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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
Commission file number 0-28572
OPTIMAL GROUP INC.
(Exact name of registrant as specified in its charter)
CANADA 98-0160833
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
3400 de Maisonneuve Blvd. W., 12th floor, Montreal, Quebec, Canada H3Z 3B8
(514) 738-8885
(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 |X| No |_|
At August 6, 2004, the registrant had 22,201,531 Class "A" shares (without
nominal or par value) outstanding.
-1-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Financial Statements of
(Unaudited)
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Six-month periods ended June 30, 2004 and 2003
(expressed in US dollars)
-2-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Financial Statements
(Unaudited)
Six-month periods ended June 30, 2004 and 2003
(expressed in US dollars)
Financial Statements
Consolidated Balance Sheets.......................................... 4
Consolidated Statements of Operations................................ 5
Consolidated Statements of Deficit................................... 6
Consolidated Statements of Cash Flows................................ 7
Notes to Consolidated Financial Statements........................... 8
-3-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Balance Sheets
(Unaudited)
June 30, 2004 and December 31, 2003
(expressed in US dollars)
===============================================================================================================
June 30, December 31,
2004 2003
- ---------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 2,772,713 $ 4,211,964
Short-term investments 161,540,386 74,301,582
Cash and short-term investments - held as reserves (note 4) 23,033,572 --
Accounts receivable, net of allowance for doubtful accounts
of $94,889 ($134,977 at December 31, 2003) 6,403,909 4,793,435
Service parts inventory 2,058,353 4,215,694
Income taxes receivable and refundable investment tax credits 1,554,750 922,130
Future income taxes 169,111 331,829
Prepaid expenses and deposits 1,648,799 795,931
Current assets related to discontinued operations (note 3 (c)) -- 25,291,718
----------------------------------------------------------------------------------------------------------
199,181,593 114,864,283
Note receivable 1,550,176 --
Other receivable (note 5) 3,122,613 --
Property and equipment 4,369,332 1,931,331
Goodwill and other intangible assets (note 6) 56,939,879 10,517,416
Deferred compensation cost (note 3 (b)) 2,374,486 --
Non-refundable investment tax credits 3,364,825 --
Future income taxes 6,403,115 2,278,016
Long-term assets related to discontinued operations (note 3 (c)) -- 5,951,279
- ---------------------------------------------------------------------------------------------------------------
$ 277,306,019 $ 135,542,325
===============================================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
Bank indebtedness (note 7) $ 10,356,442 $ 10,726,076
Customer reserves and security deposits (note 4) 63,292,345 --
Accounts payable and accrued liabilities 22,771,441 5,569,250
Deferred revenue 3,849,228 1,302,146
Current portion of obligations under capital leases 358,357 --
Future income taxes 133,806 133,806
Current liabilities related to discontinued operations (note 3 (c)) -- 4,388,826
----------------------------------------------------------------------------------------------------------
100,761,619 22,120,104
Future income taxes 3,674,120 129,583
Deferred revenue 318,168 --
Obligations under capital leases 270,224 --
Shareholders' equity:
Share capital (note 8) 183,547,829 122,102,244
Additional paid-in capital 7,515,887 5,282
Deficit (17,169,821) (7,330,417)
Cumulative translation adjustment (1,612,007) (1,484,471)
----------------------------------------------------------------------------------------------------------
172,281,888 113,292,638
Contingencies (note 9)
Subsequent event (note 16)
- ---------------------------------------------------------------------------------------------------------------
$ 277,306,019 $ 135,542,325
===============================================================================================================
See accompanying notes to unaudited consolidated financial statements.
-4-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Statements of Operations
(Unaudited)
Periods ended June 30, 2004 and 2003
(expressed in US dollars)
=====================================================================================================================
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------
Revenues $ 24,041,660 $ 2,093,825 $ 34,322,086 $ 4,196,779
Expenses:
Transaction processing and
service costs 14,049,474 1,381,705 21,372,410 2,804,005
Selling, general and administrative 9,054,974 2,624,279 14,331,120 4,606,127
Research and development 458,237 -- 458,237 --
Operating leases 1,120,576 199,081 1,854,304 320,925
----------------------------------------------------------------------------------------------------------------
24,683,261 4,205,065 38,016,071 7,731,057
Investment income 375,201 242,740 560,472 511,162
- ---------------------------------------------------------------------------------------------------------------------
Loss before undernoted items (266,400) (1,868,500) (3,133,513) (3,023,116)
Restructuring costs (note 10) 1,324,648 -- 1,324,648 108,900
Inventory write-downs (note 10) 2,429,989 -- 2,930,536 --
Stock-based compensation
(notes 3 (b) and 10) 1,933,713 -- 1,933,713 --
Amortization of intangibles 659,372 39,318 841,494 78,641
Amortization of property and equipment 609,295 118,040 790,585 222,189
Foreign exchange 89,964 19,376 (61,550) 173,132
- ---------------------------------------------------------------------------------------------------------------------
7,046,981 176,734 7,759,426 582,862
- ---------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (7,313,381) (2,045,234) (10,892,939) (3,605,978)
(Provision for) recovery of
income taxes (note 11) (308,283) 1,073,000 19,717 2,879,000
- ---------------------------------------------------------------------------------------------------------------------
Loss from continuing operations (7,621,664) (972,234) (10,873,222) (726,978)
Loss from discontinued operations
(note 3 (c)) (3,188,760) (245,089) (3,130,527) (471,253)
Gain on disposal of net assets from
discontinued operations, net of
income taxes of $2,342,000 (note 3 (c)) 4,164,345 -- 4,164,345 --
- ---------------------------------------------------------------------------------------------------------------------
Net loss $ (6,646,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
=====================================================================================================================
Weighted average number of shares:
Basic 21,702,051 14,936,235 18,337,833 14,936,235
Plus impact of stock options -- 426 506 213
- ---------------------------------------------------------------------------------------------------------------------
Diluted 21,702,051 14,936,661 18,338,399 14,936,448
=====================================================================================================================
Earnings per share :
Continuing operations:
Basic $ (0.35) $ (0.07) $ (0.59) $ (0.05)
Diluted (0.35) (0.07) (0.59) (0.05)
Discontinued operations:
Basic 0.04 (0.01) 0.05 (0.03)
Diluted 0.04 (0.01) 0.05 (0.03)
Total:
Basic (0.31) (0.08) (0.54) (0.08)
Diluted (0.31) (0.08) (0.54) (0.08)
=====================================================================================================================
See accompanying notes to unaudited consolidated financial statements.
-5-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Statements of Deficit
(Unaudited)
Periods ended June 30, 2004 and 2003
(expressed in US dollars)
=======================================================================================================
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------
Deficit, beginning of period $(10,523,742) $ (1,142,933) $ (7,330,417) $ (1,162,025)
Net loss (6,646,079) (1,217,323) (9,839,404) (1,198,231)
- -------------------------------------------------------------------------------------------------------
Deficit, end of period $(17,169,821) $ (2,360,256) $(17,169,821) $ (2,360,256)
=======================================================================================================
See accompanying notes to unaudited consolidated financial statements.
