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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO
Commission file number 0-23049
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ISLAND PACIFIC, INC.
--------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0896617
---------------------------- ---------------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
19800 MACARTHUR BOULEVARD, 12TH FLOOR, IRVINE, CALIFORNIA 92612
- --------------------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(949) 476-2212
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $0.0001 Par Value - 54,809,255 shares as of July 31, 2004.
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TABLE OF CONTENTS
PAGE
----
PART I. - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2004
and March 31, 2004.............................................3
Condensed Consolidated Statements of Operations for the Three
Months Ended June 30, 2004 and 2003............................4
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended June 30, 2004 and 2003............................5
Notes to Condensed Consolidated Financial Statements ................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................20
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........39
Item 4. Controls and Procedures..............................................40
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings....................................................40
Item 2. Changes in Securities and Use of Proceeds............................40
Item 3. Defaults Upon Senior Securities......................................40
Item 4. Submission of Matters to a Vote of Security Holders..................40
Item 5. Other Information....................................................40
Item 6. Exhibits and Reports on Form 8-K.....................................41
SIGNATURES....................................................................46
2
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ISLAND PACIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
JUNE 30, MARCH 31,
2004 2004
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 1,289 $ 2,108
Accounts receivable, net of allowance for doubtful accounts of
$1,044 and $409, respectively 6,615 4,572
Other receivables, including $14 and $37 from related parties,
respectively 83 143
Inventories 40 46
Current portion of non-compete agreements 471 668
Current portion of note receivable 36 36
Prepaid expenses and other current assets 673 472
--------- ---------
Total current assets 9,207 8,045
Note receivable 117 126
Property and equipment, net 1,226 821
Goodwill, net 30,654 20,469
Other intangibles, net 25,270 22,099
Other assets, including $170 from related party 211 202
--------- ---------
Total assets $ 66,685 $ 51,762
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of notes payable to related parties $ 451 $ --
Current portion of notes payable 2,470
Current portion of convertible debentures 1,189 146
Current portion of capital leases 176 169
Line of credit 182 --
Accounts payable 2,007 1,255
Accrued expenses 3,709 3,016
Deferred revenue 6,327 2,657
Income tax payable 127 --
--------- ---------
Total current liabilities 16,638 7,243
Notes payable to related parties, less current maturities 2,134 --
Notes payable, less current maturities 352 --
Convertible debentures, net of debt discount of $623 and $706,
respectively, less current maturities 1,210 2,160
Capital lease obligations, less current maturities 52 89
Deferred revenue 906 --
Deferred rent 89 70
--------- ---------
Total liabilities 21,381 9,562
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred Stock, $.0001 par value; 5,000,000 shares authorized:
Series A Convertible Preferred, 7.2% cumulative 141,100 shares
issued and outstanding with a stated value of $100 per share,
dividends in arrears of $2,286 and $2,002, respectively 14,100 14,100
Series B Convertible Preferred , cumulative dividend of $0.136 per
share per annum commencing on January 1, 2005, 2,517,233 shares
issued and outstanding with a stated value of $3 per share 5,709 --
Common Stock, $.0001 par value; 100,000,000 shares authorized;
53,974,532 and 52,427,799 shares issued and outstanding, respectively 5 5
Additional paid in capital 74,001 72,813
Accumulated deficit (48,511) (44,718)
--------- ---------
Total stockholders' equity 45,304 42,200
--------- ---------
Total liabilities and stockholders' equity $ 66,685 $ 51,762
========= =========
The accompanying notes are an integral part of
these condensed consolidated financial statements.
3
ISLAND PACIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended
June 30,
2004 2003
--------- ---------
Net sales $ 5,283 $ 5,466
Cost of sales 1,833 1,654
--------- ---------
Gross profit 3,450 3,812
Expenses:
Application development 1,247 137
Depreciation and amortization 1,306 868
Selling, general and administrative 4,517 2,796
--------- ---------
Total expenses 7,070 3,801
--------- ---------
Income (loss) from operations (3,620) 11
Other income (expense):
Interest income -- 26
Other income (expense) 97 (11)
Interest expense (270) (311)
--------- ---------
Total other expense (173) (296)
--------- ---------
Loss before provision for income taxes (3,793) (285)
Provision for income tax benefits -- 570
--------- ---------
Net income (loss) (3,793) 285
Cumulative preferred dividends (286) (272)
--------- ---------
Net income (loss) available to common stockholders $ (4,079) $ 13
========= =========
Basic earnings (loss) per share:
Net loss $ (0.07) $ 0.01
Cumulative preferred dividends (0.01) (0.01)
--------- ---------
Net income (loss) available to common stockholders $ (0.08) $ --
========= =========
Diluted earnings (loss) per share:
Net income (loss) $ (0.07) $ --
Cumulative preferred dividends (0.01) --
--------- ---------
Net income (loss) available to common stockholders $ (0.08) $ --
========= =========
Weighted-average common shares outstanding:
Basic 52,938 31,615
Diluted 52,938 64,743
The accompanying notes are an integral part of
these condensed consolidated financial statements.
4
ISLAND PACIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
THREE MONTHS ENDED
JUNE 30,
2004 2003
-------- --------
Cash flows from operating activities:
Net income (loss) $(3,793) $ 285
Adjustments to reconcile net income (loss) to net cash used for operating
activities:
Depreciation and amortization 1,306 868
Amortization of debt discount and conversion option 83 189
Provision for allowance for doubtful accounts, net of recoveries 48 81
Stock-based compensation 18 --
Common stock issued for services rendered and settlement cost -- 25
Changes in assets and liabilities net of effects from acquisitions:
Accounts receivable and other receivables (470) (2,797)
Income tax refund receivable -- (845)
Inventories 7 5
Prepaid expenses and other assets (62) (74)
Accounts payable and accrued expenses (182) (866)
Income tax payable -- 271
Accrued interest on stockholders' loans, convertible notes and term loan 85 57
Deferred revenue 1,887 1,483
-------- --------
Net cash used for operating activities (1,073) (1,318)
-------- --------
Cash flows from investing activities:
Payment from note receivable 9 --
Proceeds from acquisition of Retail Technologies International, Inc., net 672 --
Purchases of furniture and equipment (30) (11)
Capitalized software development costs (260) (900)
-------- --------
Net cash provided by (used for) investing activities 391 (911)
-------- --------
Cash flows from financing activities:
Sale of common stock, net of offering costs -- 7,264
Decrease in amount due to stockholders, net (220) --
Proceeds from convertible debts -- 700
Payments on capital leases (40) --
Payments on convertible debentures (59) --
Proceeds from line of credit 182 --
-------- --------
Net cash provided by (used for) financing activities (137) 7,964
-------- --------
Effect of exchange rate changes on cash -- (1)
-------- --------
Net increase (decrease) in cash and cash equivalents (819) 5,734
Cash and cash equivalents, beginning of period 2,108 1,319
-------- --------
Cash and cash equivalents, end of period $ 1,289 $ 7,053
======== ========
Supplemental disclosure of cash flow information:
Interest paid $ 76 $ 61
Income taxes paid
Supplemental schedule of non-cash investing and financing activities:
Issued 2,517,233 shares of Series B Convertible Preferred Stock in
connection with the acquisition of Retail Technologies International, Inc. 5,709 --
Issued 1,546,733 shares of common stock in connection with the acquisition
of Retail Technologies International, Inc. 1,169 --
Issued promissory notes in connection with the acquisition of Retail
Technologies International, Inc. 3,622 --
-------- --------
Issued 9,849 shares of common stock as payments for
bonuses and services rendered in prior periods $ -- $ 8
The accompanying notes are an integral part of
these condensed consolidated financial statements.
5
ISLAND PACIFIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BASIS OF PREPARATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles applicable
to interim financial statements. Accordingly, they do not include all of the
information and notes required for complete financial statements. In the opinion
of management, all adjustments necessary to present fairly the financial
position, results of operations and cash flows at June 30, 2004 and for all the
periods presented have been made.
Certain amounts in the prior periods have been reclassified to conform to the
presentation for the three months ended June 30, 2004. The financial information
included in this quarterly report should be read in conjunction with the
consolidated financial statements and related notes thereto in our Form 10-K for
the year ended March 31, 2004.
The results of operations for the three months ended June 30, 2004 and 2003 are
not necessarily indicative of the results to be expected for the full year.
NOTE 2 - ACQUISITIONS
PAGE DIGITAL INCORPORATED
Effective January 30, 2004, we acquired all of the issued and outstanding shares
of Page Digital Incorporated ("Page Digital"), a Colorado-based developer of
multi-channel commerce software, through a merger with our newly-formed
wholly-owned subsidiary. The purchase price for the acquisition was $7.0
million, consisting of $2.0 million in cash and 2.5 million shares of our common
stock valued at $2.00 per share. Upon the consummation of this transaction, we
entered into two-year employment agreements for executive officer positions with
two of the principals of Page Digital and a two-year non-compete agreement with
one of the two principals of Page Digital.
The following unaudited pro forma consolidated results of continuing operations
for the three months ended June 30, 2003 assume the acquisition of Page Digital
occurred as of April 1, 2003. The pro forma results are not necessarily
indicative of the actual results that would have occurred had the acquisitions
been completed as of the beginning of the period presented, nor are they
necessarily indicative of future consolidated results.
Quarter ended
June 30, 2003
-------------
(unaudited)
(in thousands, except
per share data)
Net sales $ 6,832
Net income $ 323
Net income available to common stockholders $ 51
Basic and diluted income per share of common stock $ 0.01
Basic and diluted income per share available to common stockholders $ --
RETAIL TECHNOLOGIES INTERNATIONAL, INC.
Pursuant to an agreement dated June 1, 2004, we acquired Retail Technologies
International, Inc. ("RTI") from Michael Tomczak, Jeffrey Boone and Intuit Inc.
