UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 1O-QSB
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE EXCHANGE ACT
For the transition period from ____________________ to _____________________
Commission file number 0-50054
USA Technologies, Inc.
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(Exact name of small business issuer as specified in its charter)
Pennsylvania 23-2679963
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(State or other jurisdiction (I.R.S. employer
of incorporation or organization) Identification No.)
100 Deerfield Lane, Suite 140, Malvern, Pennsylvania 19355
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, area code first. (610)-989-0340
--------------
Check whether the Registrant has (1) 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__
As of February 10, 2004 there were 293,516,953 shares of Common Stock, no par
value, outstanding.
USA TECHNOLOGIES, INC.
INDEX
PAGE NO.
PART I - Financial Information
ITEM 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - December 31, 2003
and June 30, 2003 2
Consolidated Statements of Operations - Three and six months
ended December 31, 2003 and 2002 3
Consolidated Statement of Shareholders' Equity - Six months
ended December 31, 2003 4
Consolidated Statements of Cash Flows - Six months ended
December 31, 2003 and 2002 5
Notes to Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis or Plan
of Operations 16
ITEM 3. Controls and Procedures 27
PART II - Other Information 28
ITEM 2. Changes in Securities
ITEM 6. Exhibits and Reports on Form 8-K 28
SIGNATURES 30
1
USA Technologies, Inc.
Consolidated Balance Sheets
DECEMBER 31, JUNE 30,
2003 2003
(UNAUDITED)
--------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,521,804 $ 2,384,455
Accounts receivable, less allowance for uncollectible accounts
of $121,000 at December 31, 2003 and $65,000 at June 30, 2003 1,850,832 414,796
Other receivable 674,649 --
Inventory 1,017,214 457,900
Prepaid expenses and other current assets 344,661 201,383
Subscriptions receivable 11,237 1,013,400
Investment 794,645 904,049
Assets held for sale 135,000 --
--------------------------------
Total current assets 7,350,042 5,375,983
Property and equipment, less accumulated depreciation of
$2,762,518 at December 31, 2003 and $3,216,139 at
June 30, 2003 728,416 943,784
Software development costs, at cost, less accumulated amortization
of $4,993,300 at December 31, 2003 and $4,327,526 at June 30, 2003 332,887 998,660
Goodwill 7,985,207 7,945,580
Intangibles, less accumulated amortization of $918,868 at
December 31, 2003 and $328,500 at June 30, 2003 11,450,132 2,591,500
Other assets 8,544 37,174
--------------------------------
Total assets $ 27,855,228 $ 17,892,681
================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,609,907 $ 2,266,156
Accrued expenses 2,841,181 2,720,743
Current obligations under long-term debt 639,611 830,674
Convertible Senior Notes 365,123 349,942
--------------------------------
Total current liabilities 6,455,822 6,167,515
Convertible Senior Notes, less current portion 6,327,306 7,808,469
Long-term debt, less current portion 23,048 224,614
--------------------------------
Total liabilities 12,806,176 14,200,598
Shareholders' equity:
Preferred Stock, no par value:
Authorized shares--1,800,000
Series A Convertible Preferred--Authorized shares - 900,000
Issued and outstanding shares--524,192 at December 31, 2003 and
524,492 at June 30, 2003 (liquidation preference of
$11,544,576 at December 31, 2003) 3,713,121 3,715,246
Common Stock, no par value:
Authorized shares--400,000,000
Issued and outstanding shares--287,317,721 at December 31, 2003
and 218,741,042 at June 30, 2003 102,939,543 78,790,405
Accumulated other comprehensive income 254,484 --
Accumulated deficit (91,858,096) (78,813,568)
--------------------------------
Total shareholders' equity 15,049,052 3,692,083
--------------------------------
Total liabilities and shareholders' equity $ 27,855,228 $ 17,892,681
================================
See accompanying notes.
2
USA Technologies, Inc.
Consolidated Statements of Operations
(Unaudited)
Three months ended Six months ended
December 31, December 31,
2003 2002 2003 2002
-------------------------------- --------------------------------
Revenues:
Equipment sales $ 1,425,176 $ 384,459 $ 2,711,654 $ 572,947
Product sales and other 222,253 75,576 296,734 278,880
License and transaction fees 267,157 314,612 586,806 657,265
-------------------------------- --------------------------------
Total revenues 1,914,586 774,647 3,595,194 1,509,092
Cost of sales (including amortization
of software development costs) 1,083,419 671,940 2,165,582 1,339,400
-------------------------------- --------------------------------
Gross profit 831,167 102,707 1,429,612 169,692
Operating expenses:
General and administrative 1,780,242 1,368,373 3,282,011 3,010,751
Compensation 1,740,012 838,713 7,443,210 1,684,432
Depreciation and amortization 420,945 247,579 815,904 494,663
Loss on debt modification 41,618 -- 318,915 --
-------------------------------- --------------------------------
Total operating expenses 3,982,817 2,454,665 11,860,040 5,189,846
-------------------------------- --------------------------------
Operating loss (3,151,650) (2,351,958) (10,430,428) (5,020,154)
Other income (expense):
Interest income 12,087 4,263 19,816 7,237
Gain on termination of contract 515,844 -- 515,844 --
Gain on sale of investment -- -- 31,361 --
Interest expense:
Coupon or stated rate (241,749) (329,677) (507,240) (585,955)
Non-cash interest and
amortization of debt discount (872,156) (953,625) (2,670,061) (1,606,343)
-------------------------------- --------------------------------
Total interest expense (1,113,905) (1,283,302) (3,177,301) (2,192,298)
-------------------------------- --------------------------------
Total other income (expense) (585,974) (1,279,039) (2,610,280) (2,185,061)
-------------------------------- --------------------------------
Net loss (3,737,624) (3,630,997) (13,040,708) (7,205,215)
Cumulative preferred dividends -- -- (393,369) (396,962)
-------------------------------- --------------------------------
Loss applicable to common shares $ (3,737,624) $ (3,630,997) $ (13,434,077) $ (7,602,177)
================================ ================================
Loss per common share (basic and diluted) $ (0.01) $ (0.04) $ (0.05) $ (0.10)
================================ ================================
Weighted average number of common shares
outstanding (basic and diluted) 284,277,552 87,713,910 267,133,382 79,493,416
================================ ================================
See accompanying notes.
3
USA Technologies, Inc.