-6-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Statements of Cash Flows
(Unaudited)
Periods ended June 30, 2004 and 2003
(expressed in US dollars)
============================================================================================================================
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Loss from continuing operations $ (7,621,664) $ (972,234) $(10,873,222) $ (726,978)
Adjustments for:
Amortization 1,268,667 157,358 1,632,079 300,831
Stock-based compensation 1,933,713 -- 1,933,713 --
Inventory write-downs 2,429,989 -- 2,930,536 --
Future income taxes 282,283 (313,000) (45,717) (1,699,000)
Changes in operating assets and liabilities:
Accounts receivable 742,190 874,118 1,100,837 622,866
Service parts inventory 89,762 (93,401) (27,467) (131,126)
Income taxes and credits receivable (44,023) (828,689) (44,023) (1,597,419)
Prepaid expenses and deposits (45,753) (196,992) (313,459) (542,310)
Accounts payable and
accrued liabilities 503,885 (399,733) 165,068 (350,310)
Customer reserves and
security deposits (9,966,565) -- (9,966,565) --
Deferred revenue (373,335) 33,548 (69,684) 102,368
-----------------------------------------------------------------------------------------------------------------------
(10,800,851) (1,739,025) (13,577,904) (4,021,078)
Cash flows from investing activities:
Additions to property and equipment (1,248,921) (226,402) (1,550,439) (248,575)
(Increase) decrease in short-term
investments (27,950,846) 2,386,103 (20,137,639) 1,908,816
Proceeds from note receivable 147,465 -- 147,465 --
Proceeds from sale of business, before
repayment of purchase price
adjustment in July 2004 35,000,000 -- 35,000,000 --
Proceeds from disposal of EBS
(note 3 (d)) 3,974,495 -- 3,974,495 --
Acquisition costs (note 3 (b)) (1,027,843) -- (1,377,828) --
Acquisition of Systech (note 3 (a)) (464,556) -- (3,464,556) --
-----------------------------------------------------------------------------------------------------------------------
8,429,794 2,159,701 12,591,498 1,660,241
Cash flows from financing activities:
Bank indebtedness (106,445) -- (369,634) --
Proceeds from issuance of share capita l32,000 -- 32,000 --
Repayment of obligation under
capital lease (103,482) -- (103,482) --
-----------------------------------------------------------------------------------------------------------------------
(177,927) -- (441,116) --
- ----------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash during the
period (2,548,984) 420,676 (1,427,522) (2,360,837)
Net increase (decrease) in cash
from discontinued operations (1,705,514) 340,823 106,441 (2,895,119)
Effect of foreign exchange (118,170) -- (118,170) --
Cash, beginning of period 7,145,381 3,597,893 4,211,964 9,615,348
- ----------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 2,772,713 $ 4,359,392 $ 2,772,713 $ 4,359,392
============================================================================================================================
Supplemental cash flow disclosure (note 12)
See accompanying notes to unaudited consolidated financial statements.
-7-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Notes to Consolidated Financial Statements
(Unaudited)
Six-month periods ended June 30, 2004 and 2003
(expressed in US dollars)
================================================================================
1. Interim financial information:
These consolidated financial statements have been prepared by management
in accordance with Canadian generally accepted accounting principles. The
unaudited balance sheet as at June 30, 2004 and the unaudited statements
of operations, deficit and cash flows for the three and six-month periods
ended June 30, 2004 and 2003 reflect all adjustments which, in the opinion
of management, are necessary to present a fair statement of the results of
the interim periods presented. The results of operations and cash flows
for any quarter are not necessarily indicative of the results or cash
flows for an entire year. These interim consolidated financial statements
follow the same accounting policies and methods of their application as
described in note 2 of the annual audited consolidated financial
statements for the year ended December 31, 2003, except as described in
note 2 below. The interim consolidated financial statements do not include
all disclosures required for annual financial statements and should be
read in conjunction with the most recent annual audited consolidated
financial statements of Optimal Group Inc. (formerly Optimal Robotics
Corp.) (the "Company") as at and for the year ended December 31, 2003.
All amounts in the attached notes are unaudited unless specifically
identified.
2. Significant accounting policies and new accounting standards:
(a) Discontinued operations:
As a result of the sale of the U-Scan(R) self-checkout business
referred to in note 3 (c), the results of discontinued operations
are included in the net loss but recorded separately for current and
prior periods. The balance sheet presents the current and long-term
assets and liabilities related to the discontinued operations for
the current and prior periods.
(b) Revenue recognition:
As a result of the business acquisitions and disposals referred to
in note 3, the Company is engaged in payment services, and, in
addition, provides hardware maintenance and repair outsourcing
services throughout North America.
Revenues from payment services are recognized at the time services
are rendered. Revenues for set-up fees are deferred and recognized
over the expected term of the customer relationship.
Revenues from repair services are recognized at the time the
services are rendered. Revenues from maintenance contracts are
deferred and amortized ratably over the term of the contract.
-8-
2. Significant accounting policies and new accounting standards (continued):
(c) Amortization:
Intangibles are being amortized using the straight-line method over
the following periods:
=====================================================================================================
Customer contracts and customer relationships 42 - 72 months
Acquired technology 60 months
Customer list 44 months
Deferred compensation cost Vesting period for periods
ranging up to 36 months
=====================================================================================================
Amortization of property and equipment is provided for over the
estimated useful lives of the assets using the straight-line method
at the following annual rates:
=====================================================================================================
Computer equipment and software 33 - 50%
Equipment 10 - 20%
Leasehold improvements Lease term
=====================================================================================================
(d) Stock-based compensation:
Effective January 1, 2003, the Company adopted the fair value-based
method to account for stock-based compensation and other stock-based
payments. Under the fair value-based method, compensation cost is
measured at fair value at the date of grant and is expensed over the
award's vesting period.
-9-
2. Significant accounting policies and new accounting standards (continued):
(d) Stock-based compensation (continued):
In accordance with the standard, the following disclosure is
required to report the pro forma net earnings (loss) and earnings
(loss) per share as if the fair value-based method had been used to
account for employee stock options granted during fiscal 2002:
===================================================================================================================
Three months ended June 30, Six months ended June 30,
-------------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Net loss, as reported $ (6,646,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
Add:
Total stock-based employee
compensation expense
determined under fair
value-based method for all
awards granted in fiscal 2002,
net of related taxes of nil -- (270,752) -- (732,673)
-------------------------------------------------------------------------------------------------------------------
Pro forma net loss $ (6,646,079) $ (1,488,075) $ (9,839,404) $ (1,930,904)
===================================================================================================================
===================================================================================================================
Three months ended June 30, Six months ended June 30,
-------------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Loss per share:
Basic:
As reported $ (0.31) $ (0.08) $ (0.54) $ (0.08)
Pro forma (0.31) (0.10) (0.54) (0.13)
Diluted:
As reported (0.31) (0.08) (0.54) (0.08)
Pro forma (0.31) (0.10) (0.54) (0.13)
===================================================================================================================
There were no stock options granted in the three and six-month
periods ended June 30, 2003. The pro forma adjustment for fiscal
2003 relates to the amortization of compensation cost for stock
options granted during fiscal 2002 over the vesting periods.
-10-
2. Significant accounting policies and new accounting standards (continued):
(e) Foreign exchange:
The accounts of Terra Payments Inc. ("Terra"), acquired on April 6,
2004 and considered a self-sustaining enterprise, have been
translated using the current-rate method. Under this method, assets
and liabilities are translated into US dollars at the exchange rate
in effect at the balance sheet date. Revenues and expenses are
translated at the average rates prevailing during the period.
Resulting unrealized gains or losses are accumulated and reported as
a "cumulative translation adjustment" in shareholders' equity.
All other subsidiaries are integrated subsidiaries and are accounted
for under the temporal method. Under this method, monetary assets
and liabilities are translated at the exchange rate in effect at the
balance sheet date. Non-monetary assets and liabilities are
translated at historical rates. Revenues and expenses are translated
at average rates for the period. Exchange gains or losses arising
from translation from these transactions are included in the
statement of operations.