("Intuit") in a merger transaction. On March 12, 2004, we, RTI, IPI Merger Sub,
Inc., ("Merger Sub") and Michael Tomczak and Jeffrey Boone (the "Shareholders")
entered the initial Agreement of Merger and Plan of Reorganization (the "March
12, 2004 Merger Agreement") which provided we would acquire RTI in a merger
transaction in which RTI would merge with and into Merger Sub. The merger
consideration contemplated by the March 12, 2004 Merger Agreement was a
combination of cash and shares of our common stock. The March 12, 2004 Merger
Agreement was amended by the Amended and Restated Agreement of Merger and Plan
of Reorganization, dated June 1, 2004, by and between us, RTI, Merger Sub, IPI
Merger Sub II, Inc. ("Merger Sub II") and the Shareholders (the "Amended Merger
Agreement").
6
Pursuant to the Amended Merger Agreement, the Merger (as defined below) was
completed with the following terms: (i) we assumed RTI's obligations under those
certain promissory notes issued by RTI on December 20, 2002 with an aggregate
principal balance of $2.3 million; (ii) the total consideration paid at the
closing of the Merger was $10.0 million paid in shares of our common stock and
newly designated Series B convertible preferred stock ("Series B Preferred") and
promissory notes; (iii) the Shareholders and Intuit are entitled to price
protection payable if and to the extent that the average trading price of our
common stock is less than $0.76 at the time the shares of our common stock
issued in the Merger and issuable upon conversion of the Series B Preferred are
registered pursuant to the registration rights agreement dated June 1, 2004
between us, the Shareholders and Intuit (the "Registration Rights Agreement");
and (iv) the merger consisted of two steps (the "Merger"), first, Merger Sub
merged with and into RTI, Merger Sub's separate corporate existence ceased and
RTI continued as the surviving corporation (the "Reverse Merger"), immediately
thereafter, RTI merged with and into Merger Sub II, RTI's separate corporate
existence ceased and Merger Sub II continued as the surviving corporation (the
"Second-Step Merger").
As a result of the Merger, each Shareholder received 1,258,616 shares of Series
B Preferred and a promissory note payable monthly over two years in the
principal amount of $1,295,000 bearing interest at 6.5% per annum. As a result
of the Merger, Intuit, the holder of all of the outstanding shares of RTI's
Series A Preferred stock, received 1,546,733 shares of our common stock and a
promissory note payable monthly over two years in the principal amount of
$530,700 bearing interest at 6.5% per annum.
The Shareholders and Intuit were also granted registration rights. Under the
Registration Rights Agreement, we agreed to register the common stock issuable
upon conversion of the Series B Preferred issued to the Shareholders within 30
days of the automatic conversion of the Series B Preferred into common stock.
The automatic conversion will occur upon us filing an amendment to our
certificate of incorporation with the Delaware Secretary of State increasing the
authorized number of shares of our common stock ("Certificate of Amendment")
after securing shareholder approval for the Certificate of Amendment. Under the
Registration Rights Agreement, Intuit is entitled to demand registration or to
have its shares included on any registration statement filed prior the
registration statement covering the Shareholders' shares, subject to certain
conditions and limitations, or if not previously registered to have its shares
included on the registration statement registering the Shareholders' shares. The
Shareholders and Intuit are entitled to price protection payments of up to a
maximum of $0.23 per share payable by promissory note, if and to the extent that
the average closing price of our common stock for the 10 days immediately
preceding the date the registration statement covering their shares is declared
effective by the Securities and Exchange Commission, is less than the 10 day
average closing price as of June 1, 2004, which was $0.76
Pursuant to the Amended Merger Agreement, The Sage Group, plc as well as certain
officers and directors signed voting agreements that provide they will not
dispose of or transfer their shares of our capital stock and that they will vote
their shares of our capital stock in favor of the Certificate of Amendment and
the Amended Merger Agreement and transactions contemplated therein.
Upon the consummation of the Merger, Michael Tomczak, RTI's former President and
Chief Executive Officer, was appointed our President, Chief Operating Officer
and director and Jeffrey Boone, RTI's former Chief Technology Officer, was
appointed our Chief Technology Officer. We entered into two-year employment
agreements and non-competition agreements with Mr. Tomczak and Mr. Boone.
We entered into an employment agreement with Michael Tomczak on June 1, 2004.
The term of the agreement is two years. Under the agreement, Mr. Tomczak is
entitled to $360,000 in annual compensation. He also received an option to
purchase 1,772,354 shares of our common stock. Mr. Tomczak's right to purchase
886,178 of the shares subject to the option shall vest at the first anniversary
date of this agreement, thereafter, the remaining option shall vest at the rate
of 73,848 shares per month during the second year of this agreement. If Mr.
Tomczak's employment with us is terminated without cause during the term of the
agreement, he will receive severance in the amount of the lesser of $360,000 or
the balance of compensation payable over the remaining term of the agreement,
but in no event should the amount be less than $180,000. We also entered into
non-competition agreement with Mr. Tomczak, pursuant to which Mr. Tomczak agreed
not to engage in any business or activity that in any way competes with us for a
period of two years after the termination of his employment with us.
7
We entered into an employment agreement with Jeffrey Boone on June 1, 2004. The
term of the agreement is two years. Under the agreement, Mr. Boone is entitled
to $240,000 in annual compensation. He also received an option to purchase
1,572,354 shares of our common stock. Mr. Boone's right to purchase 786,179 of
the shares subject to the option shall vest at the first anniversary date of
this agreement, thereafter, the remaining option shall vest at the rate of
65,514 shares per month during the second year of this agreement. If Mr. Boone's
employment with us is terminated without cause during the term of the agreement,
he will receive severance in the amount of the lesser of $240,000 or the balance
of his compensation payable over the remaining term of the agreement, but in no
event should the amount be less than $120,000. We also entered into
non-competition agreement with Mr. Boone, pursuant to which Mr. Boone agreed not
to engage in any business or activity that in any way competes with us for a
period of two years after the termination of his employment with us.
The acquisition has been accounted for as a purchase. The results of the
operations of RTI have been included in the consolidated financial statements
since the date of the acquisition. The excess of purchase price over the fair
values of net assets acquired was approximately $10.2 million and has been
recorded as goodwill. The fair value of assets acquired and liabilities assumed
were as follows (in thousands):
Accounts receivable $ 1,348
Inventory
Property and equipment 496
Other assets 4,931
Liabilities assumed (6,460)
---------
Net assets 315
Excess of cost over fair value of net assets acquired 10,185
---------
Total purchase price $ 10,500
=========
The following unaudited pro forma consolidated results for the three months
ended June 30, 2004 and 2003 assume the acquisitions of RTI occurred as of April
1, 2004 and 2003, respectively, and Page Digital occurred as of April 1, 2003.
The pro forma results are not necessarily indicative of the actual results that
would have occurred had the acquisitions been completed as of the beginning of
the period presented, nor are they necessarily indicative of future consolidated
results.
Quarters Ended
June 30,
2004 2003
-------- --------
(unaudited)
(in thousands, except per share data)
Net sales $ 6,676 $ 8,974
Net income (loss) $(4,725) $ 365
Net income (loss) available to common stockholders $(5,011) $ 93
Basic and diluted income (loss) per share of common stock $ (0.09) $ 0.01
Basic and diluted income (loss) per share available to common
stockholders $ (0.09) $ --
NOTE 3 - NOTE RECEIVABLE
Effective April 1, 2003, we sold our wholly-owned subsidiary, SVI Training
Products, Inc. ("Training Products"), to its former president, for the sale
price of $180,000 plus earn-out payments equal to 20% of the total gross
revenues of Training Products in each of its next two fiscal years, to the
extent the revenues in each of those years exceed certain targets. We received a
promissory note for the amount of $180,000 and the earn-out payments, if any,
will be made in quarterly installments following each fiscal year, bearing an
annual interest rate of 5%. We agreed to postpone the payments due January 2004
and April 2004 until April 2008. The note has a balance of $153,000 and $162,000
at June 30, 2004 and March 31, 2004, respectively, of which $36,000 is current.
8
NOTE 4 - INVENTORIES
Inventories consist of finished goods and are stated at the lower of cost or
market, on a first-in, first-out basis.
NOTE 5 - GOODWILL AND OTHER INTANGIBLES
At June 30, 2004 and March 31, 2004, goodwill and other intangibles consist of
the following (in thousands):
JUNE 30, 2004 MARCH 31, 2004
Gross Gross
carrying Accumulated carrying Accumulated
amount amortization Net amount amortization Net
--------------------------------------- ---------------------------------------
Goodwill $ 37,147 $ (6,493) $ 30,654 $ 26,962 $ (6,493) $ 20,469
--------------------------------------- ---------------------------------------
Other intangibles:
Amortized intangible
assets
Software technology 35,874 (14,164) 21,710 34,257 (13,317) 20,940
Non-compete agreements 7,015 (6,543) 471 6,986 (6,318) 668
Customer relationships 2,564 (89) 2,475 904 (30) 874
Unamortized intangible
Trademark 1,085 -- 1,085 285 -- 285
--------------------------------------- ---------------------------------------
46,537 (20,796) 25,741 42,432 (19,665) 22,767
Less: current portion of
non- compete agreements 471 -- 471 668 -- 668
--------------------------------------- ---------------------------------------
Long-term portion of other
intangibles 46,066 (20,796) 25,270 41,764 (19,665) 22,099
--------------------------------------- ---------------------------------------
Long-term portion of
goodwill and other
intangibles $ 83,213 $(27,289) $ 55,924 $ 68,726 $(26,158) $ 42,568
======================================= =======================================
During the quarter ended June 30, 2004, we recorded approximately $10.2 million
goodwill, $1.4 million software, $1.7 million customer relationships, $800,000
trademark and $29,000 non-compete agreement in connection with the acquisition
of RTI. Software and customer relationships are amortized on a straight-line
basis over their useful lives, seven and ten years, respectively. The goodwill
and the trademark have indefinite useful lives and are not subject to
amortization. The non-compete agreement will be amortized its remaining useful
life of seven months.
We found no indication of impairment of the goodwill during the quarter ended
June 30, 2004. Accordingly, absent of future indications of impairment, the next
annual impairment test will be performed in fourth quarter of fiscal 2005.