Consolidated Statement of Shareholders' Equity
(Unaudited)
SERIES A ACCUMULATED
CONVERTIBLE OTHER
PREFERRED COMMON ACCUMULATED COMPREHENSIVE
STOCK STOCK DEFICIT INCOME TOTAL
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Balance, June 30, 2003 $ 3,715,246 $ 78,790,405 $ (78,813,568) $ -- $ 3,692,083
Issuance of 300 shares of Common
Stock from the conversion of 300
shares of Preferred Stock (2,125) 2,125 -- -- --
Issuance of 382 shares of Common Stock
from the conversion of cumulative
preferred dividends at $10.00 per share -- 3,820 (3,820) -- --
Exercise of 3,035,258 Common Stock
Warrants at $0.10 per share -- 303,526 -- -- 303,526
Issuance of 9,971,669 shares of Common
Stock from the conversion of
12% Senior Notes -- 1,994,334 -- -- 1,994,334
Issuance of 594,000 shares of Common
Stock in exchange for salaries and
professional services -- 215,980 -- -- 215,980
Issuance of 10,500,000 shares of
Common Stock to executive in
connection with employment agreement -- 4,620,000 -- -- 4,620,000
Issuance of 23,239,036 shares of
Common Stock with various private
placement offerings at varying
prices per share -- 5,270,529 -- -- 5,270,529
Issuance of shares of Common Stock and
related Common 1,066,034 Stock
Warrants in lieu of cash payment
for interest on the 12% Senior Notes -- 479,617 -- -- 479,617
Debt discount relating to beneficial
conversion feature on 12% Senior Notes -- 1,981,007 -- -- 1,981,007
Issuance of 20,170,000 shares of Common
Stock in connection with the Bayview
acquisition -- 9,278,200 -- -- 9,278,200
Net loss -- -- (13,040,708) -- (13,040,708)
Unrealized gain on investment -- -- -- 254,484 254,484
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Total comprehensive loss (12,786,224)
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Balance, December 31, 2003 $ 3,713,121 $ 102,939,543 $ (91,858,096) $ 254,484 $ 15,049,052
====================================================================================
See accompanying notes
4
USA Technologies, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
SIX MONTHS ENDED
DECEMBER 31,
2003 2002
------------------------------
OPERATING ACTIVITIES
Net loss $(13,040,708) $ (7,205,215)
Adjustments to reconcile net loss to net cash used in operating activities:
Charges incurred in connection with the issuance of Common Stock,
Common Stock Purchase Warrants and Senior Notes 4,835,980 399,187
Interest expense on Senior Notes paid through the issuance of Common Stock 479,617 318,011
Interest amortization related to Senior Notes and Convertible Debentures 2,190,444 1,288,332
Amortization 1,256,142 728,552
Depreciation 271,294 348,663
Loss on debt modification 318,915 --
Gain on sale of investment (31,361) --
Gain on contract settlement (515,844) --
Changes in operating assets and liabilities:
Accounts receivable (1,442,536) (82,311)
Inventory (559,314) 135,199
Prepaid expenses and other assets (131,744) (48,190)
Accounts payable 474,592 1,006,528
Accrued expenses 410,372 25,182
------------------------------
Net cash used in operating activities (5,484,151) (3,086,062)
INVESTING ACTIVITIES
Purchase of property and equipment (229,369) (92,484)
Cash paid in connection with Bayview acquisition (727,969) --
Cash received for sale of Jubilee shares 395,249 --
------------------------------
Net cash used in investing activities (562,089) (92,484)
FINANCING ACTIVITIES
Net proceeds from issuance of Common Stock and
exercise of Common Stock Warrants 5,574,055 1,657,583
Net proceeds from issuance of Senior Notes and Convertible Debentures -- 1,792,150
Net repayment of long-term debt (392,629) (346,348)
Collection of subscriptions receivable 1,002,163 35,000
------------------------------
Net cash provided by financing activities 6,183,589 3,138,385
------------------------------
Net increase (decrease) in cash and cash equivalents 137,349 (40,161)
Cash and cash equivalents at beginning of period 2,384,455 557,970
------------------------------
Cash and cash equivalents at end of period $ 2,521,804 $ 517,809
==============================
Supplemental disclosures of cash flow information:
Conversion of Convertible Preferred Stock to Common Stock $ 2,125 $ 1,062
==============================
Conversion of Convertible Preferred Dividends to Common Stock $ 3,820 $ 1,570
==============================
Cash paid for interest $ 464,864 $ 371,972
==============================
Subscriptions receivable $ 11,237 $ 276,000
==============================
Conversion of Senior Notes and Convertible Debenture to Common Stock $ 1,994,334 $ 273,058
==============================
Beneficial conversion feature related to Senior Notes $ 1,981,007 $ 1,084,120
==============================
Prepaid stock expenses through issuance of Common Stock $ 105,000 $ 236,800
==============================
Prepaid Senior Note issuances $ -- $ 1,329,800
==============================
Issuance of Common Stock in connection with the Bayview acquisition $ 9,278,200 $ --
==============================
Other receivable from termination of contract $ 674,649 $ --
==============================
Deposits used to fund debt and equity $ -- $ 360,000
==============================
Issuance of Common Stock related to Senior Note Offering $ -- $ 1,750,062
==============================
See accompanying notes.
5
USA Technologies, Inc.
Notes To Consolidated Financial Statements
(Unaudited)
1. BUSINESS
USA Technologies, Inc., a Pennsylvania corporation (the "Company"), was
incorporated on January 16, 1992. The Company provides unattended cashless
payment/control systems and associated network and services for the copy, fax,
debit card, smart card, personal computer, laundry, and vending industries. The
Company's devices make available credit and debit card and other payment methods
in connection with the sale of a variety of products and services. The Company's
customers are principally located in the United States and are comprised of
hotels, chains, consumer package goods companies, information technology and
vending operators.
The Company offers the Business Express(R) and Business Express(R)
Limited Service (LSS) principally to the hospitality industry. The Business
Express(R) and Business Express(R) Limited Service (LSS) combines the Company's
business applications for computers, copiers and facsimile machines into a
business center unit. The Company has developed its next generation of cashless
control/payment systems (e-Port(TM)), which includes capabilities for
interactive multimedia and e-commerce, acceptance of other forms of electronic
payments and remote monitoring of host machine data and is being marketed and
sold to operators, distributors and original equipment manufacturers (OEM)
primarily in the vending industry.
With the acquisition of the assets of Bayview Technology Group, LLC in
July 2003, the Company also sells and distributes energy saving devices. These
devices control energy consumption in vending machines, glass front coolers,
laser printers, monitors and other office peripherals, and are used throughout
the United States by many of the same customers that use the Company's other
equipment and services.
2. ACCOUNTING POLICIES
INTERIM FINANCIAL INFORMATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments considered necessary have been included.
Operating results for the three and six month periods ended December 31, 2003
are not necessarily indicative of the results that may be expected for the year
ending June 30, 2004. The balance sheet at June 30, 2003 has been derived from
the audited financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
For further information, refer to the financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-KSB for the
year ended June 30, 2003.
6
RECLASSIFICATION
Certain amounts in the prior period financial statements have been
reclassified to conform to the current year presentation.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company and Stitch Networks Corporation ("Stitch"). All significant
intercompany accounts and transactions have been eliminated in consolidation.
CASH EQUIVALENTS
Cash equivalents represent all highly liquid investments with original
maturities of three months or less. Cash equivalents are comprised of a money
market fund and certificates of deposit.
INVENTORY
Inventory, which principally consists of finished goods and components,
is stated at the lower of cost (first-in, first-out basis) or market.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. The straight-line method
of depreciation is used over the estimated useful lives of the related assets.
Leasehold improvements are amortized on the straight-line basis over the lesser
of the estimated useful life of the asset or the respective lease terms.
IMPAIRMENT OF LONG LIVED ASSETS
In accordance with Statement of Financial Accounting Standards No. 144
(SFAS 144), "Accounting for the Impairment or Disposal of Long-lived Assets",
the Company reviews its long-lived assets whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be
recoverable. If the carrying amount of an asset or group of assets exceeds its
net realizable value, the asset will be written down to its fair value.
In the period when the plan of sale criteria of SFAS 144 are met,
long-lived assets are reported as held for sale, depreciation and amortization
cease, and the assets are reported at the lower of carrying value or fair value
less costs to sell.
7
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of cost over fair value of the net
assets purchased in acquisitions. The Company accounts for goodwill in
accordance with Statement of Financial Accounting Standards No. 142 (SFAS No.
142), "Goodwill and Other Intangible Assets". Under SFAS No. 142, goodwill is
not amortized to earnings, but instead is subject to periodic testing for
impairment. The Company tests goodwill for impairment using a two-step process.
The first step screens for potential impairment, while the second step measures
the amount of impairment, if any. The Company uses a discounted cash flow
analysis to complete the first step in this process. Testing for impairment is
to be done at least annually and at other times if events or circumstances arise
that indicate that impairment may have occurred. The Company has selected April
1 as its annual test date. During the six months ended December 31, 2003, no
events or circumstances arose indicating that impairment of goodwill may have
occurred.
Intangible assets include patents, trademarks and non-compete
arrangements purchased in acquisitions. Amortization of these intangibles is
computed using the straight-line method over their estimated useful lives of
five and ten years. Amortization expense was $309,150 and $590,368 for the three
and six months ended December 31, 2003, respectively, and $73,000 and $146,000
for the three and six months ended December 31, 2002, respectively.
REVENUE RECOGNITION
Revenue from the sale of equipment is recognized on the terms of
freight-on-board shipping point, or upon installation and acceptance of the
equipment if installation services are purchased for the related equipment.
Transaction processing revenue is recognized upon the usage of the Company's
cashless payment and control network. Service fees for access to the Company's
equipment and network services are recognized on a monthly basis. Product
revenues are recognized from the sale of products from Company owned vending
machines when there is purchase and acceptance of product by the vending
customer. Customers have the ability to return vended products for a full
refund. The Company estimates an allowance for product returns at the date of
sale.
INVESTMENT
The Company accounts for investments in accordance with Statement of
Financial Accounting Standards No. 115 "Accounting for Certain Investments in
Debt and Equity Securities". Management determines the appropriate
classifications of securities at the time of purchase and reevaluates such
designation as of each balance sheet date. Available-for-sale securities are
carried at fair value, with the unrealized gains and losses reported as a
separate component of shareholders' equity in accumulated other comprehensive
income (loss). If the investment sustains an other-than-temporary decline in
fair value, the investment is written down to its fair value by a charge to
earnings.
8
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs pursuant to
Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed", after technological
feasibility of the software is established and through the product's
availability for general release to the Company's customers. All costs incurred
in the research and development of new software and costs incurred prior to the
establishment of technological feasibility are expensed as incurred.
Amortization of software development costs commences when the product becomes
available for general release to customers. Amortization of software development
costs is calculated as the greater of the amount computed using (i) the ratio
that current gross revenues for a product bear to the total of current and
anticipated future gross revenues of that product or (ii) the straight-line
method over the remaining estimated economic life of the product. The Company
reviews the unamortized software development costs at each balance sheet date
and, if necessary, will write down the balance to net realizable value if the
unamortized costs exceed the net realizable value of the asset.