(f) Asset retirement obligations:
On January 1, 2004, the Company adopted the new recommendations of
the Canadian Institute of Chartered Accountants relating to asset
retirement obligations. This standard was established for the
recognition, measurement and disclosure of liabilities for asset
retirement obligations and the associated retirement cost. The
standard applies to legal obligations associated with the retirement
of a tangible long-lived asset that results from acquisition,
development or normal operations. The standard requires an entity to
record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred and when a
reasonable estimate of fair value can be made. An entity is
subsequently required to allocate the asset retirement cost to
expense using a systematic and rational method over its estimated
life. The adoption of this standard did not have an impact on the
Company's financial statements.
3. Business acquisitions and disposals:
(a) Systech Retail Systems:
On February 27, 2004, the Company acquired the hardware service
division of Systech Retail Systems ("Systech"). The Company believes
that the combination of this division with Optimal's existing
service organization will contribute positively to the Company's
financial results in 2004.
The net assets acquired for cash were approximately $3.5 million.
The acquisition is accounted for by the Company using the purchase
method and the results of Systech are consolidated with those of the
Company from the date of acquisition.
-11-
3. Business acquisitions and disposals (continued):
(a) Systech Retail Systems (continued):
The following table summarizes the estimated fair value of the
assets acquired and liabilities assumed at the date of acquisition.
The Company is in the process of finalizing its valuation of the net
assets acquired, including goodwill and other intangible assets;
thus, the allocation of the purchase price is subject to refinement.
====================================================================
Assets acquired:
Accounts receivable $ 1,428,411
Inventories 745,728
Property and equipment 273,706
Prepaid expenses and deposits 64,536
Customer contracts and customer relationships 612,332
Goodwill 4,364,411
---------------------------------------------------------------
7,489,124
Liabilities assumed:
Accounts payable and accrued liabilities 1,533,571
Deferred revenue 2,490,997
---------------------------------------------------------------
4,024,568
--------------------------------------------------------------------
Net assets acquired for cash $ 3,464,556
====================================================================
During the period ended June 30, 2004, the Company adjusted the fair
value of inventories acquired at the date of acquisition to $745,728
from $3,620,125 for service parts that could not be used by the
Company, increased accrued liabilities assumed by $475,078 for
accrued vacation due to Systech employees at the date of acquisition
and recorded a value of $612,332 as the estimated fair value of the
customer contracts and customer relationships.
(b) Terra Payments Inc.:
Effective April 6, 2004, the Company completed a Combination
Agreement with Terra Payments Inc. ("Terra"), a Canadian
publicly-traded company that offers proprietary technology and
services to businesses to accept credit card, electronic check and
direct debit payments. Terra processes credit card payments
primarily for non-face-to-face transactions, including
mail-order/telephone order, licensed online gaming and other online
merchants, as well as for retail point-of-sale merchants. Terra also
processes checks and direct debits online and by telephone. The
Company believes that this transaction will provide a platform for
enhanced growth and profitability.
-12-
3. Business acquisitions and disposals (continued):
(b) Terra Payments Inc. (continued):
The agreement provided for a stock-for-stock merger in which 0.4532
of the Company's common shares were exchanged for each share of
Terra. The total purchase price of $65,993,820 was paid through the
issuance of 7,242,168 Class A shares by the Company, the acquisition
of outstanding options and warrants issued by Terra and estimated
transaction costs of the Company.
The acquisition is accounted for by the Company using the purchase
method. The following table presents the estimated fair value of the
assets and liabilities of Terra on April 6, 2004. The Company is in
the process of finalizing its valuation of the net assets acquired,
including goodwill and other intangible assets; thus, the allocation
of the purchase price is subject to refinement.
===========================================================================
Assets acquired:
Short-term investments $ 66,579,709
Cash and short-term investments - held as reserves 23,555,028
Accounts receivable 1,282,900
Refundable investment tax credits receivable 588,597
Prepaid expenses and deposits 474,873
Property and equipment 1,466,194
Investment in ebs Electronic Billing Systems AG 3,974,495
Note receivable 1,697,640
Other assets 3,122,490
Non-refundable investment tax credits 3,330,343
Future income taxes 6,750,092
Customer contracts and customer relationships 5,456,000
Acquired technology 4,520,000
Non-deductible goodwill 32,249,461
----------------------------------------------------------------------
155,047,822
Liabilities assumed:
Accounts payable and accrued liabilities 10,697,312
Deferred revenue 443,937
Customer reserves and security deposits 73,258,910
Future income taxes 3,921,780
Obligations under capital leases 732,063
----------------------------------------------------------------------
89,054,002
---------------------------------------------------------------------------
Net assets acquired $ 65,993,820
===========================================================================
-13-
3. Business acquisitions and disposals (continued):
(b) Terra Payments Inc. (continued):
========================================================================================
Consideration:
7,242,168 common shares $ 61,413,585
Transaction costs 1,377,828
Options and warrants 5,877,330
Less: options and warrants considered deferred compensation (2,674,923)
----------------------------------------------------------------------------------------
Total purchase price $ 65,993,820
========================================================================================
The per share value of the shares issued as consideration for the
business acquisition was $8.48, which was determined using the
Company's average closing share price on NASDAQ over a reasonable
period before and after the date the terms of the business
combination were agreed to and announced.
The Company assumed 1,587,058 stock options and warrants having a
fair value of $5,877,330, or a weighted average of $3.70 per share,
relating to the Terra outstanding stock options and warrants. This
also represents 0.4532 stock option or warrant of the Company for
each stock option or warrant of Terra. The fair value of the vested
stock options and warrants of $3,202,407 is included in the purchase
consideration. The remaining $2,674,923 representing the fair value
of the unvested stock options, is recorded as deferred compensation
cost and is being amortized over the vesting periods. For the three
and six months ended June 30, 2004, an amount of $300,437 was
amortized as stock-based compensation in the consolidated statements
of operations.
The fair values were determined using the Black-Scholes option
pricing model using the following weighted average assumptions:
========================================================================================
Expected volatility 70%
Expected life 2.9 years
Risk-free interest rate 2%
Dividend rate 0%
========================================================================================
-14-
3. Business acquisitions and disposals (continued):
(c) Sale of U-Scan(R) self-checkout business:
Effective April 8, 2004, the Company sold its U-Scan(R)
self-checkout business to Fujitsu Transaction Solutions Inc.
("Fujitsu"), including all related tangible assets, intellectual
property rights, and obligations, for $35,000,000 in cash plus the
assumption of liabilities. Fujitsu funded the payment of a
termination fee owed by the Company to NCR Corporation as a result
of the termination of their offer to purchase the self-checkout
business. Included in accounts payable and accrued liabilities at
June 30, 2004 is an amount of $4,806,240 owing to Fujitsu due to
purchase price adjustments mainly attributed to there being less net
assets sold to Fujitsu as the Company collected a large portion of
the accounts receivable and realized the cash thereon in advance of
the sale. Thus, the net proceeds realized on the sale to Fujitsu
were $30,193,760.
The sale of the U-Scan(R) self-checkout business is consistent with
the Company's strategy to reposition the business as a payments and
services leader. As a result of weak capital spending environment
for retail technology and a significantly more competitive landscape
in the self-checkout business, which negatively impacted sales,
gross margins and overall financial results, the Company decided to
exit this business and focus on building a payments and services
business.
