SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
10-Q
x
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
|
For the
quarterly period ended March 31, 2008 OR
o
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
|
|
For the transition period from ______________to
______________
|
Commission File Number 0-27494
SILVERSTAR HOLDINGS, LTD.
(Exact
name of Registrant as Specified in Its Charter)
Bermuda
|
Not Applicable
|
(State or Other Jurisdiction of
|
(IRS Employer Identification No.)
|
Incorporation or Organization)
|
|
Clarendon House, Church Street, Hamilton HM CX, Bermuda
(Address
of Principal Executive Offices with Zip Code)
Registrant’s Telephone Number, Including Area Code:
809-295-1422
_____________________________________________________________________
Former
Name, Former Address and Former Fiscal Year, if Changed Since Last Report.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the
definitions of “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
|
|
Accelerated filer
o
|
Non-accelerated filer
o
|
|
Smaller reporting company
x
|
(Do not check if a smaller a smaller reporting
company
|
|
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes
o
No
x
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of
1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes
o
No
o
APPLICABLE ONLY TO CORPORATE ISSUERS:
Title of Class
|
Shares Outstanding
on May 7, 2008
|
Class A Common Stock
|
19,914,417
|
|
|
|
|
SILVERSTAR HOLDINGS, LTD.
INDEX
TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended March 31, 2008
PART I
– FINANCIAL INFORMATION
PART II
– OTHER INFORMATION
2
SILVERSTAR HOLDINGS, LTD. AND
SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
|
March 31,
2008
|
June 30,
2007
|
Current Assets:
|
(Unaudited)
|
|
Cash and cash equivalents, includes restricted cash
of
$756,370 and $590,990, respectively
|
$7,408,235
|
$3,693,149
|
Cash restricted for foreign tax estimated
liability
|
658,373
|
1,064,040
|
Accounts receivable, net
|
2,240,510
|
6,908,846
|
Inventories, net
|
808,022
|
900,128
|
Current portion of long-term notes receivable
|
294,147
|
256,982
|
Prepaid expenses and other current assets
|
430,376
|
669,730
|
Assets available for sale
|
|
|
Total current assets
|
|
|
Property, plant and equipment, net
|
526,085
|
488,031
|
Software development costs, net
|
7,832,701
|
5,183,033
|
Investments in non-marketable securities
|
1,131,066
|
1,143,566
|
Long-term notes receivable
|
-
|
214,222
|
Goodwill, net
|
921,440
|
890,038
|
Intangible assets, net
|
15,588,953
|
20,611,189
|
Deferred tax asset
|
622,471
|
625,217
|
Deferred charges and other assets
|
|
|
Total assets
|
|
$43,785,664
|
LIABILITIES AND STOCKHOLDERS’
EQUITY
|
|
|
Current Liabilities:
|
|
|
Lines of credit
|
$2,203,292
|
$2,875,472
|
Notes payable – acquisition
|
2,665
|
5,475,179
|
Earn out notes payable - acquisition
|
3,953,887
|
3,847,426
|
Accounts payable
|
3,519,416
|
6,959,835
|
Accrued royalty expense
|
1,655,577
|
2,937,887
|
Accrued expenses
|
2,281,038
|
3,355,852
|
Deposit on July 2007 private placement
|
-
|
630,403
|
Estimated liability for foreign tax
|
|
|
Total current liabilities
|
13,887,560
|
26,698,512
|
|
|
|
Convertible secured debentures
|
7,246,238
|
4,790,779
|
Other long-term liabilities
|
|
|
Total Liabilities
|
|
|
Commitments, contingencies and other matters
|
|
|
Stockholders’ equity:
|
|
|
Preferred stock, $.01 par value; 5,000,000 shares
authorized;
no shares issued and outstanding
|
-
|
-
|
Common stock, Class A, $.01 par value, 50,000,000 shares
authorized; 19,806,177, 1,496,700 shares in treasury and 9,621,891 shares
issued and outstanding, respectively
|
198,061
|
96,218
|
Common stock, Class B, $.01 par value; 2,000,000 shares
authorized; 0 shares and 835,260 shares issued and outstanding,
respectively
|
-
|
8,353
|
Common stock, FSAH Class B $.001 par value; 10,000,000
shares authorized;0 and 2,671,087 shares issued and outstanding,
respectively
|
-
|
600
|
Additional paid-in capital
|
82,720,580
|
67,843,919
