The Company has provided a full valuation allowance on the deferred tax assets at December 31, 2010 and June 30, 2010 to reduce such asset to zero since there is no assurance that the Company will generate future taxable income to utilize such asset. Management will review this valuation allowance requirement periodically and make adjustments as warranted.   

At December 31, 2010 and June 30, 2010, the Company had federal net operating loss (“NOL”) carryforwards of approximately $1,461,000 and state NOL carryforwards of approximately $1,094,000. Federal NOLs could, if unused, expire in 2030. State NOLs, if unused, could expire in 2020.

 

Effective January 1, 2007, the Company adopted FASB guidelines that address the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under this guidance, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. This guidance also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of December 31, 2010 and June 30, 2010, the Company did not have a liability for unrecognized tax benefits, and no adjustment was required at adoption.  

The Company files income tax returns in the U.S. federal jurisdiction and various states. The Company is subject to U.S. federal or state income tax examinations by tax authorities for years after 2006.

 

On January 11, 2011, the Company issued options to purchase 10,000 shares of the Company’s common stock to one employee under the 2007 Equity Compensation Plan, at an exercise price of $3.00.  These options vest over 3 years, with one-twelfth of the grant vesting on the last day of each calendar quarter though March 31, 2014.

On February 9, 2011, the Company issued 19,172 shares of the Company’s common stock to two consultants in exchange for services.

On February 9, 2011, the Company issued options to purchase 10,000 shares of the Company’s common stock to one employee under the 2007 Equity Compensation Plan, at an exercise price of $3.05.  These options vest over 3 years, with one-twelfth of the grant vesting on the last day of each calendar quarter though March 31, 2014.

 

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On February 9, 2011, the Company approved the issuance of options to purchase 10,000 shares of the Company’s common stock to one employee under the 2007 Equity Compensation Plan, at an exercise price of $1.50.  These option were erroneously excluded from the option grants approved on July 27, 2010.  These options vest over 3 years, with one-twelfth of the grant vesting on the last day of each calendar quarter though September 30, 2013.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT’S DISCUSSION

AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our results of operations and financial condition for the three and six months ended December 31, 2010 and 2009 should be read in conjunction with the notes to those financial statements that are included in Item 1 of Part 1 of this Quarterly Report. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including our limited operating history, our ability to compete successfully with existing and new reprint companies, and the sufficiency of our cash and cash equivalents. We use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements. All forward-looking statements included in this Quarterly Report are based on information available to us on the date hereof and, except as required by law, we assume no obligation to update any such forward-looking statements.

 

Overview

 

Derycz Scientific, Inc. (the “Company” or “Derycz”) was incorporated in the State of Nevada on November 2, 2006. In November 2006 the Company entered into a Share Exchange Agreement with Reprints Desk, Inc. (“Reprints”). At the closing of the transaction contemplated by the Share Exchange Agreement, the Company acquired all of the outstanding shares of Reprints from the shareholders of Reprints and issued 8,000,003 of its common shares to the shareholders. Following completion of the exchange transaction, Reprints became a wholly-owned subsidiary of the Company.

 

On February 28, 2007, the Company entered into an agreement with Pools Press, Inc. (“Pools”) of Northbrook, Illinois, a privately held company, pursuant to which the Company acquired 75% of the issued and outstanding common stock of Pools for consideration of $616,080. The Company purchased the remaining interest in Pools that it did not already own on August 31, 2010.  Pools is a commercial printer, specializing in reprints of copyrighted articles. The results of Pools Press’ operations have been included in the consolidated financial statements since March 1, 2007.