-15-
3. Business acquisitions and disposals (continued):
(c) Sale of U-Scan(R) self-checkout business (continued):
The following table summarizes the book value of the assets and
liabilities at April 8, 2004 and December 31, 2003 relating to the
business sold by the Company:
================================================================================================
April 8, December 31,
2004 2003
------------------------------------------------------------------------------------------------
Current assets:
Accounts receivable $ 8,193,454 $ 6,289,527
Inventories 17,915,397 18,722,431
Prepaid expenses and deposits 169,347 279,760
-------------------------------------------------------------------------------------------
26,278,198 25,291,718
Long-term assets:
Property and equipment 3,936,821 4,358,857
Intangible assets 3,500,444 1,592,422
-------------------------------------------------------------------------------------------
7,437,265 5,951,279
Current liabilities:
Accounts payable accrued liabilities 2,896,110 2,830,850
Deferred revenue 7,131,938 1,557,976
-------------------------------------------------------------------------------------------
10,028,048 4,388,826
------------------------------------------------------------------------------------------------
Net assets relating to U-Scan(R) self-checkout business 23,687,415 26,854,171
Proceeds from sale 30,193,760 N/A
------------------------------------------------------------------------------------------------
Gain on sale of net assets of U-Scan(R) self-checkout business
before income taxes 6,506,345 N/A
Income taxes 2,342,000 N/A
------------------------------------------------------------------------------------------------
Net gain on sale of net assets of U-Scan(R) self-checkout
business $ 4,164,345 $ N/A
================================================================================================
-16-
3. Business acquisitions and disposals (continued):
(c) Sale of U-Scan(R) self-checkout business (continued):
The results of operations of this business for the three and six
months ended June 30, 2004 and 2003 were as follows:
========================================================================================================
Three months ended June 30, Six months ended June 30,
--------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------
Systems and hardware service
revenue $ 734,783 $ 14,485,661 $ 10,870,032 $ 28,682,933
Cost of sales 1,037,814 10,283,699 6,929,014 19,545,480
--------------------------------------------------------------------------------------------------------
(303,031) 4,201,962 3,941,018 9,137,453
Expenses:
Selling, general and
administrative 2,830,738 3,565,655 5,968,133 7,727,352
Amortization 54,991 542,231 664,195 1,030,992
Operating leases -- 209,697 237,363 504,010
Research and development -- 293,468 201,854 522,752
Restructuring costs -- -- -- 138,600
---------------------------------------------------------------------------------------------------
2,885,729 4,611,051 7,071,545 9,923,706
--------------------------------------------------------------------------------------------------------
Loss before income taxes (3,188,760) (409,089) (3,130,527) (786,253)
Income taxes recovery -- 164,000 -- 315,000
--------------------------------------------------------------------------------------------------------
Net loss from discontinued
operations $ (3,188,760) $ (245,089) $ (3,130,527) $ (471,253)
========================================================================================================
The results of operations include management assumptions and
adjustments related to cost allocations which are inherently
subjective.
(d) Disposition of ebs Electronic Billing Systems AG:
In May 2004, the Company sold its investment in ebs Electronic
Billing Systems AG ("EBS") to EBS' majority shareholder for a net
cash consideration of $3,974,495, which was the fair value of the
investment recorded by the Company upon the acquisition of Terra at
April 6, 2004. Accordingly, there was no gain or loss on this
transaction.
-17-
3. Business acquisitions and disposals (continued):
(e) RBA Inc.:
On September 30, 2003, the Company acquired substantially all of the
assets and the ongoing business of RBA Inc. ("RBA"), a company that
provides hardware maintenance outsourcing services, including
debit/credit card system maintenance and computer maintenance
services, across Canada.
The net assets acquired for cash are approximately $6.0 million
(CA$8.1 million), subject to the determination of certain
post-closing adjustments, if any. The acquisition is accounted for
by the Company using the purchase method and the results of RBA are
consolidated with those of the Company from the date of acquisition.
In fiscal 2004, an adjustment of $139,327 was made to increase
goodwill attributable to the acquisition of the ongoing business of
RBA Inc. for liabilities estimated at time of the acquisition. As at
June 30, 2004, the Company is still in the process of finalizing its
valuation of the net assets acquired, including the determination of
post-closing adjustments and the allocation to goodwill and to other
intangible assets; thus, the allocation of the purchase price is
subject to final modifications.
4. Cash and short-term investments held as reserves, and customer reserves
and security deposits:
Cash and short-term investments held as reserves:
The Company has agreements with various financial institutions for the
settlement of payment transactions. Under the terms of these agreements,
the Company is required to maintain certain amounts as reserves, which may
be applied against any amounts for which the financial institutions would
be entitled to reimbursement. Any amounts charged by the financial
institutions are charged to the Company's customers.
Customer reserves and security deposits:
Customer reserves and security deposits are required from the customers to
allow the Company to recover any amounts charged by the financial
institutions under the arrangements described above. Customer reserves
relate to the short-term portion of collateral and outstanding payments
due to customers. Security deposits are held by the Company over the term
of the customer relationship, which has generally been of a long-term
nature.
5. Other receivable:
During Terra's fiscal year ended March 31, 2002, Terra was assessed a
charge of $6.8 million (CA$8.8 million) by one of its credit card
suppliers of services. This amount was withdrawn by the supplier from
Terra's bank account. The Company believes this charge is largely
unsubstantiated and is pursuing the claim through legal recourse. A
provision of $3.7 million has been made against the amount receivable.
-18-
6. Goodwill and other intangible assets:
----------------------------------------------------------------------------------------------------
June 30,
2004
----------------------------------------------------------------------------------------------------
Gross carrying Accumulated Net book
amount amortization value
----------------------------------------------------------------------------------------------------
Goodwill $ 43,708,452 $ 141,750 $ 43,566,702
Customer contracts and customer
relationships 9,468,052 756,082 8,711,970
Acquired technology 4,520,000 226,000 4,294,000
Customer list 786,414 419,207 367,207
----------------------------------------------------------------------------------------------------
$ 58,482,918 $ 1,543,039 $ 56,939,879
====================================================================================================
====================================================================================================
December 31,
2003
----------------------------------------------------------------------------------------------------
Gross carrying Accumulated Net book
amount amortization value
----------------------------------------------------------------------------------------------------
Goodwill $ 6,955,251 $ 141,750 $ 6,813,501
Customer contracts and customer
relationships 3,399,720 141,655 3,258,065
Customer list 786,414 340,564 445,850
----------------------------------------------------------------------------------------------------
$ 11,141,385 $ 623,969 $ 10,517,416
====================================================================================================
7. Bank indebtedness:
The Company has credit facilities in the amount of approximately CA$15
million (U.S.$11.6 million), which can be utilized in the form of loans or
bankers' acceptances in Canadian dollars. At June 30, 2004, the Company
utilized US$10,356,442 of the facilities. The borrowings are due on demand
and bear interest either at the bank's prime rate or the market rate for
bankers' acceptances plus an acceptance fee of 0.75% per annum, depending
on the form of the facility utilized. The facilities are secured by a
first ranking moveable hypothec on short-term investments.
-19-
8. Share capital:
(a) Issued and outstanding share capital were as follows:
=====================================================================================================
June 30, 2004 December 31, 2003
------------------------------- -------------------------------
Number Book value Number Book value
-----------------------------------------------------------------------------------------------------
Common shares 22,183,403 $ 183,547,829 14,936,235 $ 122,102,244
=====================================================================================================
Changes in the issued and outstanding share capital were as follows:
=====================================================================================================
Book
Number value
-----------------------------------------------------------------------------------------------------
Balance, December 31, 2003 14,936,235 $ 122,102,244
Shares issued on acquisition of Terra (note 3 (b)) 7,242,168 61,413,585
Exercise of options 5,000 32,000
-----------------------------------------------------------------------------------------------------
Balance, June 30, 2004 22,183,403 $ 183,547,829
=====================================================================================================
(b) Stock options:
Details of the outstanding stock options are as follows:
=====================================================================================================
Weighted-average
exercise price
Number per share
-----------------------------------------------------------------------------------------------------
Balance, December 31, 2003 5,000 $ 6.40
Granted 4,606,926 7.10
Expired/cancelled (50,000) 7.10
Exercised (5,000) 6.40
-----------------------------------------------------------------------------------------------------
Balance, June 30, 2004 4,556,926 $ 7.10
=====================================================================================================
During the period ended June 30, 2004, the Company granted 4,606,926
stock options having an exercise price of $7.10 per share. Included
in the stock option grants are 3,484,417 stock options that have
certain performance vesting triggers tied to the market price of the
Company's shares.