We also evaluated the remaining useful lives of our intangible assets in the
quarter ended June 30, 2003 and during the fourth quarter 2004. No adjustments
have been made to the useful lives of our intangible assets.
Amortization expense from continuing operations for quarters ended June 30, 2004
and 2003 was $1.2 million and $812,000, respectively. We expect amortization
expense for the next five years to be as follows (in thousands):
Year Ending March 31:
2006 $ 4,981
2007 $ 4,340
2008 $ 4,162
2009 $ 4,138
2010 $ 3,211
9
NOTE 6 - DEBTS
NOTES PAYABLE TO RELATED PARTIES
In connection with the RTI acquisition, we issued promissory notes to RTI's two
principal officers totaling $2,585,000 , payable in installments totaling
$20,000 per month for the period of June 1, 2004 through May 1, 2005 and
increasing to $200,000 per month from June 1, 2005 through June 1, 2006, at 6.5%
interest per annum. The notes have a balance of $2,585,000 as of June 30, 2004,
of which $451,000 is current. There were no notes payable due to related parties
at March 31, 2004.
NOTES PAYABLE
In connection with the acquisition of RTI, we issued a promissory note to Intuit
and assumed RTI's obligations under certain promissory notes originally issued
by RTI. Notes payable consisted of the following (in thousands):
June 30, March 31,
2004 2004
------ ------
Notes payable, secured by common stock of our new subsidiary, IP Retail
Technologies International, Inc. ("IP RTI"), payable in monthly
installments totaling $197,000 including interest at 6.5%
per annum beginning June 1, 2004 through May 31, 2005 $2,289 $ --
Note payable, to Intuit, secured by IP RTI's common stock, payable in
monthly installments of $4,000 for the period from June 1, 2004 through
December 1, 2004 and $30,000 from January 1, 2005 through
June 1, 2006, including interest at 6.5% per annum 533 --
------ ------
Total 2,822 --
Less: accrued interest 3 --
------ ------
$2,819 $ --
====== ======
Total notes payable (including accrued interest) $2,822 $ --
------ ------
Less: current maturities 2,470 --
------ ------
Long-term portion of notes payable $ 352 $ --
====== ======
CONVERTIBLE DEBENTURES
In March 2004, we entered into a Securities Purchase Agreement for the sale of
convertible debentures (the "March '04 Debentures") to two investors (the
"Purchasers") for the total gross proceeds of $3.0 million. The debentures
mature in May 2006, bear an interest rate of 9% per annum and provide for
interest only payments on a quarterly basis, payable, at our option, in cash or
shares of our common stock. The debentures are convertible into shares of our
common stock at a conversion price of $1.32 per share, subject to adjustment if
we offer or sell any securities for an effective per share price that is less
than 87% of the then current conversion price, negatively restate any of our
financial statement or make any public disclosure that negatively revises or
supplements any prior disclosure regarding a material transaction consummated
prior to March 15, 2004 or trigger other customary anti-dilution protections. If
certain conditions are met, we have the option to redeem the March '04
Debentures at 110% of their face value, plus accrued but unpaid interest.
We must redeem the debentures at the initial monthly amount of $233,333
commencing on February 1, 2005. If the daily volume weighted average price of
our common stock on the American Stock Exchange exceeds $1.15 by more than 200%
for 15 consecutive trading days, we have the option to cause the Purchasers to
convert the then outstanding principal amount of March '04 debentures into our
common stock at the conversion price then in effect.
We also issued the Purchasers two warrants as follows: (1) Series A Warrants to
purchase up to an aggregate of 1,043,479 shares of our common stock at an
exercise price of $1.15 per share with a five-year term, exercisable at anytime
after September 16, 2004, subject to adjustment if we offer or sell any
securities for an effective per share price that is less than the then current
exercise price, negatively restate any of our financial statements or make any
public disclosure that negatively revises or supplements any prior disclosure
regarding a material transaction consummated prior to March 15, 2004 or trigger
other customary anti-dilution protections and (2) Series B Warrants to purchase
up to 8,500,000 shares of our common stock with an exercise price of $5 per
share, these warrants are immediately exercisable and expire on the earlier of
the six-month anniversary of the effective date of the registration statement
10
that is required to be filed or 18 months from March 15, 2004, subject to
adjustment upon the issuance or sale of securities in a public offering for an
effective per share price that is less than the then-current exercise price and
upon the trigger of other customary anti-dilution protections.
For a period of one hundred eighty (180) days following the date the
registration statement is declared effective ("Effective Date"), each Purchaser
has the right, in its sole discretion, to elect to purchase such Purchaser's pro
rata portion of additional Debentures and Series A Warrants for an aggregate
purchase price of up to $2,000,000 in a second closing (the "Second Closing").
The terms of the Second Closing shall be identical to the terms set forth in the
Purchase Agreement and related documents, except that, the conversion price for
the additional debentures and the exercise price for the additional warrants
shall be equal to 115% of the average of the daily volume weighted average price
of our common stock on the American Stock Exchange for the ten (10) days
preceding the Second Closing ("Second Closing Price"). The Series A Warrant
coverage for the Second Closing shall be 40% of each Purchaser's subscription
amount divided by the Second Closing Price.
For a period of one hundred eighty (180) days following the Effective Date, if
the daily volume weighted average price of our common stock for twenty (20)
consecutive trading days exceeds $2.00, subject to adjustment, we may, on one
occasion, in our sole determination, require the Purchasers to purchase each
such Purchaser's pro rata portion of additional debentures and Series A Warrants
for an aggregate purchase price of up to $2,000,000. Any such additional
investment shall be under the terms set forth in the Purchase Agreement and
related documents, except that, the conversion price for the additional
Debentures and the exercise price for the additional warrants shall be equal to
the then current conversion price and warrant exercise price for the 9%
Debentures and warrants purchased on March 15, 2004.
For a period of six (6) months from the Effective Date, the Purchasers have a
right of first refusal to participate in certain future financings by us
involving the sale of our common stock or equivalent securities. The Purchasers
were also granted registration rights under a Registration Rights Agreement
dated March 15, 2004, pursuant to which we were required to file a registration
statement respecting the common stock issuable upon the conversion of the
debentures and exercise of the warrants within thirty (30) days after March 15,
2004, and to use best efforts to have the registration statement declared
effective at the earliest date. If a registration statement was not filed within
such thirty (30) day period or declared effective within such ninety (90) day
period (or within one hundred twenty (120) days in the event of a full review by
the SEC), we became obligated to pay liquidated damages to the Purchasers equal
to 2% per month of each such Purchasers' subscription amount under the Purchase
Agreement plus the value of any warrants issued pursuant to the Purchase
Agreement then held by such Purchaser. The registration statement has not been
filed as of the date of this report, June 30, 2004; therefore, liquidated
damages in the amounts of $81,000 and $120,000 have been recorded in the
quarters ended June 30, 2004 and March 31, 2004, respectively. Included in
accrued expenses at June 30, 2004 and March 31, 2004 is $201,000 and $120,000,
respectively, related to accrued liquidated damages.
In accordance with generally accepted accounting principles, we will compute the
difference between the conversion price of $1.32 and our stock price of the date
of issuance of the debentures and record the relative portion as an interest
expense in the second quarter of fiscal 2005.
We will also allocate the proceeds received from convertible debt with
detachable warrants using the relative fair market value of the individual
elements at the time of issuance and amortize the change over the life of the
note.
The balance of convertible debentures is $2,399,000 and $2,306,000 at June 30,
2004 and March 31, 2004, of which $1,189,000 and $146,000, respectively, are
current.
Subsequent to June 30, 2004, we sold and issued a secured convertible term note
to an unrelated investor for $7.0 million (the "Laurus Transaction")(see Note
15). Part of the proceeds from this debt financing were used to pay off $1.8
million due to one of the two investors. We issued 600,000 shares of our common
stock to the remaining investor in order to pay $112,000 in liquidated damages
and secure such investor's consent to the Laurus Transaction. We also amended
the remaining investor's debenture in exchange for the remaining investors
consent for the Laurus Transaction. Pursuant to Amendment No. 1 to the 9%
Debenture Due May 15, 2006 Issued to Midsummer Investments, Ltd. And Waiver, the
terms of the remaining debenture were amended as follows:
o Prepayment penalty is eliminated,
o Conversion price is reduced to $0.56 per share,
o Interest payments are due on a monthly basis, and
11
o The commencement of monthly redemption payments was
accelerated to September 1, 2004 and the payments due were
revised such that payments of $50,000 are due monthly from
September 1, 2004 and the monthly payments increase to $62,500
starting February 1, 2005. Monthly redemption payments are
payable in cash or registered shares at a 90% of the
average of the 20 days volume weighted average price
In addition, the exercise price of the Series A Warrants held by both investors
was reduced to $0.56 per share.
NOTE 7 - CAPITAL LEASES
In connection with the acquisition of Page Digital, we assumed capital lease
obligations on certain office equipment and fixtures leases expiring from
November 2004 through November 2006. The capital leases bear interest at rates
between 7% and 11% per annum and monthly lease payments range between
approximately $1,000 to $8,000.
In connection with the acquisition of RTI, we assumed a capital lease obligation
for certain office equipment, expiring in February 2006. The capital lease bears
interest at a rate of approximately 11% per annum and monthly lease payments of
approximately $600.
The balance of capital leases is $228,000 and $258,000 at June 30, 2004 and
March 31, 2004, respectively, of which the current portion is $176,000 and
$169,000, respectively.
NOTE 8 - LINE OF CREDIT
In connection with the acquisition of RTI, we assumed obligation under a line of
credit with a balance of $182,000 at June 30, 2004. Subsequent to June 30, 2004,
the line of credit was paid off in full.