 

Derycz, through Reprints and Pools, seeks to facilitate the use of scientific and technical information in both traditional and innovative ways.   The Company serves both the publishers who own the rights to use the information and the customers who use the information.  The Company utilizes web-based platforms as well as traditional delivery channels and is developing products and services that make it easier for our customers to find and use information.  The publishers of scientific and technical information publish hundreds of thousands of new articles each year in addition to the tens of millions of existing articles that have been published in the past.  Derycz Scientific, through Reprints, provides its customers with access to that published content and related software, systems and services.  Our customers use this content for marketing, regulatory or research purposes. Generally, marketing departments order large quantities of printed copies, called “reprints,” that they distribute to interested parties, including customers and doctors who may prescribe a customer’s products, and electronic copies, called “eprints”, for distribution through the Internet and other electronic mechanisms. Researchers and regulatory personnel generally order single copies, called “document delivery”, for use in their research activities.  In order to use the content, our customers must pay appropriate copyright fees and our services ensure that we have obtained the necessary permissions from the owners of the published content so that our customers’ use of the content complies with applicable copyright laws. Our services alleviate the need for our customers to contact multiple publishers in order to obtain the required permissions. Pools Press also offers other commercial printing products, such as the production of documents and newsletters as well as distribution logistics for printed materials.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements and accompanying notes, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. When making these estimates and assumptions, we consider our historical experience, our knowledge of economic and market factors and various other factors that we believe to be reasonable under the circumstances. Actual results may differ under different estimates and assumptions.

 

 

(a) Revenue recognition

 

The Company's primary source of revenue is from information and printing services.  The Company recognizes revenue when the sales process is deemed complete and associated revenue has been earned.  The Company's policy is to recognize revenue when services have been performed, risk of loss and title to the product transfers to the customer, the selling price is fixed and determinable and collectibility is reasonably assured.

 

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The Company recognizes revenues from printing services when services have been rendered and accepted by the customer while revenues from the re-use of published articles and rights management services are recognized upon shipment or electronic delivery to the customer.

 

(b) Stock based compensation

The Company adopted Financial Accounting Standards Board (“FASB”) guidelines that require that the cost resulting from all share-based payment transactions be recognized in the financial statements. This guidance establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. Effective January 1, 2006, we adopted the fair value recognition provisions of the current guidelines of the FASB, using the modified prospective method. Under this method, the provisions of such guidance apply to all awards granted or modified after the date of adoption and all previously granted awards not yet vested as of the date of adoption.

Determining the appropriate fair value model and calculating the fair value of stock-based payment awards require the input of highly subjective assumptions, including the expected life of the stock-based payment awards and stock price volatility. We use the Black-Scholes option-pricing model to value compensation expense. The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates, but the estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

 

(c) Goodwill and Intangible Assets

 

 

(d) Recently issued accounting pronouncements

 

In April 2010, the FASB issued new accounting guidance in applying the milestone method of revenue recognition to research or development arrangements. Under this guidance management may recognize revenue contingent upon the achievement of a milestone in its entirety, in the period in which the milestone is achieved, only if the milestone meets all the criteria within the guidance to be considered substantive. This standard is effective on a prospective basis for research and development milestones achieved in fiscal years, beginning on or after June 15, 2010. Early adoption is permitted; however, adoption of this guidance as of a date other than January 1, 2011 will require the Company to apply this guidance retrospectively effective as of January 1, 2010 and will require disclosure of the effect of this guidance as applied to all previously reported interim periods in the fiscal year of adoption. As the Company plans to implement this standard prospectively, the effect of this guidance will be limited to future transactions. The Company does not expect adoption of this standard to have a material impact on its financial position or results of operations as it has no material research and development arrangements which will be accounted for under the milestone method.

In January 2010, the FASB issued new accounting guidance which requires new disclosures regarding transfers in and out of Level 1 and Level 2 fair value measurements, as well as requiring presentation on a gross basis of information about purchases, sales, issuances and settlements in Level 3 fair value measurements. The guidance also clarifies existing disclosures regarding level of disaggregation, inputs and valuation techniques. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2009.  Disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements are effective for fiscal years beginning after December 15, 2010.  As this guidance requires only additional disclosure, there should be no impact on the consolidated financial statements of the Company upon adoption.

 

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The Company does not believe that the adoption of the above recent pronouncements will have a material effect on the Company’s consolidated results of operations, financial position, or cash flows.

 

Results of Operations

 

Three Months Ended December 31, 2010 Compared to the Three Months Ended December 31, 2009:

 

Sales and Cost of Goods Sold

 

We achieved revenue of $8,514,233 for the three months ended December 31, 2010, compared to revenue of $7,590,459 for the three months ended December 31, 2009, an increase of 12%.  Sales of reprints were strong in both quarters.