-20-
8. Share capital (continued):
(b) Stock options (continued):
Under the terms of the Combination Agreement with Terra, the Company
assumed Terra's stock option plan, as such, stock options governed
by this plan will be exercisable for the Company's common shares.
The exercise price and number of options outstanding on April 6,
2004, the effective date of the acquisition of Terra, were adjusted
based on the exchange ratio of 0.4532 of the Company's common shares
for each share of Terra.
Details of the outstanding stock options under this plan are as
follows:
==================================================================================================
US dollar exercise price Canadian dollar exercise price
--------------------------------------------------------------------------------------------------
Weighted-average Weighted-average
exercise price exercise price
Number per share Number per share
--------------------------------------------------------------------------------------------------
Balance, April 6, 2004 217,451 $ 7.43 611,541 $ 16.24
Expired/cancelled -- -- (16,829) 6.04
--------------------------------------------------------------------------------------------------
Balance, June 30, 2004 217,451 $ 7.43 594,712 $ 12.10
==================================================================================================
As at April 6, 2004 and June 30, 2004, there was 758,066 warrants
outstanding with a weighted average exercise price of CA$9.43 and
expiring on December 19, 2005.
There are 6,143,984 options and warrants that could potentially
dilute basic earnings per share in the future that were not included
in the computation of diluted earnings per share because to do so
would have been antidilutive for the period ended June 30, 2004.
9. Contingencies:
(a) The Company received a legal letter from a claimant in 1999, and
again in February 2001, alleging infringement of a patent related to
the U-Scan(R) self-checkout business. In March 2003, this claimant
also sent a third demand letter alleging infringement of additional
patents. The Company believes these claims to be without merit and
intends to vigorously defend its position should this claimant
initiate a civil action. No amounts have been specified in these
claims. It is not possible at this time to make an estimate of the
amount of damages, if any, that may result and, accordingly, no
provision has been made in these financial statements with respect
to such claims.
-21-
9. Contingencies (continued):
(b) In connection with the sale of the U-Scan(R) self-checkout business
on April 8, 2004 to Fujitsu, orders were obtained from the Superior
Court of Quebec permitting the Company to submit the sale to Fujitsu
to the Company's shareholders for approval in lieu of the originally
proposed sale to NCR Corporation ("NCR"). NCR is seeking to appeal
these decisions. The Company believes that these appeals will not
prevail. NCR has also delivered a notice of dispute under its now
terminated purchase agreement alleging a breach of the
non-solicitation provisions of that agreement. The Company believes
that such allegations are without merit and intends to vigorously
defend itself in any arbitration proceedings that may ensue.
Accordingly, no provision has been made in these financial
statements with respect to such claims.
(c) The Company is contractually bound to indemnify Fujitsu for any
losses, claims, liabilities or other damages resulting from the
U-Scan(R) self-checkout business arising on or before April 8, 2004.
A reasonable estimate of the maximum potential amount the Company
could be required to pay to Fujitsu cannot be made given the nature
of the indemnification.
(d) The Company is party to litigation arising in the normal course of
operations. The Company does not expect the resolution of such
matters to have a materially adverse effect on the financial
position or results of operations of the Company.
10. Other charges:
(a) Restructuring and inventory write-downs:
Restructuring costs of $1,324,648 were recorded in the three-month
period ended June 30, 2004 as a result of efficiency initiatives
undertaken that relate principally to the services operating
segment. The restructuring costs relate primarily to workforce
reduction of approximately $0.9 million and facility closure costs
of $0.4 million. At June 30, 2004, the entire amount of costs
accrued is included in accounts payable and accrued liabilities in
the consolidated balance sheets.
Inventory write-downs of $2,429,989 were recorded in the three-month
period ended June 30, 2004 ($2,930,536 year-to-date) for service
parts inventory that were deemed to be no longer of use to the
Company in light of the realignment of its services business.
-22-
10. Other charges (continued):
(b) Stock-based compensation:
The fair value of stock options granted during the three-month
period ended June 30, 2004 was determined at the date of grant using
the Black-Scholes option pricing model and the following
weighted-average assumptions:
===================================================================================================
Volatility 69.4%
Expected life 5 years
Risk-free interest rate 3.39%
Dividend rate 0%
===================================================================================================
The weighted-average fair value of stock options granted was as
follows:
===================================================================================================
Weighted-average
grant date
Number fair value
of options per share
---------------------------------------------------------------------------------------------------
Exercise price per share equal to market price
per share 4,606,926 $ 4.25
===================================================================================================
-23-
11. Income taxes:
The income tax provision differs from the amount computed by applying the
combined Canadian federal and Quebec provincial tax rates to earnings
before income taxes. The reasons for the difference and the related tax
effects are as follows:
===========================================================================================================
Three months ended June 30, Six months ended June 30,
-----------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes $ (7,313,381) $ (2,045,234) $(10,892,939) $ (3,605,978)
===========================================================================================================
Combined Canadian federal and
Quebec provincial income taxes
at 31% (2003 - 33%) $ (2,267,148) $ (674,927) $ (3,376,811) $ (1,189,973)
Foreign exchange (1) (4,259) (174,763) 21,436 (1,418,982)
Benefits of losses not recorded 1,915,425 -- 2,699,223 --
Stock-based compensation 512,000 -- 512,000 --
Permanent differences and other 152,265 (223,310) 124,435 (270,045)
-----------------------------------------------------------------------------------------------------------
Income tax provision (recovery) $ 308,283 $ (1,073,000) $ (19,717) $ (2,879,000)
===========================================================================================================
(1) For purposes of calculating the income tax provision of the Company,
a tax liability is recognized on the foreign exchange gains which
arise on the conversion into Canadian dollars of the net monetary
assets denominated in U.S. dollars which is required for Canadian
tax purposes. As these financial statements are presented in U.S.
dollars, these foreign exchange gains do not impact earnings
(losses) before income taxes even though the income tax provision
would include a tax liability for these gains. Future fluctuations
in the foreign exchange rate between the Canadian and U.S. dollar
will change the amount of the foreign exchange gains and thus, the
provision for or recovery of income taxes thereon.
The provision for (recovery) of income taxes is composed of the following:
===========================================================================================================
Three months ended June 30, Six months ended June 30,
-----------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------
Current income taxes $ 26,000 $ (760,000) $ 26,000 $ (1,180,000)
Future income taxes 282,283 (313,000) (45,717) (1,699,000)
-----------------------------------------------------------------------------------------------------------
$ 308,283 $ (1,073,000) $ (19,717) $ (2,879,000)
===========================================================================================================
-24-
12. Supplemental cash flow disclosure:
======================================================================================================
Three months ended June 30, Six months ended June 30,
------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
------------------------------------------------------------------------------------------------------
Non-cash transactions:
Issue of shares on acquisition
of Terra $61,413,585 $ -- $61,413,585 $ --
Assumption of stock options
and warrants of Terra 5,877,330 -- 5,877,330 --
======================================================================================================
13. Segmented information:
As a result of the business acquisitions and disposals referred to in note
3, the Company now operates in two segments, namely payments, and hardware
maintenance and repair outsourcing services. Management measures the
results of operations based on segment income before income taxes adjusted
for certain non-cash and non-recurring items provided by each business
segment.