|
Accumulated deficit
|
(65,525,174)
|
(56,796,978)
|
Accumulated comprehensive income
|
|
|
Total stockholders’ equity
|
|
|
Total liabilities and stockholders’ equity
|
|
|
See notes to condensed consolidated financial statements
3
SILVERSTAR HOLDINGS, LTD. AND
SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
|
Three Months Ended March 31,
|
|
2008
|
2007
|
Net Revenues
|
$5,861,240
|
$4,603,017
|
Operating expenses:
|
|
|
Cost of sales
|
2,370,810
|
1,782,905
|
Development costs and royalties
|
327,017
|
399,609
|
Selling, general and administrative
|
3,147,412
|
2,689,716
|
Amortization of software development costs
|
1,246.772
|
53,617
|
Amortization of acquired intangibles
|
1,054,426
|
1,929,917
|
Depreciation
|
|
|
|
|
|
Operating loss
|
(2,335,435)
|
(2.315,205)
|
|
|
|
Other income (expense)
|
2
|
(426)
|
Foreign currency loss
|
(280,448)
|
(88,212)
|
Amortization of convertible debt discounts and issuance
costs
|
(63,073)
|
(172,990)
|
Interest expense
|
(129,100)
|
(254,155)
|
Interest income
|
|
|
Loss before income taxes
|
(2,766,567)
|
(2,741,291)
|
Provision for income taxes
|
|
|
Net Loss
|
|
|
|
|
|
Loss per share:
|
|
|
Basic and diluted
|
|
|
|
|
|
Weighted average common stock outstanding:
|
|
|
Basic and diluted
|
|
|
See notes to condensed consolidated financial statements
4
SILVERSTAR HOLDINGS, LTD. AND
SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
|
Nine Months Ended March 31,
|
|
2008
|
2007
|
Net Revenues
|
$20,536,813
|
$7,842,551
|
Operating Expenses:
|
|
|
Cost of sales
|
8,187,392
|
3,154,475
|
Development costs and royalties
|
1,342,124
|
1,455,325
|
Selling, general and administrative
|
10,299,600
|
4,754,887
|
Amortization of software development costs
|
2,795,404
|
53,617
|
Amortization of acquired intangibles
|
5,488,688
|
2,603,105
|
Depreciation
|
|
|
|
|
|
|
|
|
Operating loss
|
(7,717,460)
|
(4,273,994)
|
|
|
|
Other income (expense)
|
(12,393)
|
(434)
|
Foreign currency (losses) gains
|
(227,420)
|
7,143
|
Gain on sale of fixed assets
|
90,348
|
-
|
Amortization of convertible debt discounts and issuance
costs
|
(617,989)
|
(503,522)
|
Interest expense
|
(430,562)
|
(614,878)
|
Interest income
|
|
|
Loss before income taxes
|
(8,728,384)
|
(4,981,040
|
Benefit (provision) for income taxes
|
|
|
Net loss
|
|
|
|
|
|
Loss per share:
|
|
|
Basic and diluted
|
|
|
Weighted average common stock outstanding:
|
|
|
Basic and diluted
|
|
|
See notes to condensed consolidated financial statements
5
SILVERSTAR HOLDINGS, LTD. AND
SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
|
Nine Months Ended March 31,
|
|
2008
|
2007
|
Cash flows from operating activities:
|
|
|
Net loss
|
($8,728,199)
|
($4,994,137)
|
Adjustments to reconcile net loss to net cash used in
operating activities:
|
|
|
Depreciation and amortization
|
9,043,146
|
3,255,380
|
Loss on disposal of marketable securities
|
12,500
|
-
|
(Gain) loss on disposal of fixed assets
|
(90,348)
|
10,195
|
Stock-based compensation
|
346,492
|
196,824
|
Stock issued for services
|
45,067
|
308,740
|
Bad debt expense (recovery)
|
(40,237)
|
80,801
|
Unrealized foreign currency (gains) losses
|
11,863
|
(19,215)
|
Accrued interest income on notes receivable
|
(19.042)
|
(20,782)
|
Changes in operating assets and liabilities, net (see note
6)
|
(6,966,640)
|
(119,006)
|
Decrease in estimated liability for foreign tax
|
(291,829)
|
-
|
Increase (decrease) in other assets
|
77,789
|
(14,675)
|
Increase in other liabilities
|
|
|
Net cash used in operating activities
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
Cash paid for acquisition of Empire
|
-
|
(8,072,070)
|
Proceeds from sale of fixed assets
|
660,896
|
11,008
|
Purchase of intangible assets
|
(435,465)
|
-
|
Purchase of fixed assets
|
(195,307)
|
(80,503)
|
Proceeds from repayment of long-term note
receivable
|
137,619
|
151,662
|
Decrease in cash restricted for foreign tax estimated
liability
|
|
|
Net cash provided by (used in) investing
activities
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