 

The revenue of our main operating company, Reprints, increased to $8,151,906 for the three months ended December 31, 2010 from $6,576,926 for the three months ended December 31, 2009, an increase of 24%. Revenue from Pools Press decreased from $1,013,533 in the 2009 period to $278,639 in the 2010 period, after reducing Pools’ revenues by the intercompany sales between Reprints Desk and Pools Press.  Approximately 22% of our revenues were derived from new customers in the 2010 period.  Our increased sales to new customers have been driven both by our publisher relationships and our internet marketing efforts, both of which provide sales leads.  Our product enhancements and new products also contribute to additional sales to existing customers and opportunities to sell to new customers.  We expect our revenue growth to continue this year as we continue these efforts. 

 

Our cost of goods sold increased from $6,497,316 for the three months ended December 31, 2009 to $7,944,794 for the three months ended December 31, 2010, which represents an increase of 22%.  Our overall gross margin percentage decreased from 14% of sales in the 2009 period to 7% in the 2010 period.  This is primarily due to our accounting method which requires us to amortize guaranteed payments due under certain publisher agreements on the conservative straight line basis over the life of the contracts, which results in higher amortized costs in the early periods of the agreements.  For certain long term contracts, both the payments due and the revenues we expect to generate related to the agreements are larger in the later periods.  However, under our accounting method we are required to accrue the greater of the amount we would accrue under a revenue method or the straight line amortization method and the straight line amounts are greater.  For the three months ended December 31, 2010, we recorded approximately $438,000 more in cost of goods sold than we recorded in revenues under those contracts, causing our cost of goods sold to increase significantly relative to the revenue levels and therefore significantly reducing our gross margin.  For our sales outside of those publisher agreements, sales of reprints, or multiple copies of an article generally have a lower margin than sales of single copies of articles, particularly when an individual order is for an amount in excess of $100,000.  We must reduce our margins on large orders in order to create incentive for the customer to arrange the order through Reprints.  Pools provides reprint printing services for several publishers and much of Pools’ revenues are derived from those sales.  The margin on these sales is lower than the margin Reprints charges for reprint sales because it is viewed as primarily providing printing services and not other related services. 

 

We expect that our sales will increase in the 2011 fiscal year as a result of our existing customers increasing their spending on existing products as well as new products and from sales to new customers. We expect our gross margin to remain constant or decline slightly due to the need for aggressive pricing in order to continue to increase our revenues.  Additionally, some of our publisher agreements require guaranteed minimum payments and those must be amortized over the life of the contract.  The amortization of those costs could cause our cost of goods sold to increase faster than our revenues at the beginning of the terms of those contracts when revenues would be expected to be lower.  While we continue to develop and market higher margin products, we face price competition in our core markets for document delivery and reprints as well as commercial printing.  Most of our costs are determined by the publishers from whom we purchase media for each individual order and they do not generally grant significant discounts at this time.

 

Operating Expenses

 

General and Administrative

 

Our general and administrative expenses increased 107% from $791,793 for the three months ended December 31, 2009 to $1,638,793 for the three months ended December 31, 2010.  These costs included $185,750 paid to a consultant as well as $408,336 recorded as an expense upon the issuance of warrants to two consultants and $40,326 related to the amortization of warrants issued to three of our directors.  Pools’ share of these expenses was approximately $55,000 in the 2010 period and $52,000 for the 2009 period. These expenses include Reprints’ administrative salary costs, which were $605,360 in the 2010 period and $442,469 in the 2009 period, an increase of $162,891 or 37%. Our sales and marketing team, information technology team and our accounting team have all increased during the past year.  Due to the expansion of our sales volume and in order to continue to develop our computer system and products, we expect to add a small number of new employees in the next twelve months.  

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	DERYCZ SCIENTIFIC, INC.
	By:	/s/ Peter Derycz
		Peter Derycz
Date: February 14, 2011		Chief Executive Officer
	By:	/s/ Richard McKilligan
		Richard McKilligan
Date: February 14, 2011		Chief Financial Officer