterclaim seeks recission of contract and/or breach of contract,
restitution and/or damages for consulting fees paid to Plaintiffs,
damages for time and money spent pursuant to the contracts alleged objectives,
plus interest, costs and attorneys' fees.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
DIVIDENDS AND RESTRICTIONS
The credit facility with Laurus prohibits us from paying any dividends
on our common stock without Laurus' permission. We were required to use the net
proceeds from the Laurus financing for general corporate purposes only. We are
also required not to permit for any fiscal quarter commencing April 1, 2003, the
net operating cash flow deficit to be greater than $500,000, excluding
extraordinary items, as determined by Laurus. At September 30, 2005, we were in
compliance with this covenant.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended September 30, 2005, no matters were
submitted to a vote of our common stockholders.
ITEM 5. OTHER INFORMATION
None.
33
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.1 Asset Purchase Agreement dated as of August 19, 2005 between netguru,
Inc. and Bentley Systems, Incorporated ("Purchase Agreement") (1)
10.2 Form of Transition Services Agreement proposed to be entered into by
and between netGuru, Inc. and Bentley Systems, Incorporated at the
closing of Purchase Agreement (1)
10.3 Voting Agreement dated as of August 19, 2005 by and between Bentley
Systems, Incorporated and Peter R. Kellogg (1)
10.4 Voting Agreement dated as of August 19, 2005 by and between Bentley
Systems, Incorporated and Santanu Das (1)
10.5 Stand Still Agreement dated as of August 19, 2005 by and between
netGuru, Inc. and Laurus Master Fund, Ltd. (1)
10.6 Summary of special compensation approved August 31, 2005 for executive
officers and special committee members. (2)
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 (3)
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 (3)
__________
(1) Filed on August 24, 2005 as an exhibit to our Form 8-K for August 18,
2005 and incorporated herein by reference.
(2) Filed on September 6, 2005 as an exhibit to our Form 8-K for August 31,
2005 and incorporated herein by reference
(3) Attached as an exhibit to this Form 10-QSB
34
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: November 14, 2005
NETGURU, INC.
By: /s/ BRUCE K. NELSON
----------------------
Bruce K. Nelson
Chief Financial Officer (principal
financial officer and duly authorized
officer)
35
EXHIBITS FILED WITH THIS QUARTERLY REPORT ON FORM 10-QSB
Exh. No. Description
-------- -----------
31 Certifications required by Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended, as
adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
36