NOTE 9 - PREFERRED STOCK
The Series A Convertible Preferred Stock (the "Series A Preferred") has a stated
value of $100 per share and is redeemed at our option any time prior to the
maturity date of December 31, 2006 for 107% of the stated value and accrued and
unpaid dividends. The preferred shares are entitled to cumulative dividends of
7.2% per annum, payable semi-annually, and have cumulative dividends of $2.3
million, or $16.22 per share, and $2.0 million, or $14.19 per share, at June 30,
2004 and March 31, 2004, respectively. The holders may convert each share of
Series A Preferred at any time into the number of shares of our common stock
determined by dividing the stated value plus all accrued and unpaid dividends,
by a conversion price initially equal to $0.80. The conversion price increases
at an annual rate of 3.5% calculated on a semi-annual basis. The conversion
price as of July 1, 2004 is $0.86. The Series A Preferred is entitled upon
liquidation to an amount equal to its stated value plus accrued and unpaid
dividends in preference to any distributions to common stockholders. The Series
A Preferred has no voting rights prior to conversion into common stock, except
with respect to proposed impairments of the Series A Preferred rights and
preferences, or as provided by law. We have the right of first refusal to
purchase all but not less than all of any shares of Series A Preferred or shares
of common stock received on conversion which the holder may propose to sell to a
third party, upon the same price and terms as the proposed sale to a third
party.
On November 14, 2003, the Sage Group plc (the "Sage Group") acquired
substantially all the assets of Softline, including Softline's 141,000 shares of
our Series A Preferred, 8,923,915 shares of our common stock and options to
purchase 71,812 shares of our common stock. On September 17, 2003, 500,000
shares of common stock constituting accrued dividends on our Series A Preferred
were issued to various financial institutions.
The Series B Convertible Preferred Stock (the "Series B Preferred") has no
stated value and is entitled to cumulative dividends at the rate of $0.136 per
share per annum, payable annually commencing on January 1, 2005. Upon our filing
of an amendment to our Certificate of Incorporation ("Certificate") increasing
the number of shares of common stock, we are authorized to issue, to a
sufficient number of shares to permit full conversion of all Series B Preferred,
each share of Series B Preferred will automatically convert into the number of
shares of our common stock determined by dividing the conversion value of $3 per
share by the conversion price of $1 per share. The Series B Preferred is
entitled upon liquidation to $2.27 per share plus unpaid dividends in preference
to any distributions to common stockholders. Each holder of Series B Preferred
is entitled to the number of votes equal to the number of shares of common stock
into which such shares of Series B Preferred are convertible. No dividends have
been declared as of June 30, 2004.
12
NOTE 10 - EQUITY TRANSACTIONS
During the quarter ended June 30, 2004, we have the following equity
transactions:
o Issued 1,546,733 shares of common stock, with a fair value of
$1,169,000, to Intuit in connection with the acquisition of
RTI.
o Issued an aggregate of 2,517,233 shares of Series B
Convertible Preferred Stock, with a fair value of $5,709,000
to Michael Tomczak, our director, COO and President, and
Jeffrey Boone, our CTO, in connection with acquisition of RTI.
o Granted options to purchase 1,572,364 and 1,772,364 shares of
common stock at an exercise price of $0.77per share to Messrs.
Boone and Tomczak, respectively, in accordance with their
employment agreements.
o Issued warrants to purchase an aggregate of 20,000 shares of
common stock at exercise prices of $0.75 and $1.05 per share
to a consulting firm for investor relation services rendered
for a fair value of $3,000.
o In connection with the acquisition of RTI, we assumed RTI's
incentive stock option plan and converted all outstanding
options at June 1, 2004 into our options at a conversion rate
of 1.5562. As a result, RTI's option holders have options to
purchase an aggregate of 1,366,911 shares of our common stock
at an exercise price of $0.02.
o Granted options to purchase an aggregate of 67,500 shares of
common stock at exercise prices ranging from $0.62 to $1.17 to
employees hired during the quarter ended June 30, 2004.
o Granted options to purchase an aggregate of 20,000 shares of
common stock at an exercise price of $0.96 to certain outside
directors of the board as directors' fees during June 30,
2004.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure." This Statement amends SFAS 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results.
The following table presents pro forma disclosures required by SFAS 123 and SFAS
148 of net income (loss) and basic and diluted earnings (loss) per share as if
stock-based employee compensation had been recognized during the quarter ended
June 30, 2004 and 2003. The compensation expense for these periods has been
determined under the fair value method using the Black-Scholes pricing model,
and assumes graded vesting.
Three Months Ended
June 30, June 30,
2004 2003
-------- --------
(in thousands, except per share amounts)
(unaudited)
Net income (loss) as reported $(3,793) $ 285
Less: stock-based compensation expense,
net of related tax effects (502) (540)
-------- --------
Pro forma net loss $(4,295) $ (255)
======== ========
Basic earnings (loss) per share - as reported $ (0.07) $ 0.01
Diluted earnings (loss) per share - as reported $ (0.07) $ --
Basic earnings (loss) per share - pro forma $ (0.08) $ --
Diluted earnings (loss) per share - pro forma $ (0.08) $ --
NOTE 11 - EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per common share are calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
reporting period. Diluted earnings per common shares ("diluted EPS") reflect the
potential dilutive effect, determined by the treasury method, of additional
common shares that would have been outstanding if the dilutive potential common
shares had been issued. Earnings per share for the three months ended June 30,
2004 and 2003 is calculated as follows (in thousands):
13
Three Months ended
June 30,
2004 2003
--------- ---------
Net income (loss) available to common
stockholders $ (4,079) $ 13
========= =========
Basic weighted average shares 52,938 31,615
Dilutive common stock equivalent -- 33,128
--------- ---------
Diluted weighted average shares 52,938 64,743
========= =========
Basic and diluted earnings (loss) per
share available to common
Stockholders $ (0.08) $ --
========= =========
The following potential common shares have been excluded from the computation of
diluted net loss per share for the three months ended June 30, 2004, because the
effect would have been anti-dilutive:
Three Months Ended
June 30,
2004
------------------
Outstanding options under our stock option plans 6,074,662
Outstanding options granted outside our stock option plans 8,314,774
Warrants issued in conjunction with private placements
and Financing 13,348,760
Warrants issued for services rendered 1,231,898
Series A Convertible Preferred Stock 19,115,405
Series B Convertible Preferred Stock 7,551,699
Convertible debentures 2,272,727
------------------
Total 57,909,925
==================
NOTE 12 - BUSINESS SEGMENTS AND GEOGRAPHIC DATA
We are a leading provider of software solutions and services to the retail
industry. Our solutions and services have been developed specifically to meet
the needs of the retail industry. We provide high value innovative solutions
that help retailers understand, create, manage and fulfill consumer demand. Our
solutions help retailers improve the efficiency and effectiveness of their
operations and build stronger, longer lasting relationships with their
customers. We acquired Page Digital, which offers multi-channel retail
solutions, on January 31, 2004 and RTI, which offers point-of-sale and inventory
management solutions, on June 1, 2004.
We currently operate in the Americas and Europe. On June 1, 2004, we began to
operate in Asia. The geographic distribution of our net sales and long-lived
assets are as follows (in thousands):
Three Months ended
June 30,
2004 2003
------ ------
Net sales:
Americas $4,232 $4,925
Europe 1,012 541
Asia 39 --
------ ------
Total net sales $5,283 $5,466
====== ======
14
June 30, March 31,
2004 2004
---- ----
Long-lived assets:
Americas $57,809 $44,229
Europe 25 30
------- -------
Total long-lived assets $57,832 $44,259
======= =======
In the three months ended June 30, 2004, net sales to one major customer
represents 12% of total net sales and accounts receivable balance at June 30,
2004 from this customer represents 8% of total accounts receivable. In the three
months ended June 30, 2003, net sales to another major customer represents 24%
of total net sales and its accounts receivable balance represents 13% of total
accounts receivable.
We structure our operations into three business units that have separate
reporting infrastructures. Each unit is evaluated primarily based on total net
sales and operation income excluding depreciation and amortization. Identifiable
assets are also managed by business units. Our three business units are as
follows:
o RETAIL MANAGEMENT SOLUTIONS ("RETAIL MANAGEMENT") - offers
suite of applications, which builds on our long history in
retail software design and development. We provide our
customers with an extremely reliable, widely deployed,
comprehensive and fully integrated retail management
solutions. Retail Management includes merchandise management
that optimizes workflow and provides the highest level of data
integrity. This module supports all operational areas of the
supply chain including planning, open-to-buy purchase order
management, forecasting, warehouse and store receiving
distribution, transfers, price management, performance
analysis and physical inventory. In addition, Retail
Management includes a comprehensive set of tools for analysis
and planning, replenishment and forecasting, event and
promotion management, warehouse, ticketing, financials and
sales audit. Through collaborations with strategic partners,
Retail Management offers tools for loss prevention,
communication with stores and vendors, integration needs,
purchase and allocation decisions, analysis of weather impact,
control and management of business processes, consumer
research, tracking consumer shopping patterns, forecasting and
replenishment, and analyzing store people productivity.
o STORE SOLUTIONS - offers suites of applications built on our
long history of providing multi-platform, client server
in-store solutions. We market these sets of applications under
the name "OnePointe,"(TM) and "Retail Pro"(R). With more than
15 years of development, OnePointe(TM) is a solution with a
high degree of fit and value out of the box. Additionally, the
software was designed for easy customization, enabling our
development team to quickly develop solutions to meet
retailers' specific point-of-sale ("POS") and in-store
processor (server) requirements. Retail Pro(R) is a leading
point-of-sale and inventory management software used by
specialty retailers worldwide.
o MULTI-CHANNEL RETAIL SOLUTIONS ("MULTI-CHANNEL RETAIL") - Page
Digital designs its application to specifically address direct
commerce business processes, which primarily relate to
interactions with the end-user. Having developed its software
out of necessity to manage its own former direct commerce
operation, Page Digital has been extremely attentive to
functionality, usability and scalability. Its software
components include applications for customer relations
management, order management, call centers, fulfillment, data
mining and financial management. Specific activities like
partial ship orders, payments with multiple tenders, back
order notification, returns processing and continuum
marketing, represent just a few of the more than 1,000
parameterized direct commerce activities that have been built
into its "Synaro"(R)applications. Page Digital makes these
components and its interfacing technology available to
customers, systems integrators and independent software
developers who may modify them to meet their specific needs.
This growing base of inherited functionality continues to
improve the market relevance of its products.