Software development costs are being amortized over a useful life of
two-years. Amortization expense, reflected in cost of sales, was $332,887 and
$665,774 for the three and six months ended December 31, 2003, respectively, and
$291,276 and $582,552 for the three and six months ended December 31, 2002,
respectively.
ACCOUNTING FOR STOCK OPTIONS
Statement of Financial Accounting Standards No. 123 (SFAS No.123),
"Accounting for Stock-Based Compensation", provides companies with a choice to
follow the provisions of SFAS No. 123 in determination of stock-based
compensation expense or to continue with the provisions of APB No. 25 (APB 25),
"Accounting for Stock Issued to Employees and Related Interpretations in
Accounting for Stock-Compensation Plans" and the related FASB Interpretation No.
44. The Company has elected to follow the provisions of APB 25. Under APB 25, if
the exercise price of the Company's stock options granted to employees and
directors equals or exceeds the market price of the underlying Common Stock on
the date of grant, no compensation expense is recognized. All stock options
granted by the Company have been at prices equal to the market price of the
Company's Common Stock on the dates of grant. Under SFAS No. 123 the fair value
of stock options is estimated at the date of grant using an option pricing model
such as Black-Scholes and the value determined is amortized to expense over the
option vesting period.
There were no stock options granted during the year ended June 30, 2003
or during the six months ended December 31, 2003. All options granted through
June 30, 2002 were vested as of that date. Therefore pro-forma net loss and
pro-forma net loss per common share under SFAS 123 for the three months and six
months ended December 31, 2003 and 2002 would be the same as reported by the
Company under APB 25.
9
LOSS PER COMMON SHARE
Basic earnings per share is calculated by dividing income (loss)
applicable to common shares by the weighted average common shares outstanding
for the period. Diluted earnings per share is calculated by dividing income
(loss) applicable to common shares by the weighted average common shares
outstanding for the period plus the dilutive effect (unless such effect is
anti-dilutive) of equity instruments. No exercise of stock options, purchase
rights, stock purchase warrants, or the conversion of senior notes, debentures,
preferred stock, or cumulative preferred dividends was assumed for the periods
presented because the assumed exercise of these securities would be
anti-dilutive.
3. ACQUISITIONS
BAYVIEW TECHNOLOGY GROUP, LLC
On July 11, 2003, the Company acquired substantially all of the assets
of Bayview Technology Group, LLC (Bayview). Under the terms of the asset
purchase agreement the Company issued to Bayview 20,000,000 shares of its
restricted Common Stock and cash of $631,247 to settle an obligation of Bayview.
The definitive agreement also provides for the Company to assume certain
obligations under a royalty agreement expiring May 31, 2006. In connection with
this transaction the Company also agreed to issue 170,000 shares of its
restricted Common Stock to a consultant who provided certain services to the
Company in connection with this acquisition.
The acquired energy control equipment is used to reduce energy
consumption in vending machines, glass front coolers, laser printers, monitors
and other office peripherals throughout the United States. As a result of the
acquisition, the Company believes it will be a leading provider of end-to-end
networked solutions that includes wireless and internet connections, cashless
transaction and security/ID capability and interactive media functionality, and
remote inventory and auditing control and energy cost reductions and
environmental emissions reductions. The Company also expects to reduce costs
through economies of scale.
The acquisition cost of Bayview was $10,030,894, which principally was
comprised of the issuance of 20,000,000 shares of restricted Common Stock valued
at $9,200,000 and a cash payment of $631,247. The value of the 20,000,000 shares
of Common Stock was determined based on the average market price of the
Company's Common Stock over the two-day period before and after the definitive
agreement date of July 11, 2003. The purchase price also included acquisition
related costs of $199,647.
The following table summarizes the fair values of the assets acquired
and liabilities assumed at the date of acquisition.
Current assets $ 7,628
Property and equipment 244,704
Intangible assets 9,449,000
Goodwill 329,562
-----------
Total assets acquired $10,030,894
===========
10
Of the $9,449,000 of acquired intangible assets, $7,424,000 was
assigned to patents that are subject to amortization over a 10-year period,
$1,011,000 was assigned to non-compete agreements that are subject to
amortization over a 5-year period and $1,014,000 was assigned to trademarks and
trade names that are not subject to amortization.
The acquisition was accounted for using the purchase method and,
accordingly, the results of operations of Bayview have been included in the
accompanying consolidated statements of operations since the date of
acquisition. Results of operations of the Company for the six months ended
December 31, 2003 would not have been significantly different than reported had
the acquisition taken place July 1, 2003 as the acquisition occurred on July 11,
2003. Pro-forma combined results for the six months ended December 31, 2002
would have been as follows had the acquisition taken place July 1, 2002 -
revenues of $4,628,479; net loss of $7,234,269; loss applicable to common shares
of $7,631,231; loss per common share (basic and diluted) of $0.08.
STITCH NETWORKS CORPORATION
In connection with the acquisition of Stitch, in May 2002, the Company
determined that it would vacate the office space previously occupied by Stitch.
Accordingly, the Company accrued the remaining lease exit costs relating to this
lease in the amount of approximately $354,000 as part of the cost of purchasing
Stitch.
In November 2003, Stitch and the lessor of the office space reached an
agreement that required Stitch to pay the lessor $55,000 as consideration to
release Stitch from any further obligations under the lease. In addition, a
security deposit of approximately $9,000 was retained by the lessor.
Accordingly, the difference between estimated lease exit costs accrued and
actual consideration paid, was recorded as a reduction of goodwill in the amount
of $290,000 during the three months ended December 31, 2003.
4. INVESTMENT IN JUBILEE INVESTMENT TRUST
During the year ended June 30, 2003, the Company issued 15,000,000
shares of its Common Stock for an investment in 1,870,091 shares of Jubilee
Investment Trust, PLC ("Jubilee"), a United Kingdom Investment Trust whose
shares trade on the London Stock Exchange. The Company agreed not to sell the
Jubilee shares for a period of 90 days from January 24, 2003 and to not sell
more than 10% of the Jubilee shares during each month thereafter. Jubilee has
agreed not to sell the Company's shares of Common Stock for a period of two
years from the date of issuance unless agreed to by the Company. In September
2003, the Company sold 700,000 of its Jubilee shares for net proceeds of
$395,249, and realized a gain of $31,361 from the sale of these shares. An
unrealized gain of $254,484 on the remaining shares held by the Company is
reflected in shareholders' equity as Accumulated other comprehensive income at
December 31, 2003.
5. FINANCING ACTIVITIES
The Company had issued five series of Senior Notes with an interest
rate of 12%, which are convertible into shares of the Company's Common Stock.
The notes were scheduled to mature on December 31, 2003, 2004, 2005, 2006 and
2007. In March 2003, holders of the Senior Notes scheduled to mature on December
31, 2003 and 2004, respectively, were granted the right to extend their maturity
to December 31, 2006 and 2007, respectively, in exchange for reducing the
conversion rates from $1.25 to $0.20 per share for the 2003 Senior Notes and
from $0.40 to $0.20 per share for the 2004 Senior Notes. This offer expired on
December 31, 2003. During the six months ended December 31, 2003, certain Senior
Note holders agreed to exchange an aggregate of $2,301,453 of these notes for
new notes maturing in 2006 and 2007. These exchanges included all but $20,000 of
the Notes scheduled to mature on December 31, 2003. This amount, and Notes
scheduled to mature on December 31, 2004, are reflected as a current liability
as of December 31, 2003.
11
The exchange of the 2003 Senior Notes and 2004 Senior Notes for 2006
Senior Notes and 2007 Senior Notes was deemed a significant modification of the
terms of the 2003 and 2004 Senior Notes and, accordingly, the 2003 and 2004
Senior Notes that were exchanged have been extinguished. The unamortized debt
discount and other issuance costs of $318,915 remaining on the 2003 and 2004
Senior Notes exchanged and extinguished during the six months ended December 31,
2003 have been expensed and have been reported in the consolidated statements of
operations as a Loss on debt modification ($41,618 for the three months ended
December 31, 2003).
During the six months ended December 31, 2003, the Company's share
price, on days when certain noteholders agreed to exchange their 2003 or 2004
Senior Notes for 2006 and 2007 Senior Notes, respectively, was greater than the
conversion price of the 2006 and 2007 Senior Notes. Therefore, the intrinsic
value of this beneficial conversion feature of $1,981,007 is reflected as
additional equity and debt discount and is being amortized to interest expense
through the maturity dates of these Senior Notes.
Debt discount and other issuance costs associated with the Senior Notes
are being amortized to interest expense over the remaining life of the debt
instruments. Upon conversion of Senior Notes into Common Stock, unamortized
costs relating to the notes converted are also charged to interest expense.