Previously, the Company also developed and sold automated transaction
products designed for use in the retail sector and provided related
hardware and software maintenance. As a result of the sale of the
U-Scan(R) self-checkout business, this segment has been reclassified as
discontinued operations.
-25-
13. Segmented information (continued):
(a) Information on the operating segments is as follows:
======================================================================================================================
Hardware
Payment maintenance and
services repair services Consolidated
---------------------------------------------------------------------------------------------------------------------
Three months ended June 30, 2004:
Revenues $ 11,895,564 $ 12,146,096 $ 24,041,660
Transaction processing/service costs 4,844,058 9,205,416 14,049,474
Amortization 854,476 414,191 1,268,667
Investment income 186,781 188,420 375,201
Stock-based compensation 1,358,703 575,010 1,933,713
Restructuring costs 76,310 1,248,338 1,324,648
Inventory write-downs -- 2,429,989 2,429,989
Loss from continuing operations before income taxes (323,115) (6,990,266) (7,313,381)
Provision for income taxes (308,283) -- (308,283)
Loss from continuing operations (631,398) (6,990,266) (7,621,664)
Three months ended June 30, 2003:
Revenues $ -- $ 2,093,825 $ 2,093,825
Transaction processing/service costs -- 1,381,705 1,381,705
Amortization -- 157,358 157,358
Investment income -- 242,740 242,740
Loss from continuing operations before income taxes -- (2,045,234) (2,045,234)
Recovery of income taxes -- 1,073,000 1,073,000
Loss from continuing operations -- (972,234) (972,234)
Six months ended June 30, 2004:
Revenues $ 11,895,564 $ 22,426,522 $ 34,322,086
Transaction processing/service costs 4,844,058 16,528,352 21,372,410
Amortization 854,476 777,603 1,632,079
Investment income 186,781 373,691 560,472
Stock-based compensation 1,358,703 575,010 1,933,713
Restructuring costs 76,310 1,248,338 1,324,648
Inventory write-downs -- 2,930,536 2,930,536
Loss from continuing operations before income taxes (323,115) (10,569,824) (10,892,939)
Provision for (recovery of) income taxes 308,283 (328,000) (19,717)
Loss from continuing operations (631,398) (10,241,824) (10,873,222)
Six months ended June 30, 2003:
Revenues $ -- $ 4,196,779 $ 4,196,779
Transaction processing/service costs -- 2,804,005 2,804,005
Amortization -- 300,830 300,830
Investment income -- 511,162 511,162
Loss from continuing operations before income taxes -- (3,605,978) (3,605,978)
Recovery of income taxes -- 2,879,000 2,879,000
Loss from continuing operations -- (726,978) (726,978)
======================================================================================================================
-26-
13. Segmented information (continued):
(a) Information on the operating segments is as follows (continued):
===================================================================================================================
Hardware
Payment maintenance and
services repair services Consolidated
-------------------------------------------------------------------------------------------------------------------
June 30, 2004:
Total assets $158,948,195 $118,357,824 $277,306,019
Total additions to property and equipment
and intangibles for the six months ended
June 30, 2004:
- at date of acquisition $ 43,691,655 $ 5,250,449 $ 48,942,104
- thereafter 571,847 978,592 1,550,439
December 31, 2003:
Total assets $ -- $104,299,328(1) $104,299,328(1)
Total additions to property and equipment
and intangibles for the year ended
December 31, 2004 $ -- $ 7,564,947 $ 7,564,947
===================================================================================================================
(1) Excluding $31,242,997 of total assets related to discontinued
operations.
(b) Geographic information is as follows:
===================================================================================================================
Property and equipment,
Revenues goodwill and intangibles
-------------------------------------------------------------- ----------------------------
Three months ended Six months ended
June 30, June 30, June 30, December 31,
2004 2003 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Canada $ 7,383,275 $ -- $14,340,552 $ -- $52,949,692 $ 8,196,857
United States 9,108,937 2,093,825 12,432,086 4,196,779 8,359,519 4,251,890
Other 7,549,448 -- 7,549,448 -- -- --
-------------------------------------------------------------------------------------------------------------------
$24,041,660 $ 2,093,825 $34,322,086 $ 4,196,779 $61,309,211 $12,448,747
===================================================================================================================
Revenues are attributed to countries based on location of customer.
-27-
14. Canada/U.S. reporting differences:
The consolidated financial statements of the Company are prepared in
accordance with Canadian generally accepted accounting principles
("GAAP"), which conform, in all material respects, with those generally
accepted in the United States except as described below:
(a) Consolidated statement of operations:
The reconciliation of net earnings (loss) reported in accordance
with Canadian GAAP with U.S. GAAP is as follows:
=================================================================================================================
Three months ended June 30, Six months ended June 30,
-----------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------
Net loss in accordance
with Canadian GAAP $ (6,640,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
Stock-based compensation costs (i) -- -- -- --
-----------------------------------------------------------------------------------------------------------------
Net loss in accordance
with U.S. GAAP $ (6,640,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
=================================================================================================================
Loss per share under
U.S. GAAP:
Basic $ (0.31) $ (0.08) $ (0.54) $ (0.08)
Diluted (0.31) (0.08) (0.54) (0.08)
=================================================================================================================
The weighted average number of common shares outstanding for
purposes of determining basic and diluted earnings (loss) per share
are the same amounts disclosed for Canadian GAAP purposes.
(i) Stock-based compensation:
Effective January 1, 2003, the Company adopted the fair value
recognition provisions of FASB Statement 123, Accounting for
Stock-based Compensation, prospectively to all employee awards
granted, modified or settled after January 1, 2003.
Consequently, for periods after January 1, 2003, there are no
differences between Canadian GAAP and US GAAP. However, for
awards granted prior to January 1, 2003, and because awards
under the Company's plan vest over a period of three years,
the cost related to stock-based compensation included in the
determination of net earnings is less than that which would
have been recognized if the fair value based method had been
applied to all awards since the original effective date of
Statement 123.
-28-
14. Canadian/U.S. reporting differences (continued):
(a) Consolidated statement of operations (continued):
(i) Stock-based compensation (continued):
The following table illustrates the effect on net loss and
loss per share if the fair value based method had been applied
to all outstanding and unvested awards in each period:
==========================================================================================================
Three months ended June 30, Six months ended June 30,
----------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
----------------------------------------------------------------------------------------------------------
Reported net loss in accordance
with US GAAP $ (6,646,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
Add: Stock-based employee
compensation expense
determined under the
intrinsic value method
included in reported net
earnings, net of related
taxes of nil -- -- -- --
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related taxes of nil -- (4,131,275) -- (9,256,295)
----------------------------------------------------------------------------------------------------------
Pro forma net loss $ (6,646,079) $ (5,348,598) $ (9,839,404) $(10,454,526)
==========================================================================================================
-29-
14. Canadian/U.S. reporting differences (continued):
(a) Consolidated statement of operations (continued):
(i) Stock-based compensation (continued):
========================================================================================
Three months ended June 30, Six months ended June 30,
----------------------------------------------------------------------------------------
2004 2003 2004 2003
----------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic:
As reported $ (0.31) $ (0.08) $ (0.54) $ (0.08)
Pro forma (0.31) (0.36) (0.54) (0.70)
Diluted:
As reported (0.31) (0.08) (0.54) (0.08)
Pro forma (0.31) (0.36) (0.54) (0.70)
========================================================================================
(b) Consolidated balance sheets:
==========================================================================================================
June 30, 2004 December 31, 2003
--------------------------------- ---------------------------------
Canadian US Canadian US
GAAP GAAP GAAP GAAP
----------------------------------------------------------------------------------------------------------
Shareholders' equity:
Share capital $ 183,547,829 $ 226,004,392 $ 122,102,244 $ 164,558,807
Additional paid-in
capital 7,515,887 37,372,614 5,282 29,862,009
Deficit (17,169,821) (87,949,349) (7,330,417) (78,109,945)
Cumulative translation
adjustment (1,612,007) -- (1,484,471) --
Accumulated other
comprehensive loss -- (3,145,769) -- (3,018,233)
----------------------------------------------------------------------------------------------------------
$ 172,281,888 $ 172,281,888 $ 113,292,638 $ 113,292,638
==========================================================================================================
(c) Supplementary information:
Under US GAAP, stock-based compensation would be presented as part
of "selling, general and administrative" expenses on the statement
of operations instead of as a separate line item.