15
A summary of the net sales and operating income (loss), excluding depreciation
and amortization, and identifiable assets attributable to each of these business
units are as follows (in thousands):
Three Months Ended
June 30,
2004 2003
--------- ---------
Net sales:
Retail Management $ 2,965 $ 5,064
Store Solutions 1,163 402
Multi-channel retail 1,155 --
--------- ---------
Total net sales $ 5,283 $ 5,466
========= =========
Operating income (loss):
Retail Management $ (864) $ 1,596
Store Solutions (358) --
Multi-channel retail (514)
Other (see below) (1,884) (1,585)
--------- ---------
Total operating income (loss) $ (3,620) $ 11
========= =========
Other operating loss:
Amortization of intangible assets $ (1,229) $ (812)
Depreciation (122) (56)
Administrative costs and other non-allocated
Expenses (533) (717)
--------- ---------
Total other operating loss $ (1,884) $ (1,585)
========= =========
Identifiable assets:
Retail Management $ 36,823 $ 34,151
Store Solutions 19,795 4,132
Multi-channel retail 9,691 --
--------- ---------
Total identifiable assets $ 66,309 $ 38,283
========= =========
Operating income (loss) in Retail Management, Store Solutions and Multi-channel
Retail includes direct expenses for software licenses, maintenance services,
programming and consulting services, sales and marketing expenses, product
development expenses, and direct general, administrative and depreciation
expenses. The "Other" caption includes depreciation, amortization of intangible
assets, non-allocated costs and other expenses that are not directly identified
with a particular business unit and which we do not consider in evaluating the
operating income of the business unit.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
We decided in the third quarter of fiscal 2002 to sell certain assets of our
Australian subsidiary to the former management of such subsidiary, and then
cease Australian operations. Such sale was, however, subject to the approval of
National Australia Bank, the subsidiary's secured lender. The bank did not
approve the sale and the subsidiary ceased operations in February 2002. The bank
caused a receiver to be appointed in February 2002 to sell substantially all of
the assets of the Australian subsidiary and pursue collections on any
outstanding receivables. The receiver proceeded to sell substantially all of the
assets for $300,000 in May 2002 to an entity affiliated with the former
management, and actively pursued the collection of receivables. If the sale
proceeds plus collections on receivables had been insufficient to discharge the
indebtedness to National Australia Bank, we might have been called upon to pay
the deficiency under our guarantee to the bank. At March 31, 2004 we accrued
$187,000 as the maximum amount of our potential exposure. In June 2004, we
settled this obligation by paying $69,000 to the bank. As a result, the $118,000
accrual in excess of settlement amount was written off to the consolidated
statement of operations as other income in the quarter ended June 30, 2004.
16
On May 15, 2002, an employee who was out on disability/worker's compensation
leave, Debora Hintz, filed a claim with the California Labor Commissioner
seeking $41,000 in alleged unpaid commissions. On or about December of 2002, Ms.
Hintz filed a discrimination claim against us with the Department of Fair
Employment and Housing, alleging harassment and sexual orientation
discrimination. We had responded appropriately to both the wage claim and the
discrimination allegations, which we believed lack merit based on present
information. On December 1, 2003, the Department of Fair Housing and Employment
closed the case on the basis of no probable cause to prove violation of statue,
and gave notice of right to sue. In January 2004, we terminated Ms. Hintz's
employment with us and, as a result, her medical insurance was terminated. On
February 12, 2004, Ms. Hintz filed a petition for violation of Labor Code
Section 132(a) before the Workers' Compensation Appeals Board of the State of
California.
On November 22, 2002, we and Sabica Ventures, Inc. ("Sabica", our wholly-owned
subsidiary), were sued in a matter entitled Stemley vs. Shea Homes, Inc. et.
al., in San Diego Superior Court Case No. GIC 787680, as Pacific Cabinets. The
case dealt with alleged construction defects. Pacific Cabinets was dismissed
from the litigation for a waiver of fees and costs. At this time, neither we nor
Pacific Cabinets are parties to this action. Because no significant discovery
was done, it is not possible at this time to provide an evaluation of potential
exposure, though it appears highly unlikely that Pacific Cabinets or we would be
brought back into this suit.
On April 2, 2004, we filed a federal court action in the Southern District of
California against 5R Online, Inc., John Frabasile, Randy Pagnotta, our former
officers, and Terry Buckley for fraud, breach of fiduciary duty, breach of
contract, and unfair business practice arising from their evaluation of,
recommendation for, and ultimately engagement in a development arrangement
between IPI and 5R. Pursuant to the development agreement entered into in June
2003 and upon reliance of the representations of the individual defendants that
product development was progressing, we paid and expensed $640,000 in
development payments in the fiscal year ended March 31, 2004 but received no
product. The amount in controversy is the $640,000 development payments as well
as a claim for punitive damages. Defendants Pagnotta and Buckley have
counterclaimed against defendant Frabasile, who has moved to dismiss in light of
a parallel action pending in Canada. Frabasile's and 5R Online, Inc.'s response
to IPI's complaint was due on August 9, 2004. Settlement negotiations are
currently underway.
RTI was named as a cross-defendant in an action by General Electric Capital
Corporation as plaintiff ("GE Capital"), against San Francisco City Stores LLC,
dated May 10, 2004. The cross-complaint filed on behalf of San Francisco City
Stores names GE Capital, Big Hairy Dog Information Systems, and RTI as
cross-defendants, claiming breach of warranty and unfair competition (against
RTI), and makes various other claims against GE Capital and Big Hairy Dog
Information Systems. The claim is for approximately $83,000. However, we believe
the claims made against RTI are without merit and we intend to vigorously defend
them.
Except as set forth above, we are not involved in any material legal
proceedings, other than ordinary routine litigation proceedings incidental to
our business, none of which are expected to have a material adverse effect on
our financial position or results of operations. However, litigation is subject
to inherent uncertainties, and an adverse result in existing or other matters
may arise from time to time which may harm our business.
NOTE 14 - RELATED-PARTY TRANSACTIONS
Included in other receivables at June 30, 2004 and March 31, 2004 are amounts
due from our officers and employees in the amount of $14,000 and $37,000,
respectively.
In connection with the Page Digital acquisition, we assumed a three-party lease
agreement for our Colorado offices between CAH Investments, LLC ("CAH"), wholly
owned by the spouse of our executive officer, Larry Page, and Southfield
Crestone, LLC, whereby Page Digital agreed to lease offices for ten years
expiring on December 31, 2013. CAH and Southfield Crestone LLC are equal owners
of the leased property. Rent expense related to this lease is $200,000 for the
three months ended June 30, 2004. Security deposit of $170,000 relating to this
lease is included in other long-term assets at June 30, 2004 and March 31, 2004.
We retain our former CEO and Chairman of the Board, Barry Schechter, to provide
consulting services starting August 2003. For the quarters ended June 30, 2004
and 2003, the expense for this service was $111,000 and $0, respectively.
We retained an entity owned by an immediate family member of our former CEO and
Chairman, Harvey Braun, to provide recruiting and marketing services. For the
quarters ended June 30, 2004 and 2003, the expense for this service was $0 and
$10,000, respectively.
In May 2004, Mr. Braun resigned from his position as Chief Executive Officer. We
are currently negotiating a separation agreement as of July 31, 2004. We
reserved an estimated severance payment of $163,000 in the three months ended
June 30, 2004 and included this in accrued expenses at June 30, 2004.
17
NOTE 15 - SUBSEQUENT EVENTS
Pursuant to a Securities Purchase Agreement dated July 12, 2004, we sold and
issued to an investor a secured convertible term note ("Note") for a gross
proceed of $7.0 million. In addition, we issued to the investor a warrant to
purchase up to 3,750,000 shares of our common stock at a price of $0.71 per
share ("Warrant"). The investor is aware that we have exceeded our authorized
share capital limit of 100,000,000 shares and that we intend to increase our
authorized share capital limit to 250,000,000. We submitted a proposal to amend
our Certificate of Incorporation to increase our authorized shares of common
stock to 250,000,000 to our stockholders at our annual meeting on August 11,
2004. We did not receive sufficient votes to authorize the increase at that time
and adjourned the meeting until August 27, 2004 to provide us additional time to
secure sufficient votes to effect the increase. Our obligations under the Note
are secured by all of our assets. All our wholly owned subsidiaries guaranteed
our obligations under the Note. We also pledged all of our interests in the
outstanding stock of our subsidiaries as security for our obligations under the
Note.
The Note matures on September 1, 2004 (Maturity Date"); provided however, the
maturity of the Note will be automatically extended to July 12, 2007 upon the
stockholders approving an amendment to our Certificate increasing the authorized
common stock to 250 million shares and us filing an amendment to our Certificate
to effect the increase with the Secretary of State of Delaware by August 31,
2004. We are required to make monthly payments in the amount of $212,000 plus
any unpaid interest commencing on August 1, 2004. In July 2004, the investor
agreed to defer the August 1, 2004 payment until Maturity Date.
The Note accrues interest at a rate per annum (the "Interest Rate") equal to the
"prime rate" (4.25% as of July 31, 2004) published in The Wall Street Journal
from time to time, plus two percent. Interest under the Note is payable monthly
in arrears commencing on August 1, 2004. The Interest Rate is calculated on the
last day of each month (the "Determination Date") and is subject to adjustment
as follows: (1) if the shares issuable upon conversion of the Note or exercise
of the Warrant have been registered with the U.S. Securities and Exchange
Commission ("SEC") under the Securities Act of 1933, as amended (the "Securities
Act") and the market price of our common stock for the five trading days
immediately preceding the Determination Date exceeds the then applicable
conversion price for the Note by at least 25%, then the Interest Rate for the
succeeding calendar month shall be reduced by 2% for each incremental 25%
increase over the then applicable conversion price or (2) if all of the
conditions set forth in subparagraph (1) have been satisfied, except that the
shares issuable upon conversion of the Note or exercise of Warrant have not been
registered, then the Interest Rate for the succeeding calendar month shall be
reduced by 1% for each incremental 25% increase over the then applicable
conversion price. The initial conversion price under the Note is $0.56 per
share, subject to adjustment upon our issuance of securities at a price per
share below the fixed conversion price, a stock split or combination,
declaration of a dividend on our common stock or reclassification of our common
stock. We have the option to redeem the Note by paying the investor 125% of the
principal amount due under the Note together with all accrued and unpaid
interest.