Total charges to interest for debt discount and other issuance costs were
$756,369 and $2,190,444 for the three and six months ended December 31, 2003,
respectively, and $774,727 and $1,288,332 for the three and six months ended
December 31, 2002, respectively.
As of December 31, 2003, outstanding debt for Senior Notes reflected in
the consolidated balance sheet was $6,692,429. This is comprised of $10,552,484
face amount of notes less unamortized debt discount and other issuance costs of
$3,860,055.
The holders of the Senior Notes have had the right to purchase shares
of the Company's Common Stock at $0.20 per share using quarterly interest
payments that are due in lieu of a cash payment for the interest. Additionally,
for each share purchased, the note holder is entitled to receive a warrant to
purchase one share of the Company's Common Stock at $0.20 per share exercisable
at any time through June 30, 2004. The Board of Directors authorized the Company
to offer Common Stock and Common Stock Warrants for cash interest due through
December 31, 2003. For the six months ended December 31, 2003, 1,066,034 common
shares were issued (along with an identical number of warrants) for payment of
interest due for the period of $213,188 to those note holders accepting the
offer. The fair value of the warrants issued and the beneficial conversion
feature related to the $0.20 per share rate used to convert the interest to
Common Stock totaled $266,429 and has been recorded as additional interest
expense for the period. For the three months ended December 31, 2003, $115,786
was charged to interest expense for these transactions.
12
During the six months ended December 31, 2003, the Company issued
shares of Common Stock in various transactions:
o 2,729,036 shares were issued at $0.10 per share under the 2003-A Private
Placement Offering authorized during fiscal year 2003 which generated net
proceeds of $268,029. The Company also issued 295,000 shares under this
offering for services rendered by consultants amounting to $105,000.
o 20,010,000 shares of Common Stock were issued to accredited investors at
$0.25 per share in four private placement offerings, which generated
proceeds of $5,002,500.
o 500,000 shares of Common Stock were issued to an accredited investor as
settlement resulting from a non-registration event as defined under the
agreement of sale entered into during November 2002.
6. LONG-TERM DEBT
Long-term debt consisted of the following:
December 31, June 30,
2003 2003
---------- ----------
Bank facility $ 516,009 $ 828,466
Working capital loans 96,765 166,765
Other, including capital lease obligations 49,885 60,057
---------- ----------
662,659 1,055,288
Less current portion 639,611 830,674
---------- ----------
$ 23,048 $ 224,614
========== ==========
The bank facility (the Facility) was utilized to fund the purchase of
vending machines placed at locations where Kodak film products are sold.
Borrowings were made from time to time under the Facility, with repayment
schedules set at the time of each borrowing, including equal monthly payments
over 36 months and an interest rate based upon 495 basis points over the three
year U.S. Treasury Notes. The Company granted the bank a security interest in
the vending machines. Repayment of principal is also insured by a Surety Bond
issued by a third-party insurer in exchange for an initial fee paid by the
Company. Final maturity, scheduled to extend into the fiscal year ending June
30, 2005, is anticipated to occur during the year ending June 30, 2004 due to
the termination of the vending placement agreement and the removal from service
and sale of the vending machines used as collateral for the bank facility. See
Note 9 Termination of Vending Agreement.
13
In connection with the Stitch acquisition, the Company assumed
long-term debt which included a vending equipment borrowing facility and working
capital loans. These loans are secured by certain assets of Stitch and bear
interest at 6.75% per annum. Such loans were payable on July 8, 2002. During
fiscal year 2003, the bank extended the due date on these loans on several
occasions under forbearance agreements. On November 6, 2003, the Company reached
an agreement with the bank to make monthly installments that will repay the
remaining balance by October 2004.
7. STOCK OPTIONS AND STOCK WARRANTS
The Company has granted options to employees to purchase shares of
Common Stock at prices that were at or above fair market value on the dates the
options were granted. The option term and vesting schedule were established by
the contract that granted the option. As of December 31, 2003, there were
2,638,985 options outstanding to purchase Common Stock at exercise prices
ranging from $0.165 to $2.00 per share, all of which were fully vested. As of
December 31, 2003, there were 44,591,785 fully vested warrants to purchase
Common Stock at exercise prices ranging from $0.067 to $1.25 per share.
8. AMENDMENT TO EXECUTIVE EMPLOYMENT AGREEMENT AND COMPENSATION
ARRANGEMENTS
In July 2003 the Company and the Company's Chief Executive Officer
(CEO) amended the terms of his employment agreement (expiring June 2005). Under
the terms of the previous Executive Employment Agreement, the CEO would have
been granted seven percent (non-dilutive) of all the then issued and outstanding
shares of the Company's Common Stock in the event a "USA Transaction" (as
defined) occurs, which among other events includes a change in control of the
Company. The amended terms of the Executive Employment Agreement, eliminates the
seven percent (non-dilutive) right to receive Common Stock upon a "USA
Transaction" and now grants the CEO an aggregate of 14,000,000 shares of Common
Stock subject to adjustment for stock splits or combinations in the event a "USA
Transaction" occurs. In exchange for the amendment of these terms, the Company
issued an aggregate of 10,500,000 shares of its Common Stock to the CEO valued
at $4,620,000 or $0.44 per share representing the quoted market price of the
Company's Common Stock on the date the purchase agreement was entered into and
the shares were granted as required by generally accepted accounting principles.
The issuance of the shares to the CEO had no effect on shareholders' equity and
did not impact the Company's cash flow from operations. In connection with this
amendment, the CEO also entered into a lock-up agreement pursuant to which he
shall not sell 2,500,000 of these shares for a one-year period and 8,000,000 of
these shares for a two-year period. The CEO will not be required to pay any
additional consideration for these shares of Common Stock. At the time of a "USA
Transaction", all of the 14,000,000 shares to be issued to the CEO in connection
with this amendment are automatically deemed to be issued and outstanding, and
will be entitled to be treated as any other issued and outstanding shares of
Common Stock. These shares will be irrevocable and fully vested, and have no
expiration date and will not be affected by the termination of the CEO with the
Company for any reason whatsoever.
14
During December 2003, the Company awarded cash bonuses based on recent
performance to its executive officers and an employee in the aggregate amount of
$645,000 that included a $250,000 bonus to its Chief Executive Officer and a
$225,000 bonus to its President.
9. TERMINATION OF KODAK VENDING PLACEMENT AGREEMENT
The Company's wholly owned subsidiary, Stitch, had entered into a
vending placement agreement whereby Stitch agreed to purchase film and cameras
directly from Eastman Kodak Company and vending machines from a supplier. Stitch
placed the vending machines at numerous locations throughout the United States
under agreements negotiated with the location owners and derived revenues
amounting to $144,000 and $347,000 for three and six months ended December 31,
2003, respectively.
As previously reported, Stitch alleged that the supplier and another
party to the vending agreement breached the vending agreement and the supplier
and another party to the vending agreement alleged that Stitch had breached the
vending agreement. Effective December 31, 2003, the parties finalized a
settlement of this matter which resulted in the termination of the vending
agreement as of December 31, 2003. Per the settlement agreement, the Company
will receive a payment from Kodak of approximately $675,000, which was received
in January 2004. The Company will also receive payments of $300 per vending
machine from the supplier of the vending machines, as the machines are pulled
from service at the supplier's sole cost and expense. Upon receipt of the $300
per machine, title to the vending machine will transfer from Stitch to the
supplier. The settlement agreement provides that all machines are to be pulled
from service no later than mid calendar year 2004. The agreement also provided
for the supplier to cancel a $124,000 obligation of Stitch for the purchase of
vending machines.
The vending machines were used as collateral to secure the bank
facility used to purchase the machines under which $516,009 was outstanding as
of December 31, 2003. The Company will repay this debt as the vending machines
are returned to the supplier.
This termination agreement resulted in a gain of $515,844 during the
quarter ended December 31, 2003 and such amount is reflected as Other income in
the December 31, 2003 Consolidated Statement of Operations. This gain is
comprised of the payment from Kodak of approximately $675,000 plus the
cancellation of Stitch's obligation to the supplier of the vending machines of
approximately $124,000 reduced by a write down of the carrying value of vending
machines of approximately $283,000 to reflect the vending machines at their
realizable value of $300 per machine. The vending machines are reported as
assets held for sale in the December 31, 2003 Consolidated Balance Sheet, as it
was determined that the plan of sale criteria in FAS 144 was met in the
termination agreement, at which time depreciation of these assets ceased. To the
extent any costs are incurred by Stitch to fulfill its obligations under the
settlement agreement, these costs will be recorded as incurred, as any
additional costs cannot be reasonably estimated at this time.
10. SUBSEQUENT EVENT
On January 16, 2004, an increase in the number of authorized shares,
from 400,000,000 to 475,000,000, was approved during the Company's Annual
Meeting of Shareholders.
Subsequent to December 31, 2003, 5,215,370 Common Stock Warrants were
exercised, which resulted in $465,070 of proceeds to the Company.