-30-
14. Canadian/U.S. reporting differences (continued):
(c) Supplementary information (continued):
The following unaudited pro forma financial information reflects the
consolidated results of operations as if the acquisitions of Terra
and RBA had taken place January 1, 2003. The pro forma financial
information is not necessarily indicative of the results of
operations as it would have been had the transactions been reflected
on the assumed date.
=================================================================================================
Three months ended June 30, Six months ended June 30,
-------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------
Revenues $ 37,183,289 $ 20,128,756 $ 47,463,715 $ 39,256,391
Net loss (7,000,003) (1,554,723) (10,190,328) (1,579,032)
Diluted loss per share $ (0.32) $ (0.10) $ (0.56) $ (0.11)
=================================================================================================
15. Comparative figures:
Certain of the comparative figures have been reclassified in order to
conform with the current period's presentation.
16. Subsequent event:
On July 1, 2004, the Company acquired National Processing Services LLC
("NPS"), a registered VISA(R) and Mastercard(R) independent sales
organization, for a cash consideration of $15 million. The Company
believes that this acquisition will diversify its payment services
portfolio and contribute positively to the Company's financial results.
The acquisition will be accounted for by the Company using the purchase
method and the results of NPS will be consolidated with those of the
Company from the date of acquisition.
-31-
16. Subsequent event (continued):
The following table summarizes the estimated fair value of the assets
acquired and liabilities assumed at date of acquisition. The Company is in
the process of finalizing its valuation of the net assets acquired,
including goodwill and other intangible assets; thus, the allocation of
the purchase price is subject to refinement.
==========================================================================
Assets acquired:
Accounts receivable $ 474,471
Inventories 37,000
Property and equipment 21,306
Prepaid expenses and deposits 12,083
Goodwill and other intangible assets 14,560,102
----------------------------------------------------------------------
15,104,962
Liabilities assumed:
Accounts payable and accrued liabilities 104,962
--------------------------------------------------------------------------
Net assets acquired for cash $ 15,000,000
==========================================================================
-32-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial condition and results of
operations of our company should be read in conjunction with our audited
consolidated financial statements for the year ended December 31, 2003, and the
factors set forth below under "Forward-Looking Statements". All dollar amounts
are expressed in U.S. dollars and, other than those expressed in millions of
dollars, have been rounded to the nearest thousand. Our accounting policies are
in accordance with Canadian generally accepted accounting principals ("GAAP").
These differ in some respects from GAAP in the United States ("US GAAP"). Our
results are reconciled to US GAAP; see note 14 to our interim consolidated
financial statements.
Overview
We have recently completed a number of business acquisitions and disposals
in pursuit of our strategy to reposition our business activities with the goal
of enhancing long-term financial results. We believe these transactions will
realign us into a strong payments and services company with a more balanced and
stable business mix. We plan to grow our core businesses on a strategic basis,
both organically and through acquisition. Furthermore, by leveraging our strong
balance sheet, we intend to take advantage of strategic and transactional
opportunities that may arise, with a focused approach on potential acquisitions.
As a result of these transactions, we currently operate in two segments;
payments, through Optimal Payments, and hardware maintenance and repair
outsourcing services, through Optimal Services Group.
For additional information relating to our Company, readers may review the
documentation filed by us with the U.S. Securities and Exchange Commission
(including the Annual Report on Form 10-K) available at www.sec.gov and with the
securities regulatory authorities of British Columbia, Alberta, Ontario and
Quebec available at www.sedar.com.
Optimal Payments
Optimal Payments is a growing presence in the payments processing industry
and provides technology and services that businesses require to accept credit
card, electronic check and direct debit payments. Optimal Payments processes
credit card payments for card-not-present and card-present (or, "swipe")
transactions, including Internet businesses, mail-order/telephone-order ("MOTO")
merchants, and retail point-of-sale merchants. Optimal Payments also processes
checks and direct debits online and by telephone. Optimal Payments has
approximately 110 employees and is headquartered in Montreal with operations
throughout North America and in the United Kingdom. Optimal Payments currently
has approximately 7,500 customers (merchants) using its credit card and
electronic check products.
Optimal Payments generates revenues primarily from fees charged to
merchants for processing services, as well as from fees charged to consumers who
utilize our FirePay(R) Personal Account stored-value offering. Fees charged to
merchants typically include a discount rate, based upon a percentage of the
dollar amounts processed, and a variety of fixed transaction or service fees.
Merchant fees charged are based upon the merchant's volume and risk profile.
Fees charged to consumers are based on fixed transaction amounts. Revenue is
recognized primarily at the time the transaction or service is performed. To the
extent that we retain responsibility to a bank or other acquiring processing
supplier for chargebacks against our merchant accounts, and therefore the
associated credit risk with regard to such merchants, we record revenue gross of
the amounts paid to the acquiring processing supplier. See note 2(b) to our
interim consolidated financial statements.
We retain a portion of amounts owed to each merchant based on processing
volume for a period of six months to cover potential merchant credit losses that
can arise as a result of, among other things,
-33-
disputes between cardholders and merchants or association fines related to
chargeback activity. The aggregate withheld amount is referred to as "reserves"
and our liability to refund our customers is included in the line item "Customer
reserves and security deposits" in the balance sheet contained in the
consolidated financial statements included in this report. If disputes are not
resolved in the merchant's favour, the transaction is charged back to us and the
purchase price is refunded to the merchant's customer. If we are unable to
collect from the merchant, we bear the credit risk for the full amount of the
transaction. As a result, our acquiring processing suppliers require us to
maintain certain amounts with them as reserves. Amounts withheld by our
acquiring processing suppliers are included in cash and short-term investments
on our balance sheet as "held as reserve". For merchants who continue to use our
services, we withhold and refund reserves on a rolling basis so that as new
transactions are processed, we withhold a portion as the reserve, while at the
same time refunding the reserves for which the six-month period has expired.
Optimal Services Group
Optimal Services Group ("OSG") offers its customers a single-source
solution for many of their computer maintenance and technology support
requirements, including hardware maintenance services, software support,
end-user/help desk services, network support and other technology support
services. OSG also provides multi-vendor parts repair, refurbishment and
inventory management services as part of its logistics services portfolio. OSG
delivers services through an extensive service organization located throughout
the United States and Canada. OSG has approximately 800 employees located
throughout the United States and Canada.