The Warrant is immediately exercisable and has a seven year term. We have the
right to require exercise of the Warrant in whole or in part if: (1) all of our
obligations under the Note have been irrevocably paid in full, (2) the common
stock underlying the Warrant has been registered on a registration statement
declared effective by the SEC, and such registration statement remains
effective, and (3) the average closing price of our common stock for the ten
(10) trading days immediately prior to the proposed date of the mandatory
exercise of the Warrant is greater than three hundred percent (300%) of the then
applicable exercise price.
We are obligated to file a registration statement on Form S-3 (or if Form S-3 is
not available another appropriate form) (the "Registration Statement")
registering the shares of our common stock issuable upon conversion of the Note
or exercise of the Warrant (the "Underlying Shares") pursuant to the
Registration Rights Agreement between us and the investor (the "Registration
Rights Agreement"). We are required to file the Registration Statement by
September 10, 2004 (the "Filing Date") and have the Registration Statement
declared effective by the SEC no later than 90 days after it is filed (the
"Effectiveness Date"). If the Registration Statement is not filed by the Filing
Date, declared effective by the Effectiveness Date, ceases to be effective for
18
more than 30 days in any calendar year or 10 consecutive calendar days or if our
common stock is not listed or traded or is suspended from trading for three
consecutive trading days, we are required to pay the investor liquidated damages
equal to 2% of original principal balance on the Note for each 30 day period
(with partial periods prorated) that such event continues. We are obligated to
keep the Registration Statement effective until the earlier of when (1) all of
the Underlying Shares have been sold or (2) such time as all of the Underlying
Shares can be sold without registration or volume restrictions under Rule 144(k)
of the Securities Act (the "Effectiveness Period"). If there is not an effective
Registration Statement covering the Underlying Shares at any time during the
Effectiveness Period and we propose to file a registration statement for our own
account or the account of others, we will be obligated to include the Underlying
Shares on that registration statement.
In accordance with generally accepted accounting principles, the difference
between the conversion price of $0.56 and our stock price on the date of
issuance of the Note was recorded as interest expense. It was recognized in the
statement of operations during the period from the issuance of the debt to the
time at which the debt first became convertible. We recognized this interest
expense of $281,000 in July 2004.
We allocated the proceeds received from the Note with a detachable warrant using
the relative fair market value of the individual elements at the time of
issuance. The amount allocated to the warrant was $531,000 and is being
amortized as interest expense over the life of the Note.
Effective July 1, 2004, Robert P. Wilkie and Ivan M. Epstein resigned from our
board of directors. Messrs. Wilke and Epstein were both independent directors
and we are currently looking for two independent individuals to fill the
vacancies resulting from their resignations.
Effective as of July 14, 2004, Steven Beck resigned from our board of directors
and Donald Radcliffe, who previously served as our director from May 1998 to
October 2003, was appointed to replace Mr. Beck. Effective July 29, 2004, Mr.
Beck resigned from his position as executive officer. We agreed to pay Mr. Beck
$325,000 with $109,000 payable on July 29, 2004 and the balance payable in four
monthly installments of $54,000 commencing on August 15, 2004.
19
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION
27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT
OF 1934 AND THE COMPANY INTENDS THAT CERTAIN MATTERS DISCUSSED IN THIS REPORT
ARE "FORWARD-LOOKING STATEMENTS" INTENDED TO QUALIFY FOR THE SAFE HARBOR FROM
LIABILITY ESTABLISHED BY THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
THESE FORWARD-LOOKING STATEMENTS CAN GENERALLY BE IDENTIFIED BY THE CONTEXT OF
THE STATEMENT WHICH MAY INCLUDE WORDS SUCH AS THE COMPANY ("IPI," "WE" OR "US")
"BELIEVES," "ANTICIPATES," "EXPECTS," "FORECASTS," "ESTIMATES" OR OTHER WORDS
SIMILAR MEANING AND CONTEXT. SIMILARLY, STATEMENTS THAT DESCRIBE FUTURE PLANS,
OBJECTIVES, OUTLOOKS, TARGETS, MODELS, OR GOALS ARE ALSO DEEMED FORWARD-LOOKING
STATEMENTS. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
FORECASTED OR ANTICIPATED AS OF THE DATE OF THIS REPORT. CERTAIN OF SUCH RISKS
AND UNCERTAINTIES ARE DESCRIBED IN CLOSE PROXIMITY TO SUCH STATEMENTS AND
ELSEWHERE IN THIS REPORT INCLUDING ITEM 2, "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." STOCKHOLDERS, POTENTIAL
INVESTORS AND OTHER READERS ARE URGED TO CONSIDER THESE FACTORS IN EVALUATING
THE FORWARD-LOOKING STATEMENTS AND ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON
SUCH FORWARD-LOOKING STATEMENTS OR CONSTRUE SUCH STATEMENTS TO BE A
REPRESENTATION BY US THAT OUR OBJECTIVES OR PLANS WILL BE ACHIEVED. THE
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE MADE ONLY AS OF THE DATE
OF THIS REPORT, AND WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE SUCH
FORWARD-LOOKING STATEMENTS TO REFLECT SUBSEQUENT EVENTS OR CIRCUMSTANCES.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND THE RELATED NOTES AND OTHER FINANCIAL INFORMATION
APPEARING ELSEWHERE IN THIS FORM 10-Q. READERS ARE ALSO URGED TO CAREFULLY
REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE BY US WHICH ATTEMPT TO ADVISE
INTERESTED PARTIES OF THE FACTORS WHICH AFFECT OUR BUSINESS, INCLUDING WITHOUT
LIMITATION THE DISCLOSURES MADE UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," AND THE AUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED IN OUR ANNUAL
REPORT FILED ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2004, AND THE DISCLOSURES
UNDER THE HEADING "RISK FACTORS" IN THE FORM 10-K, AS WELL AS OTHER REPORTS AND
FILINGS MADE WITH THE SECURITIES AND EXCHANGE COMMISSION.
OVERVIEW
We are a provider of software solutions and services to the retail industry. We
provide solutions that help retailers understand, create, manage and fulfill
consumer demand. We derive the majority of our revenues from the sale of
application software licenses and the provision of related professional and
support services. Application software license fees are dependent upon the sales
volume of our customers, the number of users of the application(s), and/or the
number of locations in which the customer plans to install and utilize the
application(s). As the customer grows in sales volume, adds additional users
and/or adds additional locations, we charge additional license fees. We
typically charge for support, maintenance and software updates on an annual
basis pursuant to renewable maintenance contracts. We typically charge for
professional services including consulting, implementation and project
management services on an hourly basis.
In recent periods, we have sustained a relatively flat period in terms of
revenues and have suffered operating and net losses, largely attributable to
general economic and competitive conditions. In this regard, we have taken a
number of steps designed to improve our operations, including:
o Acquired two complementary companies with substantial revenues
and earnings potential;
o Revamped our management team by adding a new President and COO
and CTO, as well as a new CFO;
o Improved our IBM-based core products through continuing
internal research and development;
o Obtained the rights to distribute complementary products,
including a new easy-to-install and easy-to-use,
open-architecture software system for very small retailers,
which we are currently offering;
o Established partnerships with several value added resellers to
provide a variety of options and product extensions;
o Improved our distribution capabilities by adding new third
party channels, such as IBM and IBM's resellers, and
professional service firms, such as CGI and LakeWest.
We believe that these actions will position us to achieve revenue growth and
profitability.
20
RECENT DEVELOPMENTS
o In June 2004, we completed the acquisition of RTI. See
"Acquisition of RTI" below.
o Upon completion of RTI's acquisition, Michael Tomczak, RTI's
CEO and President, was appointed our President, Chief
Operating Officer and director and Jeffrey Boone, RTI's Chief
Technology Officer, was appointed our CTO. Mr. Tomczak
replaced Steve Beck, who was serving as our president and Mr.
Page, who was serving as our COO. Mr. Boone replaced Mr. Page
as our CTO. Mr. Beck served as our President from April 2003
to June 2004 and our COO from April 2003 to February 2004. Mr.
Page served as our CTO from January 2004 to June 2004 and as
our COO from February 2004 to June 2004.
o Harvey Braun resigned from the board of directors and the
position of CEO in May 2004.
o Mr. Beck resigned from the board of directors and the position
of executive officer in July 2004. Donald Radcliffe, who
previously served as our director from May 1998 to October
2003, was appointed to replace Mr. Beck.
o In July, we sold and issued a secured convertible note for a
gross proceed of $7.0 million. See "Indebtedness - Laurus"
below.
ACQUISITION OF RTI
Pursuant to an agreement dated June 1, 2004, we acquired RTI from Michael
Tomczak, Jeffrey Boone and Intuit in a merger transaction. On March 12, 2004,
we, RTI, Merger Sub and the Shareholders entered the March 12, 2004 Merger
Agreement which provided we would acquire RTI in a merger transaction in which
RTI would merge with and into Merger Sub. The merger consideration contemplated
by the March 12, 2004 Merger Agreement was a combination of cash and shares of
our common stock. The March 12, 2004 Merger Agreement was amended by the Amended
Merger Agreement dated June 1, 2004.
Pursuant to the Amended Merger Agreement, the Merger was completed with the
following terms: (i) we assumed RTI's obligations under those certain promissory
notes issued by RTI on December 20, 2002 with an aggregate principal balance of
$2.3 million; (ii) the total consideration paid at the closing of the Merger was
$10.0 million paid in shares of our common stock and newly designated Series B
Preferred and promissory notes; (iii) the Shareholders and Intuit are entitled
to price protection payable if and to the extent that the average trading price
of our common stock is less than $0.76 at the time the shares of our common
stock issued in the Merger and issuable upon conversion of the Series B
Preferred are registered pursuant to the Registration Rights Agreement dated
June 1, 2004 between us, the Shareholders and Intuit; and (iv) the merger
consisted of two steps (the "Merger"), first, Merger Sub merged with and into
RTI, Merger Sub's separate corporate existence ceased and RTI continued as the
surviving corporation (the "Reverse Merger"), immediately thereafter, RTI merged
with and into Merger Sub II, RTI's separate corporate existence ceased and
Merger Sub II continued as the surviving corporation (the "Second-Step Merger").