Pursuant to the registration rights agreement with La Jolla Cove
Investors, Inc., we agreed to maintain an effective registration statement for
the resale by La Jolla of the 2,252,683 shares and the 17,465,370 shares
underlying the unexercised warrants held by La Jolla at all times from and after
the date of issuance of the shares or warrants, as the case may be. These shares
and warrants were issued by us to La Jolla in April, May and June 2003. From and
after the date of issuance of these securities and until December 22, 2003,
there was no effective registration statement covering these shares. In January
2004, we received a letter from La Jolla claiming, among other things, damages
in an unspecified amount because the Company had failed to maintain an effective
registration statement for these shares. We have informed La Jolla that any
delay in having the registration statement declared effective was reasonable
under the circumstances, and La Jolla is not entitled to damages. The Company
believes that the claims of La Jolla are without merit and that it will prevail
in this matter. Accordingly, there has been no provision recorded for this claim
in the financial statements.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.
CRITICAL ACCOUNTING POLICIES
GENERAL
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. The Company believes that its critical accounting policies and
estimates relate to revenue recognition, software development costs, impairment
of long-lived assets, goodwill and intangible assets and investments. Future
results may differ from the estimates under different assumptions or conditions.
REVENUE RECOGNITION
Revenue from the sale of equipment is recognized on the terms of
freight-on-board shipping point, or upon installation and acceptance of the
equipment if installation services are purchased for the related equipment.
Transaction processing revenue is recognized upon the usage of the Company's
cashless payment and control network. Service fees for access to the Company's
equipment and network services are recognized on a monthly basis. Product
revenues are recognized from the sale of products from Company owned vending
machines when there is purchase and acceptance by the vending customer.
Customers have the ability to return vended products for a full refund. The
Company estimates an allowance of product returns at the date of sale.
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs pursuant to
Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed", after technological
feasibility of the software is established and through the product's
availability for general release to the Company's customers. All costs incurred
in the research and development of new software and costs incurred prior to the
establishment of technological feasibility are expensed as incurred.
Amortization of software development costs commences when the product becomes
available for general release to customers. Amortization of software development
costs is calculated as the greater of the amount computed using (i) the ratio
that current gross revenues for a product bear to the total of current and
anticipated future gross revenues of that product or (ii) the straight-line
method over the remaining estimated economic life of the product. The Company
reviews the unamortized software development costs at each balance sheet date
and, if necessary, will write down the balance to net realizable value if the
unamortized costs exceed the net realizable value of the asset.
Software development costs are being amortized over a useful life of
two years ending in April 2004. Amortization expense, reflected in cost of
sales, was $333,000 and $666,000 for the three and six months ended December 31,
2003, respectively, and $291,000 and $583,000 for the three and six months ended
December 31, 2002, respectively.
16
IMPAIRMENT OF LONG LIVED ASSETS
In accordance with Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-lived Assets", the Company
reviews its long-lived assets whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable. If the
carrying amount of an asset or group of assets exceeds its net realizable value,
the asset will be written down to its fair value.
In the period when the plan of sale criteria of SFAS 144 are met,
long-lived assets are reported as held for sale, depreciation and amortization
cease, and assets are reported at the lower of carrying value or fair value less
costs to sell.
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of cost over fair value of the net
assets purchased in acquisitions. The Company accounts for goodwill in
accordance with Statement of Financial Accounting Standards No. 142 (SFAS No.
142), "Goodwill and Other Intangible Assets". Under SFAS No. 142, goodwill is
not amortized to earnings, but instead is subject to periodic testing for
impairment. The Company tests goodwill for impairment using a two-step process.
The first step screens for potential impairment, while the second step measures
the amount of impairment, if any. The Company uses a discounted cash flow
analysis to complete the first step in this process. Testing for impairment is
to be done at least annually and at other times if events or circumstances arise
that indicate that impairment may have occurred. The Company has selected April
1 as its annual test date. To date, no impairment of goodwill has occurred.
Intangible assets include patents, trademarks and non-compete
arrangements purchased in acquisitions. Amortization of these intangibles is
computed using the straight-line method over their estimated useful lives of
five and ten years. Amortization expense was $309,000 and $590,000 for the three
and six months ended December 31, 2003, respectively, and $73,000 and $146,000
for the three and six months ended December 31, 2002, respectively.
INVESTMENT
The Company accounts for investments in accordance with Statement of
Financial Accounting Standards No. 115 "Accounting for Certain Investments in
Debt and Equity Securities". Management determines the appropriate
classifications of securities at the time of purchase and reevaluates such
designation as of each balance sheet date. Available-for-sale securities are
carried at fair value, with the unrealized gains and losses reported as a
separate component of shareholders' equity in accumulated other comprehensive
income (loss).
A judgmental aspect of accounting for investments involves determining
whether an other-than-temporary decline in value of the investment has been
sustained. If it has been determined that an investment has sustained an
other-than-temporary decline in its value, the investment is written down to its
fair value by a charge to earnings. Such evaluation is dependent on the specific
facts and circumstances. Factors that are considered by the Company each quarter
in determining whether an other-than-temporary decline in value has occurred
include: the market value of the security in relation to its cost basis; the
financial condition of the investee; and the intent and ability to retain the
investment for a sufficient period of time to allow for recovery in the market
value of the investment. In evaluating the factors above for available-for-sale
securities, management presumes a decline in value to be other-than-temporary if
the quoted market price of the security is below the investment's cost basis for
a period of six months or more. However, the presumption of an
other-than-temporary decline in these instances may be overcome if there is
persuasive evidence indicating that the decline is temporary in nature (e.g.,
strong operating performance of investee, historical volatility of investee,
etc.).
17
FORWARD LOOKING STATEMENTS
This Form 10-QSB contains certain forward looking statements regarding,
among other things, the anticipated financial and operating results of the
Company. For this purpose, forward looking statements are any statements
contained herein that are not statements of historical fact and include, but are
not limited to, those preceded by or that include the words, "believes,"
"expects," "anticipates," or similar expressions. Those statements are subject
to known and unknown risks, uncertainties and other factors that could cause the
actual results to differ materially from those contemplated by the statements.
The forward looking information is based on various factors and was derived
using numerous assumptions. Important factors that could cause the Company's
actual results to differ materially from those projected, include, for example
(i) the ability of the Company to generate sufficient sales to generate
operating profits, or to sell products at a profit, (ii) the ability of the
Company to raise funds in the future through sales of securities, including but
not limited to the exercise of outstanding options and warrants, (iii) whether
the Company is able to enter into binding agreements with third parties to
assist in product or network development, (iv) the ability of the Company to
commercialize its developmental products, or if actually commercialized, to
obtain commercial acceptance thereof, (v) the ability of the Company to compete
with its competitors to obtain market share, (vi) the ability of the Company to
obtain sufficient funds through operations or otherwise to repay its debt
obligations, including but not limited to Senior Notes, or to fund development
and marketing of its products (vii) the ability of the Company to obtain
approval of its pending patent applications, or (viii) the ability of the
Company to satisfy its trade obligations included in accounts payable and
accrued liabilities. Although the Company believes that the forward looking
statements contained herein are reasonable, it can give no assurance that the
Company's expectations will be met.
RESULTS OF OPERATIONS
For the three months ended December 31, 2003 versus the three months ended
--------------------------------------------------------------------------------
December 31, 2002
-----------------
The three month period ended December 31, 2003 resulted in a net
operating loss of $3,737,624 (approximately $1.3 million non-cash) compared to a
net loss of $3,630,997 (approximately $1.7 million non-cash) for the comparable
quarter in the prior fiscal year.
Revenues for the three month period ended December 31, 2003 increased
to $1,914,586 from $774,647 during the same period in the prior fiscal year, an
increase of $1,139,939 or 147%. This increase was primarily attributed to sales
of the Company's energy conservation equipment for the three months ended
December 31, 2003, as such revenues did not exist in the corresponding quarter
of the prior fiscal year since the acquisition of Bayview occurred in July 2003.
Revenues are discussed in more detail as follows:
18
Equipment sales: Revenues from equipment sales increased to $1,425,176
from $384,459 in the corresponding quarter of the prior fiscal year, an increase
of $1,040,717 or 271%. This increase is mainly due to sales of the Company's
energy conservation equipment of approximately $1,162,000 for the three months
ended December 31, 2003, as such revenues did not exist in the corresponding
quarter of the prior year, since the acquisition of Bayview occurred in July
2003. The increase from energy conservation equipment sales was offset by a
decrease in Business Center equipment sales of approximately $86,000 due to a
lower average selling price per Business Center. The average selling price per
business center decreased as a result of the popularity of the Company's newly
introduced, lower priced Space Saver product.