Short term borrowings (repayments), net
|
(6,009,228)
|
(66,302)
|
Net proceeds from convertible debenture less capitalized
costs of
$936,024 and $270,286
|
6,563,976
|
1,129,714
|
Proceeds from exercise of warrants
|
1,397,937
|
-
|
Proceeds from private placement sales of common stock, net
of
offering costs of $1,089,726 and $0
|
7,910,269
|
650,000
|
Proceeds from the exercise of stock options
|
170,850
|
56,472
|
Purchase of treasury stock
|
|
|
Net cash provided by financing activities
|
|
|
|
|
|
Effect of exchange rates on cash
|
(168,785)
|
345,276
|
Net increase (decrease) in cash and cash
equivalents
|
3,715,086
|
(7,043,017)
|
Cash and cash equivalents, beginning of period
|
|
|
Cash and cash equivalents, end of period
|
|
|
Supplemental cash flow information:
|
|
|
Cash paid for interest
|
|
|
Cash paid for income taxes
|
|
|
See notes to condensed consolidated financial statements
6
SILVERSTAR HOLDINGS, LTD. AND
SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1.
|
FINANCIAL INFORMATION
|
Silverstar Holdings, Ltd. (the “Company”) is the parent company
of Empire Interactive, PLC (“Empire”), a leading worldwide publisher of
interactive entertainment software for all game platforms, and Strategy First, Inc.
(“Strategy First”), a leading worldwide publisher of entertainment software for
the Personal Computer (PC). The Company is also a minority shareholder in Magnolia
Broadband Wireless, a development stage company which is developing mobile wireless
broadband products.
NOTE 2.
|
LIQUIDITY CONSIDERATIONS
|
Historically, we have met our cash flow requirements through the sale of
debt or equity securities, the sale of assets, or through operating cash flow. However,
there is no guarantee that we will be successful in meeting our cash flow requirements
going forward. We anticipate meeting our cash flow requirements through one or a
combination of the following:
|
•
|
Generate significant short term operating earnings and cash
flow primarily through our Empire subsidiary. Empire’s title release
schedule for the next 12 months includes several multi-platform games most
notably Hello Kitty and PipeMania. We anticipate that the launch of these
games, along with Empire’s ongoing business will generate operating
profits and cash flow in the short term. Empire continues to explore US
distribution agreements with major entertainment publishers which would
provide significant short term cash flow to us.
|
|
•
|
Raise additional capital through the exercise of existing
warrants and the sale of equity or debt securities. The Company currently
has approximately 7.78 million warrants outstanding with exercise prices
ranging from $1.50 to $2.50. The company has a continuing relationship with
an investment banking firm to assist it should it decide to raise
additional capital in the future.
|
|
•
|
Raise additional capital through the sale of certain
intellectual property. The company has had preliminary discussions with a
third party to sell certain of its intellectual property and would
entertain the sale of such intellectual property should the sales price
justify a transaction.
|
|
•
|
The Company has approximately $658,000 of restricted cash
set aside to match our current South African tax assessment. We believe
that we have strong arguments to set aside this assessment. If this
assessment is set aside, this cash would be available for
operations.
|
The
Company believes that these actions and others to be taken by us will improve liquidity and
achieve positive cash flow. However, there can be no assurance that any of these events
will occur.
NOTE 3.
|
BASIS OF PREPARATION
|
The
unaudited consolidated financial statements include the accounts of the Company and all of
its subsidiaries in which it has a majority voting interest. Investments in affiliates are
accounted for under the equity or cost method of accounting. All significant inter-company
accounts and transactions have been eliminated in the consolidated financial
statements.