As a result of the Merger, each Shareholder received 1,258,616 shares of Series
B Preferred and a promissory note payable monthly over two years in the
principal amount of $1,295,000 bearing interest at 6.5% per annum. As a result
of the Merger, Intuit, the holder of all of the outstanding shares of RTI's
Series A Preferred stock, received 1,546,733 shares of our common stock and a
promissory note payable monthly over two years in the principal amount of
$530,700 bearing interest at 6.5% per annum.
The Shareholders and Intuit were also granted registration rights. Under the
Registration Rights Agreement, we agreed to register the common stock issuable
upon conversion of the Series B Preferred issued to the Shareholders within 30
days of the automatic conversion of the Series B Preferred into common stock.
The automatic conversion will occur upon us filing the Certificate of Amendment
with the Delaware Secretary of State increasing the authorized number of shares
of our common stock after securing shareholder approval for the Certificate of
Amendment. Under the Registration Rights Agreement, Intuit is entitled to demand
registration or to have its shares included on any registration statement filed
prior the registration statement covering the Shareholders' shares, subject to
certain conditions and limitations, or if not previously registered to have its
shares included on the registration statement registering the Shareholders'
shares. The Shareholders and Intuit are entitled to price protection payments of
up to a maximum of $0.23 per share payable by promissory note, if and to the
extent that the average closing price of our common stock for the 10 days
immediately preceding the date the registration statement covering their shares
is declared effective by the Securities and Exchange Commission, is less than
the 10 day average closing price as of June 1, 2004, which was $0.76.
21
Pursuant to the Amended Merger Agreement, The Sage Group, plc as well as certain
officers and directors signed voting agreements that provide they will not
dispose of or transfer their shares of our capital stock and that they will vote
their shares of our capital stock in favor of the Certificate of Amendment and
the Amended Merger Agreement and transactions contemplated therein.
Upon the consummation of the Merger, Michael Tomczak, RTI's former President and
Chief Executive Officer, was appointed our President, Chief Operating Officer
and director and Jeffrey Boone, RTI's former Chief Technology Officer, was
appointed our Chief Technology Officer. We entered into two-year employment
agreements and non-competition agreements with Mr. Tomczak and Mr. Boone.
The combination of Island Pacific and RTI, will enable us to offer a fully
integrated solution to mid-tier retailers that will be unique in the
marketplace. As a result of this transaction, smaller retailers will now be able
to cost-effectively acquire a solution that provides both front and back-end
support. The combination instantly expands our products, services offerings and
distribution channels.
RECENT ACCOUNTING PRONOUNCEMENTS
None.
QUARTER ENDED JUNE 30, 2004 COMPARED TO QUARTER ENDED JUNE 30, 2003
NET SALES
Net sales decreased by $0.2 million, or 4%, to $5.3 million in the quarter ended
June 30, 2004 from $5.5 million in the quarter ended June 30, 2003. The decrease
is due to a $1.3 million decrease in modification and services sales on the Toys
"R" Us, Inc. ("Toys") contract, which was completed in the fiscal year ended
March 31, 2004, a $0.4 million decrease in software license revenue and $0.6
million decrease in services revenue; offset in part by $1.2 million in revenues
from Page Digital, $0.7 million in revenues from RTI and $0.2 increase in
hardware sales.
COST OF SALES/GROSS PROFIT
Cost of sales increased by $0.1 million, or 6%, to $1.8 million in the quarter
ended June 30, 2004 from $1.7 million in the quarter ended June 30, 2003. Gross
profit as a percentage of net sales decreased to 65% in the quarter ended June
30, 2004 from 70% in the prior comparative period. The increase in cost of sales
and the decrease in gross profit as a percentage of net sales were due to
increase in hardware and support services revenues which have lower margins and
decrease in software license revenues, which has higher margins.
APPLICATION DEVELOPMENT EXPENSE
Application development expense increased by $1.1 million, or 1100%, to $1.2
million in the quarter ended June 30, 2004 from $0.1 million in the quarter
ended June 30, 2003. The increase is primarily due to $0.6 million decrease in
capitalization of development costs for new products and our continuing efforts
in enhancing and improving our existing products. We've made significant
investments in our new products in fiscal 2004 and the first quarter of fiscal
2005. Most of these new products were completed in the quarter ended June 30,
2004.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased by $0.5 million, or 56%, to $1.4 million
in the quarter ended June 30, 2004 from $0.9 million in the quarter ended June
30, 2003. The increase is due to additions of fixed assets and intangible assets
from acquisitions of Page Digital in the fourth quarter of fiscal 2004 and RTI
in the first quarter of fiscal 2005.
22
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased by $1.7 million, or 61%,
to $4.5 million in the quarter ended June 30, 2004 from $2.8 million in the
quarter ended June 30, 2003. The increase is mainly due to the additions of
selling, general and administrative expenses of $0.5 million from the
acquisition of Page Digital and $0.6 million from the acquisition of RTI. In
addition, the increase is due to increasing our efforts and spending in
marketing and sales activities and professional fees related to the acquisition
of RTI and financing activities.
INCOME (LOSS) FROM OPERATIONS
Loss from operations which included depreciation and amortization expense, was
$3.6 million for the quarter ended June 30, 2004, compared to an income from
operations of $0.01 million for the quarter ended June 30, 2003.
INTEREST EXPENSE
Interest expense was $0.3 million in the quarters ended June 30, 2004 and 2003.
PROVISION FOR INCOME TAXES
No provision was made at June 30, 2004 due to the availability of tax losses.
Provision for income taxes for the quarter ended June 30, 2003 produced an
income of $0.6 million. The income tax refund of $0.6 million at June 30, 2003
resulted from the amendment of prior years' income tax returns to carry back net
operating losses incurred in the prior years.
CUMULATIVE PREFERRED DIVIDENDS
Cumulative dividends on the outstanding preferred stock attributable to the
quarter ended June 30, 2004 and 2003 were $0.3 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
During the quarter ended June 30, 2004, we financed our operations, using cash
on hand and, internally generated cash. At June 30, 2004 and March 31, 2004, we
had cash of $1.3 million and $2.1 million, respectively.
Operating activities used cash of $1.1 million in the quarter ended June 30,
2004 and $1.3 million in the quarter ended June 30, 2003. Cash used for
operating activities in the quarter ended June 30, 2004 resulted from $3.8
million net loss, $0.5 million increase in accounts receivable and other
receivables and $0.2 million decrease in accounts payable and accrued expenses;
offset in part by $1.9 million increase in deferred revenue and $1.4 million of
non-cash depreciation and amortization.
Investing activities provided cash of $0.4 million in the quarter ended June 30,
2004 and used cash of $0.9 million in the quarter ended June 30, 2003. Cash
provided by investing activities in the current quarter was primarily from $0.6
million cash from acquisition of RTI; offset in part by capitalization of $0.3
million software development costs.
Financing activities used cash of $0.2 million in the quarter ended June 30,
2004 and provided cash of $8.0 million in the quarter ended June 30, 2003. Cash
used for financing activities in the quarter ended June 30, 2004 was primarily
$0.2 million payments on notes payable to related parties.
Accounts receivable increased to $6.6 million at June 30, 2004 from $4.6 million
at March 31, 2004. The increase is primarily due to increase in current
receivables for semi-annual maintenance contracts billed in the quarter ended
June 30, 2004 and $1.3 million in receivables from RTI in the current quarter.
We believe that our cash and cash equivalent and funds generated from operations
will provide adequate liquidity to meet our normal operating requirements for at
least the next twelve months.
23
INDEBTEDNESS
NATIONAL AUSTRALIA BANK LIMITED
We decided in the third quarter of fiscal 2002 to sell certain assets of the
Australian subsidiary to the former management of such subsidiary, and then
cease Australian operations. The sale was subject to the approval of National
Australia Bank, the subsidiary's secured lender. The bank did not approve the
sale and the subsidiary ceased operations in February 2002. The bank caused a
receiver to be appointed in February 2002 to sell substantially all of the
assets of the Australian subsidiary and pursue collections on any outstanding
receivables. The receiver proceeded to sell substantially all of the assets for
$300,000 in May 2002 to an entity affiliated with former management, and
actively pursued the collection of receivables. If the sale proceeds plus
collections on receivables were insufficient to discharge the indebtedness to
National Australia Bank, we might be called upon to pay the deficiency under our
guarantee to the bank. We accrued $187,000 as the maximum amount of our
potential exposure as of March 31, 2004. In June 2004, we settled this
obligation by paying $69,000 to the bank. As a result, the $118,000 accrual in
excess of settlement amount was written off to the consolidated statement of
operations as other income in the quarter ended June 30, 2004.
OMICRON/MIDSUMMER
In March 2004, we entered into a Securities Purchase Agreement for the sale of
9% convertible debentures (the "March '04 Debentures") to Omicron Master Trust
("Omicron") for gross proceeds of $1.75 million ("Omicron Debenture") and
Midsummer Investments, Ltd. ("Midsummer") for gross proceeds of $1.25 million
("Midsummer Debenture"). With proceeds from the sale of a secured convertible
term note to Laurus Master Fund, Ltd. ("Laurus") in July 2004 for $7.0 million,
the Omicron Debenture with the principal balance of $1.75 million was paid off
in full together with $0.1 million in accrued interest, liquidated damages and
prepayment penalty. We also amended the Midsummer Debenture pursuant to
Amendment No. 1 to the 9% Convertible Debenture, Due May 15, 2006 Issued to
Midsummer and Waiver dated July 30, 2004 as partial consideration for Midsummer
consenting to the transaction with Laurus and issued 600,000 shares of common
stock to Midsummer as payment for $112,000 in liquidated damages and as partial
consideration for for Midsummer consenting to the transaction with Laurus and
issued 600,000 shares of common stock to Midsummer as payment for $112,000 in
liquidated damages and as partial consideration for its consent to the Laurus
Transaction.