License and transaction fees: Revenues from license and transaction
fees decreased $47,455 or 15% from $314,612 to $267,157 for the three months
ended December 31, 2002 and 2003, respectively. This decrease was due to a
decrease in fees earned from the Kodak Vending Placement Agreement of
approximately $59,000 as a result of the wind down of the contract, offset by an
increase in fees of approximately $12,000 as a result of an increase in the
number of the Company's e-Port and TransAct units connected to the Company's
network.
Product sales and other: Revenues from product sales and other
increased to $222,253 from $75,576, an increase of $146,677 or 194% over the
same period of the prior fiscal year. This increase was due to $200,000 recorded
for the three months ended December 31, 2003 related to the Strategic Alliance
Agreement executed in October 2003 between the Company and Conopco, Inc dba
Unilever Home & Personal Care North America. This was offset by a decrease in
camera and film sales from Company owned vending machines of approximately
$56,000 as a result of the wind down of the Kodak Vending Placement Agreement.
Cost of sales consisted of equipment, product and labor costs of
approximately $615,000 and $242,000 for the three months ended December 31, 2003
and 2002, respectively, an increase of $373,000; software development
amortization of approximately $333,000 and $292,000 for the three months ended
December 31, 2003 and 2002, respectively, an increase of $41,000; and network
and transaction related costs of $135,000 and $139,000 for the three months
ended December 31, 2003 and 2002, respectively, a decrease of $4,000. The
increase in total cost of sales to $1,083,419 from $671,940 in the same period
prior fiscal year, an increase of $411,479 or 61%, was principally attributable
to the increase in equipment sales.
Gross profit for the three months ended December 31, 2003 was $831,167,
compared to gross profit of $102,707 in the same period in the prior fiscal
year. The increase of $728,460 or 709% was primarily due to the addition of our
higher margin, energy conservation equipment sales that were not present in the
same period in the prior fiscal year.
Total operating expenses for the three months ended December 31, 2003
was $3,982,817, an increase of $1,528,152 or 62% over the same period from the
prior fiscal year. The components of operating expenses (General and
administrative, Compensation, Depreciation and amortization and Loss on debt
modification) and the causes of this significant increase are explained further
below:
19
General and administrative expenses increased from $1,368,373 for the
three months ended December 31, 2002 to $1,780,242 for the three months ended
December 31, 2003, an increase of $411,869 or 30%. This increase is due to
increases in overall general and administrative expenses of approximately
$369,000 related to the acquired energy conservation operation, as such expenses
did not exist in the comparable period last fiscal year, an increase of $89,000
in consulting and temporary services, primarily for network services and a
$41,000 increase in utility expenses. These increases were offset by decreases
in expenses related to professional fees of $130,000, primarily related to
promotion and public relations.
Compensation expense increased to $1,740,012 for the three months ended
December 31, 2003, a $901,299 or 107% increase over the comparable period last
fiscal year. This increase is due to approximately $641,000 increase in bonus
expenses, primarily to the Company's executive officers and approximately
$205,000 of additional compensation, including sales commissions, related to the
acquired energy conservation operations in July 2003, as such expenses did not
exist in the comparable period last fiscal year.
Depreciation and amortization expense for the three months ended
December 31, 2003 was $420,945, compared to $247,579 for the same period in the
prior fiscal year, a $173,366 or 70% increase. This increase was attributable to
amortization expense of intangible assets of $236,000 and depreciation expense
of fixed assets of $30,000 acquired from Bayview in July 2003. These increases
were offset by a decrease of $93,000 of depreciation expense in this quarter
compared to the same period last fiscal year, due to assets reaching the end of
their estimated useful life after December 31, 2002 but prior to the quarter
ended December 31, 2003.
The Company incurred a charge this quarter relating to the modification
of debt terms for certain of the 2003 and 2004 Senior Notes in the amount of
$41,618. There was no such comparable charge in the same quarter of the prior
year. This charge relates to the unamortized debt discount remaining for the
Senior Notes maturing in December 2003 and December 2004 whose conversion and
maturity terms were modified. The Company offered these note modifications to
the Note holders, and recognized the related non-cash charge to operations in
order to manage short-term cash flows.
In the three months ended December 31, 2003, a gain of $515,844 was
recorded relating to the termination of the Kodak Vending Placement Agreement.
This gain is comprised of the payment from Kodak of approximately $675,000 plus
the cancellation of Stitch's obligation to the supplier of the vending machines
of approximately $124,000 reduced by a write down of the carrying value of
vending machines of approximately $283,000 to their realizable value of $300 per
vending machine. To the extent any costs are incurred by Stitch to fulfill its
obligations under the settlement agreement, these costs will be recorded as
incurred, as any additional costs cannot be reasonably estimated at this time.
Total interest expense decreased from $1,283,302 to $1,113,905 for the
three months ended December 31, 2002 and 2003, respectively, a decrease of
$169,397 or 13%. This decrease was primarily due to lower principal balances on
the Company's 12% Senior Notes as the result of conversions of the Senior Notes
into shares of the Company's Common Stock. At the time of conversion, the note
holder is issued shares equivalent to the conversion rate on the Senior Note,
any unamortized debt discount on the note is accelerated and charged to interest
expense and future interest on the converted note ceases to accrue. Therefore,
interest expense and debt discount amortization for the three months ended
December 31, 2003 decreased from the comparable period last fiscal year.
20
For the six months ended December 31, 2003 versus the six months ended December
--------------------------------------------------------------------------------
31, 2002
--------
The six month period ended December 31, 2003 resulted in a net
operating loss of $13,040,708 (approximately $8.8 million non-cash) compared to
a net loss of $7,205,215 (approximately $3.1 million non-cash) for the
comparable period in the prior fiscal year.
Revenues for the six month period ended December 31, 2003 increased to
$3,595,194 from $1,509,092 during the same period in the prior fiscal year, an
increase of $2,086,102 or 138%. This increase was primarily attributed to sales
of the Company's energy conservation equipment for the six months ended December
31, 2003, as such revenues did not exist in the corresponding period of the
prior fiscal year since the acquisition of Bayview occurred in July 2003.
Revenues are discussed in more detail as follows:
Equipment sales: Revenues from equipment sales increased to $2,711,654
from $572,947 in the corresponding period of the prior fiscal year, an increase
of $2,138,707 or 373%. This increase is mainly due to sales of the Company's
energy conservation equipment of approximately $2,107,383. During the period,
the Company fulfilled purchase orders for its energy conservation equipment from
customers such as food and drug retailer, Albertsons, automotive parts retailer,
AutoZone, and Texas energy utility company, Austin Energy. Revenue from the
sales of the Company's e-Port device increased to approximately $264,000 for the
six months ended December 31, 2003, an increase of $136,000 or 106%, from
$128,000 for the six months ended December 31, 2002. During the period, the
Company fulfilled purchase orders for its e-Port device from customers such as
vending management company, International Vending Management (IVM), and food
service and vending company, Canteen. The increases from energy conservation
equipment and e-Port sales was offset by a slight decrease in Business Center
equipment sales of approximately $76,000 due to a lower average selling price
per business center. The average selling price per business center decreased as
a result of the popularity of the Company's newly introduced, lower priced Space
Saver product.
License and transaction fees: Revenues from license and transaction
fees decreased $70,459 or 11% from $657,265 to $586,806 for the six months ended
December 31, 2002 and 2003, respectively. This decrease was due to a decrease in
fees earned from the Kodak Vending Placement Agreement of approximately $94,000
as a result of the wind down of the contract, offset by an increase in fees of
approximately $24,000 as a result of an increase in the number of the Company's
e-Port and TransAct units connected to the Company's network.
Product sales and other: Revenues from product sales and other
increased to $296,734 from $278,880, an increase of $17,854 or 6% over the same
period of the prior fiscal year. This increase was due to $200,000 recorded in
the quarter ended December 31, 2003 related to the Strategic Alliance Agreement
executed in October 2003 between the Company and Conopco, Inc dba Unilever Home
& Personal Care North America. This increase was offset by a decrease in camera
and film sales from Company owned vending machines of approximately $182,000 as
a result of the wind down of the Kodak Vending Placement Agreement.
21
Cost of sales consisted of equipment, product and labor costs of
approximately $1,213,000 and $451,000 for the six months ended December 31, 2003
and 2002, respectively, an increase of $762,000; software development
amortization of approximately $666,000 and $583,000 for the six months ended
December 31, 2003 and 2002, respectively, an increase of $83,000; and network
and transaction related costs of $287,000 and $306,000 for the six months ended
December 31, 2003 and 2002, respectively, a decrease of $19,000. The increase in
total cost of sales to $2,165,582 from $1,339,400 in the same period prior
fiscal year, an increase of $826,182 or 62%, was primarily attributable to the
increase in equipment sales.