OSG's primary source of revenue is contracted computer maintenance and
technology support services. These contracts typically have a stipulated monthly
fee over a fixed initial term, and continue thereafter unless canceled by either
party. In addition, we enter into per-incident contracts with customers.
Per-incident contracts can cover a range of bundled services for computer
maintenance or support services or can be for a specific service. Another form
of per-incident service revenues is time and material billings for services
provided on an as needed basis, principally for maintenance and repair.
We also derive revenue from the repair of hardware and components at our
logistics services and depot repair facilities. Pricing of these services is
based on various factors, including equipment failure rates, cost of parts and
labor expenses. We customize our contracts to the individual customer based
generally on the nature of the customer's requirements, the term of the contract
and the services which are provided. Revenue is recognized upon the completion
of services performed on a per-incident basis and ratably for contracts based on
monthly fees.
Recent developments
On July 1, 2004, Optimal Payments completed the acquisition of National
Processing Services LLC ("NPS"), a Detroit, Michigan-based registered Visa(R)
and MasterCard(R) independent sales organization for $15 million in cash. The
portfolios acquired in this transaction include approximately 4,500 merchants,
processing in excess of $1 billion in annual credit and debit card volume. As a
result of this acquisition, we anticipate that Optimal Payments' customers will
process approximately $2 billion in annual electronic check and credit card
volume. The acquisition will be accounted for using the purchase method of
accounting and the financial results will be consolidated from the date of the
acquisition in our third quarter. See note 16 to our interim consolidated
financial statements for details of the transaction.
On May 6, 2004, we disposed of Optimal Payments' investment in ebs
Electronic Billing Systems AG ("ebs Billing"). The shares in ebs Billing were
sold to ebs Billing's majority shareholder EBS Holding AG for a net cash
consideration of $4.0 million. The investment in ebs Billing was no longer
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considered strategic to Optimal Payments; however Optimal Payments intends to
continue its business relations with ebs Billing for the mutual providing of
payment processing services.
On April 8, 2004, we completed the sale of our U-Scan(R) self-checkout
business to Fujitsu Transaction Solutions, Inc. ("Fujitsu") for $35.0 million
plus the assumption of certain liabilities. Included in accounts payable and
accrued liabilities as at June 30, 2004 is an amount of $4.8 million owing to
Fujitsu as we collected a large portion of the accounts receivable and realized
the cash thereon in advance of the sale. Thus, the net proceeds realized on the
sale to Fujitsu was $30.2 million. The U-Scan(R) self-checkout business has been
accounted for as discontinued operations in this second quarter of 2004 and
comparative figures have been reclassified accordingly. See note 3(c) to our
interim consolidated financial statements.
On April 6, 2004, the corporation's name was changed from Optimal Robotics
Corp. to Optimal Group Inc.
On April 6, 2004, we completed the amalgamation of a wholly-owned
subsidiary with Terra Payments Inc. ("Terra Payments"). The amalgamated company
is a wholly-owned subsidiary of Optimal Group Inc. and will continue its
business under the name of Optimal Payments Inc. We believe that this
acquisition will provide us with a superior platform for enhanced growth and
financial results. The acquisition is accounted for using the purchase method
and the financial results have been consolidated from the date of the
acquisition. See note 3(b) to our interim consolidated financial statements.
On February 27, 2004, we acquired the hardware service division of Systech
Retail Systems ("Systech") at a net cost of approximately $3.5 million. We
believe that the combination of the Systech hardware service division with our
existing service organization will contribute positively to our financial
results in 2004. The acquisition is accounted for using the purchase method and
the financial results have been consolidated from the date of the acquisition.
See note 3(a) to our interim consolidated financial statements.
Critical accounting policies and estimates
The accompanying interim consolidated financial statements have been prepared in
accordance with Canadian GAAP. In the preparation of financial statements we are
required to make numerous estimates and assumptions. Actual results could differ
from those estimates and assumptions, impacting our reported results of
operations and financial position. Our significant accounting policies are more
fully described in Note 2 of our annual audited consolidated financial
statements included in our Form 10-K Annual Report for the year ended December
31, 2003. The critical accounting policies described here are those that are
most important to the depiction of our financial condition and results of
operations and their application requires our most subjective judgment in making
estimates about the effect of matters that are inherently uncertain.
Service Parts Inventory
Periodic revisions to obsolescence provisions are required, based upon the
evaluation of several factors, including changes in usage levels and technology
changes. Changes in these estimates are reflected immediately in income.
Merchant Losses
When a consumer pays a merchant for goods or services using a credit card and
the consumer disputes the charge, the amount of the disputed item gets charged
back to us and the credit card associations may levy fees against us. In
addition, if our chargeback rate becomes excessive, credit card associations can
also
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require us to pay fines In turn, we attempt to recover from the merchant the
amount charged back and the amount of such fines. However, we may not always be
successful in doing so, for reasons which could include merchant insolvency. We
evaluate the risk associated with each merchant and estimate our potential loss
for chargebacks based primarily on historical experience and other relevant
factors.
Goodwill and Other Intangibles
Effective January 1, 2002, we adopted the new recommendations of the Canadian
Institute of Chartered Accountants, Handbook Section 3062, with respect to the
accounting for goodwill and other intangible assets with indefinite lives which
are not amortized but rather evaluated under an impairment approach. Other
intangible assets with finite lives continue to be amortized over their
estimated useful lives. In our assessment of impairment, we are required to
determine the fair value of the businesses acquired from which the goodwill and
intangibles originated. For intangibles with finite lives, we make estimates of
future cash flows to be generated from the related assets.
Other Receivable
During Terra Payments' fiscal year ended March 31, 2002, Terra Payments was
assessed a charge of $6.8 million from one of its credit card suppliers of
services. We believe this charge is largely unsubstantiated and are pursuing a
claim through legal recourse. We have recorded a provision of $3.7 million
against the amount receivable based on our estimate of the value.
Income Taxes
We provide for income taxes using the asset and liability method of tax
allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities using
substantively enacted income tax rates expected to be in effect for the year in
which the differences are expected to reverse. We establish a valuation
allowance against future income tax assets if, based on available information,
it is more likely than not that some or all of the future income tax assets will
not be realized.
New accounting policy
Asset Retirement Obligations
This standard was established for the recognition, measurement and
disclosure of liabilities for asset retirement obligations and the associated
retirement cost. The standard applies to legal obligations associated with the
retirement of tangible long-lived assets that result from acquisition,
development or normal operations. The standard requires an entity to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred and when a reasonable estimate of fair value can be made.
The entity is subsequently required to allocate the asset retirement cost to
expense using a systematic and rational method over the estimated life of the
asset. The standard is effective for fiscal years beginning on or after January
1, 2004. The adoption of this standard did not have an impact on our financial
statements.
Financial Condition
As at June 30, 2004, cash, cash equivalents and short-term investments
totaled $187.3 million (including $23.0 million held as reserves), compared to
$78.5 million as at December 31, 2003. The increase in cash and short-term
investments is primarily due to the acquisition of Terra Payments, which
resulted in the consolidation of its cash balance with the Optimal Group cash
balance, as well as the
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proceeds on the disposal of the U-Scan self-checkout business and the investment
in ebs Billing. As already described, a significant portion of cash and
short-term investments have a corresponding liability as these amounts are
derived from reserves and security deposits which are due to merchants (see
Overview - Optimal Payments). As at June 30, 2004, our cash position, net of
bank indebtedness and customer reserves and security deposits, was as follows:
$000s
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Cash and cash equivalents 2,773
Short-term investments 161,540
Cash and short-term investments - held as reserves 23,034
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187,347
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Less:
Bank indebtedness (10,356)
Customer reserves and security deposits (63,292)
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