The amended Midsummer Debenture matures in May 2006 and bears an interest rate
of 9% per annum. Interest only payments, payable, at our option, in cash or
shares of common stock, are payable on a monthly basis. The amended Midsummer
Debenture is convertible into shares of our common stock at a conversion price
of $0.56 per share, subject to adjustment if we offer or sell any securities for
an effective per share price that is less than 87% of the then current
conversion price, negatively restate any of our financial statement or make any
public disclosure that negatively revises or supplements any prior disclosure
regarding a material transaction consummated prior to March 15, 2004 or trigger
other customary anti-dilution protections. If certain conditions are met, we
have the option to redeem the amended Midsummer Debenture at 100% of its face
value, plus accrued but unpaid interest.
We must redeem the amended Midsummer Debenture at the initial monthly amount of
$50,000 commencing on September 1, 2004 which increases to $62,500 as of
February 1, 2005. If the daily volume weighted average price of our common stock
on the American Stock Exchange exceeds the then current conversion price by more
than 200% for 15 consecutive trading days, we have the option to cause Midsummer
to convert the then outstanding principal amount of amended Midsummer Debenture
into our common stock at the conversion price then in effect.
We also issued Omicron and Midsummer (the "Purchasers") two warrants as follows:
(1) Series A Warrants to purchase up to an aggregate of 1,043,479 shares of our
common stock at an exercise price of $1.15 per share, which was reduced to $0.56
per share as a result of the transaction with Laurus, with a five-year term,
exercisable at anytime after September 16, 2004, subject to adjustment if the we
offer or sell any securities for an effective per share price that is less than
the then current exercise price, negatively restate any of our financial
statements or make any public disclosure that negatively revises or supplements
any prior disclosure regarding a material transaction consummated prior to March
15, 2004 or trigger other customary anti-dilution protections and (2) Series B
Warrants to purchase up to 8,500,000 shares of our common stock with an exercise
price of $5 per share, these warrants are immediately exercisable and expire on
the earlier of the six-month anniversary of the effective date of the
registration statement that is required to be filed or 18 months from March 15,
2004, subject to adjustment upon the issuance or sale of securities in a public
offering for an effective per share price that is less than the then-current
exercise price and upon the trigger of other customary anti-dilution
protections.
For a period of one hundred eighty (180) days following the date the
registration statement is declared effective ("Effective Date"), each Purchaser
has the right, in its sole discretion, to elect to purchase such Purchaser's pro
rata portion of additional Debentures and Series A Warrants for an aggregate
purchase price of up to $2,000,000 in a second closing (the "Second Closing").
The terms of the Second Closing shall be identical to the terms set forth in the
24
Purchase Agreement and related documents, except that, the conversion price for
the additional debentures and the exercise price for the additional warrants
shall be equal to 115% of the average of the daily volume weighted average price
of our common stock on the American Stock Exchange for the ten (10) days
preceding the Second Closing ("Second Closing Price"). The Series A Warrant
coverage for the Second Closing shall be 40% of each Purchaser's subscription
amount divided by the Second Closing Price.
For a period of one hundred eighty (180) days following the Effective Date, if
the daily volume weighted average price of our common stock for twenty (20)
consecutive trading days exceeds $2.00, subject to adjustment, we may, on one
occasion, in our sole determination, require the Purchasers to purchase each
such Purchaser's pro rata portion of additional debentures and Series A Warrants
for an aggregate purchase price of up to $2,000,000. Any such additional
investment shall be under the terms set forth in the Purchase Agreement and
related documents, except that, the conversion price for the additional
Debentures and the exercise price for the additional warrants shall be equal to
the then current conversion price and warrant exercise price for the 9%
Debentures and warrants purchased on March 15, 2004.
For a period of six (6) months from the Effective Date, the Purchasers have a
right of first refusal to participate in certain future financings by us
involving the sale of our common stock or equivalent securities. The Purchasers
were also granted registration rights under a Registration Rights Agreement
dated March 15, 2004, pursuant to which we were required to file a registration
statement respecting the common stock issuable upon the conversion of the
debentures and exercise of the warrants within thirty (30) days after March 15,
2004, and to use best efforts to have the registration statement declared
effective at the earliest date. If a registration statement was not filed within
such thirty (30) day period or declared effective within such ninety (90) day
period (or within one hundred twenty (120) days in the event of a full review by
the SEC), we became obligated to pay liquidated damages to the Purchasers equal
to 2% per month of each such Purchasers' subscription amount under the Purchase
Agreement plus the value of any warrants issued pursuant to the Purchase
Agreement then held by such Purchaser. The registration statement has not been
filed as of July 31, 2004; therefore, liquidated damages in the amount of
$201,000 in liquidated damages have been recorded and included in accrued
expenses at June 30, 2004.
In accordance with generally accepted accounting principles, the difference
between the original conversion price of $1.32 and our stock price of the date
of issuance of the debentures was recorded as interest expense. It was
recognized in the statement of operations during the period from the issuance of
the debt to the time at which the debt first became convertible. We recognized
this interest expense of $265,000 in the fiscal year ended March 31, 2004.
We allocated the proceeds received from convertible debt with detachable
warrants using the relative fair market value of the individual elements at the
time of issuance. The amount allocated to the warrants was $720,000 and is being
amortized as interest expense over the life of the convertible debentures. We
recorded an interest expense of $83,000 and $0 in the quarter ended June 30,
2004 and 2003, respectively.
The outstanding balance of Midsummer Debenture, including accrued interest, is
$1.3 million at July 31, 2004.
INTUIT
In connection with the RTI acquisition in June 2004, we issued a promissory note
to Intuit for $0.5 million ("Intuit Note"). The Intuit Note is due on June 1,
2006 and payable in monthly installments of $4,000 from June 1, 2004 through
December 1, 2004, increasing to $30,000 from January 1, 2005. The Intuit Note
earns interest at a rate of 6.5% per annum. The balance of Intuit Note including
accrued interest is $0.5 million at July 31, 2004.
RTI NOTEHOLDERS
In connection with the RTI acquisition in June 2004, we assumed RTI's
obligations on notes payable totaling $1.8 million and issued additional $0.5
25
million to the holders of these notes. These notes are secured by common stock
of our subsidiary IP Retail Technology International, Inc. (formerly known as
IPI Merger Sub II, Inc.; "IP RTI"). The notes are due on May 31, 2005 and
payable in monthly installments in aggregate of $197,000 commencing May 31,
2004. These notes earn interest at a rate of 6.5% per annum. The balance of
these notes, including accrued interest, is $1.9 million at July 31, 2004.
TOMCZAK/BOONE
In connection with the RTI acquisition in June 2004, we issued promissory notes
to RTI's two principals, Michael Tomczak and Jeffrey Boone, totaling $2.6
million ("Officers Notes"). The Officers Notes are due on June 1, 2006 and
payable in monthly installments in aggregate of $20,000 from June 1, 2004
through May 1, 2005, increasing to $200,000 from June 1, 2005. The Officers
Notes earn interest at a rate of 6.5% per annum. The balance of the Officers
Notes is $2.6 million at July 31, 2004.
LAURUS
Pursuant to a Securities Purchase Agreement dated July 12, 2004, we sold and
issued to an investor a secured convertible term note ("Note") for gross
proceeds of $7.0 million. In addition, we issued to the investor a warrant to
purchase up to 3,750,000 shares of our common stock at a price of $0.71 per
share ("Warrant"). The investor is aware that we have exceeded our authorized
share capital limit of 100,000,000 shares and that we intend to increase our
authorized share capital limit to 250,000,000. We submitted a proposal to amend
our Certificate of Incorporation to increase our authorized shares of common
stock to 250,000,000 to our stockholders at our annual meeting on August 11,
2004. We did not receive sufficient votes to approve the amendment to the
Certificate of Incorporation at that time and have adjourned the meeting until
August 27, 2004 to provide us time to secure additional votes sufficient to
effect such amendment. Our obligations under the Note are secured by all of our
assets. All our wholly owned subsidiaries guarantied our obligations under the
Note. We also pledged all of our interests in the outstanding stock of our
subsidiaries as security for our obligations under the Note.
The Note matures on September 1, 2004 ("Maturity Date"); provided however, the
maturity of the Note will be automatically extended to July 12, 2007 upon the
stockholders approving an amendment to our Certificate increasing our authorized
common stock to 250 million shares and us filing an amendment to our Certificate
to effect the increase with the Secretary of State of Delaware by August 31,
2004. We are required to make monthly payments of $212,000 commencing August 1,
2004. In July 2004, the investor agreed to defer the August 1, 2004 payment
until Maturity Date.
The Note accrues interest at a rate per annum (the "Interest Rate") equal to the
"prime rate" published in The Wall Street Journal from time to time, plus two
percent. Interest under the Note is payable monthly in arrears commencing on
August 1, 2004. The Interest Rate is calculated on the last day of each month
(the "Determination Date") and is subject to adjustment as follows: (1) if the
shares issuable upon conversion of the Note or exercise of the Warrant have been
registered with the U.S. Securities and Exchange Commission ("SEC") under the
Securities Act of 1933, as amended (the "Securities Act") and the market price
of our common stock for the five trading days immediately preceding the
Determination Date exceeds the then applicable conversion price for the Note by
at least 25%, then the Interest Rate for the succeeding calendar month shall be
reduced by 2% for each incremental 25% increase over the then applicable
conversion price or (2) if all of the conditions set forth in subparagraph (1)
have been satisfied, except that the shares issuable upon conversion of the Note
or exercise of Warrant have not been registered, then the Interest Rate for the
succeeding calendar month shall be reduced by 1% for each incremental 25%
increase over the then applicable conversion price. The initial conversion price
under the Note is $0.56 per share, subject to adjustment upon our issuance of
securities at a price below the fixed conversion price, a sto