Gross profit for the six months ended December 31, 2003 was $1,429,612,
compared to gross profit of $169,692 in the same period in the prior fiscal
year. The increase of $1,259,920 or 742% was primarily due to the addition of
our higher margin, energy conservation equipment sales that were not present in
the same period in the prior fiscal year.
Total operating expenses for the six months ended December 31, 2003 was
$11,860,040, an increase of $6,670,194 or 129% over the same period from the
prior fiscal year. The components of operating expenses (General and
administrative, Compensation, Depreciation and amortization and Loss on debt
modification) and the causes of this significant increase in each category are
explained further below:
General and administrative expenses increased from $3,010,751 for the
six months ended December 31, 2002 to $3,282,011 for the six months ended
December 31, 2003, an increase of $271,260 or 9%. This increase is due to
increases in overall general and administrative expenses of approximately
$731,000 related to the acquired energy conservation operation, as such expenses
did not exist in the comparable period last fiscal year. This increase was
offset by decreases of $240,000 related to professional fees, primarily related
to promotion and public relations, $140,000 of utility expenses and $120,000 in
consulting and temporary services, primarily for network services.
Compensation expense increased to $7,443,210 for the six months ended
December 31, 2003, a $5,758,778 or 342% increase over the comparable period last
fiscal year. This increase is primarily due to the issuance of 10,500,000 shares
of Common Stock to the Company's Chief Executive Officer in connection with the
amendment of his employment agreement. This was a one-time, non-cash payment
valued at $4,620,000 representing 80% of the total increase. Other components of
this increase were due to approximately $711,000 increase in bonus expenses,
primarily to the Company's executive officers and approximately $412,000 of
additional compensation, including sales commissions, related to the acquired
energy conservation operations in July 2003, as such expenses did not exist in
the comparable period last fiscal year.
Depreciation and amortization expense for the six months ended December
31, 2003 was $815,904, compared to $494,663 for the same period in the prior
fiscal year, a $321,241 or 65% increase. This increase was attributable to
amortization expense of intangible assets of $444,000 and depreciation expense
of fixed assets of $60,000 acquired from Bayview in July 2003. These increases
were offset by a decrease of $183,000 of depreciation expense during the current
six month compared to the same period last fiscal year, due to assets reaching
the end of their estimated useful life after December 31, 2002.
22
The Company incurred a charge during the six months ended December 31,
2003 relating to the modification of debt terms for certain of the 1999 and 2000
Senior Notes in the amount of $318,915. There was no such comparable charge in
the same period of the prior year. This charge relates to the unamortized debt
discount remaining for the Senior Notes maturing in December 2003 and December
2004 whose conversion and maturity terms were modified. The Company offered
these note modifications to the Note holders, and recognized the related
non-cash charge to operations in order to manage short-term cash flows.
In the six months ended December 31, 2003, a gain of $515,844 was
recorded relating to the termination the Kodak Vending Placement Agreement. This
gain is comprised of the payment from Kodak of approximately $675,000 plus the
cancellation of Stitch's obligation to the supplier of the vending machines of
approximately $124,000 less a write down of the carrying value of vending
machines of approximately $283,000 to their realizable value of $300 per vending
machine. To the extent any costs are incurred by Stitch to fulfill its
obligations under the settlement agreement, these costs will be recorded as
incurred, as any additional costs cannot be reasonably estimated at this time.
Total interest expense increased from $2,192,298 to $3,177,301 for the
six months ended December 31, 2002 and 2003, respectively, an increase of
$985,003 or 45%. This increase was primarily attributable to charges incurred
due to the acceleration of unamortized debt discount and other issuance costs on
the 12% Senior Notes that were converted into Common Stock during the six month
period.
PLAN OF OPERATIONS
With the acquisition of Bayview on July 11, 2003, the Company now
designs and manufactures patented energy conservation devices for equipment such
as laser printers, monitors, office peripherals, refrigerated vending machines
and glass front merchandisers (referred to as slide or visi coolers). These
energy conservation devices reduce power consumption of various types of
equipment by allowing the equipment to operate in power saving mode when full
power mode is not necessary. These devices, which include the VendingMiser,
CoolerMiser, SnackMiser, MonitorMiser and LaserMiser can use activity,
occupancy, temperature, timing or other various methods to determine which mode
the equipment should be in. Route to market for the energy conservation devices
is much the same as the Company's e-Port technology, with the notable addition
of governmental and utility rebate and give-away programs, where by part or all
of the cost of the energy management device is covered by government funds
allocated to energy conservation projects.
In October 2003, the Company signed a strategic alliance agreement with
Conopco, Inc. dba Unilever Home & Personal Care North America to be the
exclusive provider of laundry detergent for the e-Suds program to be used in
colleges and universities located in the United States. Per the terms of the
agreement, the Company agrees to be a reseller of Unilever Products that are
dispensed through the USA e-Suds System and the Company will also receive fees
from Unilever based on the number of injections of Unilever Products through the
USA e-Suds System.
23
In December 2003, the parties to the Kodak Vending Placement Agreement
agreed to the termination of the contract effective December 31, 2003. The
settlement resulted in the termination of the vending agreement pursuant to
which the Company will receive a payment from Kodak of approximately $675,000
(received in January 2004) and payments equal to $300 per vending machine, due
from the supplier of the vending machines, as the machines are pulled from
service at the supplier's sole cost and expense. Upon receipt of the $300 per
vending machine, title to the vending machine will transfer from Stitch to the
supplier. The settlement agreement provides that all machines are to be pulled
from service no later than mid calendar year 2004. In addition, the supplier
agreed to cancel an obligation for the purchase of vending machines owed by
Stitch in the approximate amount of $124,000.
The vending machines were used as collateral to secure a bank facility
used to purchase the machines under which $516,009 was outstanding as of
December 31, 2003. Final payment of the debt will occur no later than the time
Stitch transfers title of the machines to the supplier.
Although revenues of the Company will be reduced as a result of vending
contract termination, because the Kodak program is and has been operating at a
loss, the termination of the program would eliminate these ongoing losses.
Revenues related to the Kodak program through the fiscal year ended June 30,
2003 were approximately $1,092,000 and approximately $144,000 and $352,000 for
the three and six months ended December 31, 2003, respectively.
In October 2002, the Company signed a Strategic Alliance Agreement with
ZiLOG Corporation, a semiconductor company, which is a supplier of
microprocessors to the retail point of sale industry. The agreement allows the
Company's proprietary network software (USALive) to be embedded on a chip
produced by ZiLOG. The Company will license its software to the purchaser and
will be entitled to receive a fee for this license. A second revenue stream
could be generated from purchasers who buy the retail point of sales terminals
and begin to use them, if they elect to use the USA network embedded on the
chip. To date, no products have been available for commercial use and
accordingly, no revenues have been generated.
In laundry, American Sales Inc. (ASI) has signed a five-year agreement
to purchase units of Stitch's e-Suds laundry solution for their university
locations in the Midwest, with initial installations to begin in the fall of
2003. In October 2003, the Company installed a system at ASI's facilities for
final testing. To date, the system has not completed final testing, and the
Company anticipates unit sales to begin during the fourth quarter of fiscal year
2004.
24
LIQUIDITY AND CAPITAL RESOURCES
For the six months ended December 31, 2003, net cash of $5,484,151 was
used by operating activities, primarily due to the net loss of $13,040,708
offset by non-cash charges aggregating to $8,805,187 for transactions involving
issuing Common Stock for services and in connection with the amendment to the
CEO's employment agreement, depreciation and amortization of assets,
amortization of debt discount, loss on debt modifications relating to the Senior
Notes and interest expense relating to the Senior Notes paid through the
issuance of Common Stock and Common Stock Warrants, offset by a gain on the sale
of investment and gain on the termination of a contract. In addition, the
Company's net operating assets increased by $1,248,630 (primarily inventory and
accounts receivable), a substantial portion of which relates to the addition of
the energy conservation equipment line from the Bayview acquisition.
For the six months ended December 31, 2003, net cash used in investing
activities was $562,089, comprised of the cash component of the investment in
Bayview, purchases of property and equipment and the proceeds received from the
sale of a portion of the investment in the Jubilee Trust.
Proceeds from financing activities for the six months ended December
31, 2003 provided the funds necessary to support cash used in operating and
investing activities. Proceeds of $6,576,218 were realized from several private
placement offerings of Common Stock, the exercise of Common Stock Warrants and
collection of Common Stock subscriptions receivable. Payments of long-term debt
and capital leases totaled $392,629.
Long-term debt obligations of the Company as of December 31, 2003 were
as follows:
Bank facility $ 516,009
Working capital loans 96,765
Other, including capital lease obligations 49,885
----------
662,659
Less current portion 639,611
----------
$ 23,048
==========
The bank facility (the Facility) was utilized to fund the purchase of
vending machines placed at locations where Kodak film products are sold.
Borrowings were made from time to time under the Facility, with repayment
schedules set at the time of each borrowing, including equal monthly payments
over 36 months and an interest rate based upon 495 basis points over the three
year U.S. Treasury Notes. The Company granted the bank a security interest in
the vending machines. Repayment of principal is also insured by a Surety Bond
issued by a third-party insurer in exchange for an initial fee paid by the
Company. Final maturity, scheduled to extend into the fiscal year ending June
30, 2005, is anticipated to occur during the year ending June 30, 2004 due to
the termination of the vending placement agreement and the removal from service
and sale of the vending machines used as collateral for the bank facility. As
described above, the debt, with a balance outstanding at December 31, 2003 of
$516,009, will be repaid no later than the time Stitch returns the vending
machines to the supplier.
25
In connection with the Stitch acquisition, the Company assumed
long-term debt which included a vending equipment borrowing facility and working
capital loans. These loans are secured by certain assets of Stitch and bear
interest at 6.75% per annum, payable on July 8, 2002. During fiscal year 2003
the bank extended the due date on these loans on several occasions under
forbearance agreements. On November 6, 2003, the Company reached an agreement
with the bank to make monthly installments that will repay the remaining balance
by October 2004.
The Company has incurred losses since inception. For the six months
ended December 31, 2003, the net loss was $13,040,708 of which $8,805,187
related to non-cash charges. Cumulative losses through December 31, 2003
amounted to approximately $92 million. The Company has continued to raise
capital through equity and debt offerings to fund operations.
The impact of the Bayview acquisition on cash flow for the six months
ended December 31, 2003 was a net cash outflow of approximately $1.2 million -
$500,000 of cash used in operations and $728,000 invested in operating assets
and liabilities in connection with the purchase. The structure of the
acquisition of the energy conservation equipment line from Bayview did not
include acquiring the working capital required to support the business. The six
months' operating cash flows reflected an investment for this working capital.
During the year ended June 30, 2003, cash used in operating activities
was approximately $750,000 per month. For the six months ended December 31, 2003
cash used in operating activities, was approximately $915,000 per month.
Operating cash flows during the six months ended December 31, 2003 was impacted
by increases in inventory and accounts receivable that were disproportionate to
the increase in revenues by approximately $600,000. The period also absorbed
costs for cash bonuses of approximately $600,000, primarily to the Company's
executive officers. The Company believes it can improve its management of
working capital, primarily related to accounts receivables, and operating costs
to reduce cash used in operating activities to approximately $700,000 per month.
Using that as a basis for estimating capital requirements for the next twelve
months, along with requirements for capital expenditures and repayment of
long-term debt, the Company's cash needs would approximate $9.4 million from
January 1, 2004 through December 31, 2004.
This estimate does not consider the positive impact the Company expects
to achieve from the Bayview acquisition during the remainder of the year and the
incremental revenues from the Company's other products and services. The energy
conservation equipment line acquired from Bayview is expected to generate
revenues of $5 million during the fiscal 2004 year and produce operating cash
flow of approximately $1.5 million during the remainder of the year. As the
Bayview acquisition only occured in July 2003, we do not have historical
experience with this operation as integrated into the Company's operations and,
therefore, the achievement of the positive cash flow impact is not certain at
this stage of integration and operation. However, deficits in consolidated
operating cash flows are still anticipated for the remainder of fiscal year
2004.
As of December 31, 2003, the Company had $2.5 million of cash and cash
equivalents, primarily as a result of proceeds from several private placements
of Common Stock entered into during the three months ended September 30, 2003.
In September 2003, the Company also sold 700,000 shares of its investment in the
Jubilee Trust generating net proceeds of $395,000 and could sell a substantial
portion of the remaining Jubilee shares during fiscal year 2004 creating
additional cash of approximately $1 million based on the investment's current
quoted market price.
26
As of December 31, 2003, there were 44,591,785 fully vested warrants to
purchase Common Stock at exercise prices ranging from $0.067 to $1.25 per share.
There are 39,251,092 warrants that are "in the money", with exercise prices
below $0.11 per share. The potential exercise of these "in the money" warrants
could provide $3,460,260 of additional proceeds to the Company. Subsequent to
December 31, 2003, 5,215,370 warrants were exercised, generating $465,070 of
proceeds to the Company. However, future exercises of warrants is uncertain and
the Company does not expect to rely on the proceeds from the potential exercise
of warrants to meet its capital requirements through the end the of 2004 fiscal
year.
Based on current revenue and operating levels, cash on hand of $2.5
million, proceeds received from the exercise of warrants subsequent to December
31, 2003 of $465,070, as well as working capital management initiatives and the
potential proceeds, at current market prices, generated from the sale of the
Jubilee shares, the Company believes it will have sufficient funds to meet its
requirements for the remainder of the 2004 fiscal year (through June 30, 2004).
However, if revenues remain at current levels during the next twelve months,
additional capital of at least $5.5 million will be required to meet cash flow
needs during this period from July 1, 2004 and through December 31, 2004
considering the assumptions described above of approximately $9.4 million cash
need, cash on hand of $2.5 million and $1 million of additional cash from the
sale of its investment in Jubilee, based on current market prices and proceeds
of $0.5 million from warrant exercises subsequent to December 31, 2003. The
Company intends to meet this capital requirement by raising additional funds
through the sale its securities, and given the Company's current product
offerings and the markets it is addressing, the Company believes the capital
markets should be available to raise sufficient capital to fund its operating
needs. However, if revenues increase significantly over this period, cash
generated from such improved operations and additional proceeds from the
potential exercise of "in the money" warrants could meet a substantial portion
of these capital requirements.
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The principal executive officer and principal financial officer have
evaluated the Company's disclosure controls and procedures as of December 31,
2003. Based on this evaluation, they conclude that the disclosure controls and
procedures effectively ensure that the information required to be disclosed in
the Company's filings and submissions under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms.
27
(b) Changes in internal controls.
There have been no changes during the quarter ended December 31, 2003
in the Company's internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, internal control over
financial reporting.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
In December 2003, the Company agreed to issue 488,577 shares of Common
Stock and Common Stock Warrants to purchase up to 488,577 shares to holders of
its Convertible Senior Notes who elected to receive these securities in lieu of
the cash interest payment due for the quarter ended December 31, 2003. The
shares were purchased at the rate of $0.20 per share and the warrants are
exercisable at $0.20 per share at any time through June 30, 2004. The Company
has agreed to use its best efforts to register these shares and the shares
underlying the warrants under the Act for resale through June 30, 2004. The
securities were offered and sold under the exemption from registration set forth
in Rule 506 promulgated under Section 4(2) of the Act. All of the note holders
are accredited investors and there was no general solicitation or advertising.
During the quarter ended December 31, 2003, 31 holders of $350,000
principal amount of the Senior Notes that matured in December 2003 elected to
extend these notes until December 31, 2006 and to have the conversion rate
reduced from $1.25 per share to $0.20 per share. The note exchange was exempt
from the registration requirements of the Act pursuant to Section 3(a)(9)
thereof.
During the quarter ended December 31, 2003, 24 holders of $127,357
principal amount of the Senior Notes maturing in December 2004 elected to extend
these notes until December 31, 2007 and to have the conversion rate reduced from
$0.40 per share to $0.20 per share. The note exchange was exempt from the
registration requirements of the Act pursuant to Section 3(a)(9) thereof.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
3.1.19 Nineteenth Amendment to Articles of Incorporation of
USA filed January 16, 2004.
3.1.20 Amended and Restated Articles of Incorporation of USA
filed January 26, 2004.
10.1.1 First Amendment to Employment and Non-Competition
Agreement between USA and Adele Hepburn dated as of February
4, 2004.
10.4.3 Fourth Amendment to Employment and Non-Competition
Agreement between USA and H. Brock Kolls dated April 15, 2002.
28
10.9.4 Fourth Amendment to Employment and Non-Competition
Agreement between USA and Stephen P. Herbert dated February 4,
2004.
10.21.6 Sixth Amendment to Employment and Non-Competition
Agreement between USA and George R. Jensen, Jr. dated February
4, 2004.
10.6 Termination Agreement dated December 31, 2003 by and
between Eastman Kodak Company, Maytag Corporation,
Dixie-Narco, Inc. and Stitch Networks Corporation.
31.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certifications by Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
On October 3, 2003, the Company filed a Form 8-K to report on
Items 5 and 7(c) the sale of 20,000,000 shares of Common
Stock, with the form of Stock Purchase Agreement and a Press
Release attached as exhibits thereto.
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
USA TECHNOLOGIES, INC.
Date: February 12, 2004 / s / George R. Jensen, Jr.
-----------------------------------------
George R. Jensen, Jr., Chairman,
Chief Executive Officer
Date: February 12, 2004 / s / David M. DeMedio
-----------------------------------------
David M. DeMedio, Chief Financial Officer
30