Pursuant to the rules and regulations of the Securities and Exchange
Commission for Form 10-Q, the financial statements, footnote disclosures and other
information normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed. The financial statements contained in
this report are unaudited but, in the opinion of the Company, reflect all
7
adjustments, consisting of only normal recurring adjustments necessary to
fairly present the financial position of the Company as of March 31, 2008 and the results
of operations and cash flows for the interim periods of the fiscal year ending June 30,
2008 (“fiscal 2008”) and the fiscal year ended June 30, 2007 (“fiscal
2007”) presented herein. The results of operations for any interim period are not
necessarily indicative of results for the full year. These financial statements, footnote
disclosures and other information should be read in conjunction with the financial
statements and the notes thereto included in the Company’s annual report on Form 10-K
for the year ended June 30, 2007.
Net
Income or Loss Per Share
Basic
net income or loss per share is computed by dividing net income or loss by the weighted
average number of shares of common stock outstanding. Diluted net income or loss per share
is computed by dividing net income or loss by the weighted average number of shares of
common stock outstanding and dilutive potential shares of common stock reflecting the
dilutive effect of stock options, warrants, convertible debentures and shares to be issued
in connection with prior acquisitions. Dilutive potential common shares, stock options,
warrants and convertible debentures for all periods presented are computed utilizing the
treasury stock method. The dilutive effect of shares to be issued in connection with the
obligations related to prior acquisitions is computed using the average market price for
the quarter. The total number of shares that could potentially dilute earnings per share,
but which were not included in the calculations of diluted earnings per share because to do
so would have been anti-dilutive, was 20,194,451 and 18,706,909 for the three months ended
March 31, 2008 and 2007 respectively and 11,063,832 and 10,352,983 for the nine months
ended March 31, 2008 and 207, respectively.
Cash
and Cash Equivalents
Cash
and cash equivalents consist of cash and all highly liquid investments with original
maturities of three months or less. The vast majority of the Company’s cash balances
are held in liquid accounts at two highly rated financial institutions. While these
deposits are not insured, the quality of such financial institutions is such that the risks
of loss on these funds are minimal. Restricted cash balances at March 31, 2008 totaled
$756,370 which is used as collateral on the Company’s line of credit.
Software Development Cost
Historically, Empire has incurred significant software development expenses
in connection with the production of its products. Pursuant to Statement of Financial
Accounting Standards (“SFAS”) No. 86 an analysis must be conducted to determine
when commercial feasibility of a product is reached. Once commercial feasibility of a
product is reached, development expenses should start to be capitalized and then the
amortization process begins. There is no consensus in the interactive entertainment
software industry with respect to commercial feasibility of a product. Empire’s
management took the position that commercial feasibility was reached toward the end of the
development process and not, as some other companies do, at the beginning of the process.
As a result, Empire had not capitalized any development costs with respect to its products.
As previously disclosed, the Company undertook an evaluation and analysis of the
appropriateness of this position. This analysis was completed during the quarter ending
March 31, 2007. Based on this evaluation and analysis, the Company determined that there is
a clearly defined decision point early in the development process where a product evolves
from concept to commercial feasibility. This decision point is either reached with the
consent of third parities or through an internal process where management decides to move
forward with a product’s development once a game concept has been approved. The
Company also concluded those instances in which concept approval had been given and a game
did not become a commercial product did not have a material adverse effect on the Company.
As a result, the Company now capitalizes research and development expenses after concept
approval.
Stock-Based Compensation
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 123R, “Share-Based Payment.” This standard replaced SFAS No. 123,
“Accounting for Stock-Based Compensation”
8
and
supersedes Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees.” The standard requires companies to
recognize all share-based payments to employees, including grants of employee stock
options, in the financial statements based on their fair values on the grant date and is
effective for annual periods beginning after June 15, 2005. In accordance with the revised
statement, the Company recognizes the expenses attributable to stock options granted or
vested subsequent to July 1, 2005. During the nine month periods ended March 31, 2008 and
2007 the Company recognized expenses of $346,492 and $196,824 respectively, for employee
stock options and restricted shares that vested. Based on existing unvested option
agreements the Company anticipates an additional expense of approximately $62,908 in fiscal
2008 which could increase if additional options are granted during the fiscal year. As of
March 31, 2008, $582,929 of total unrecognized compensation costs related to non-vested
options is scheduled to be recognized over a weighted average period of 2.38 years. The
Company’s options and warrants outstanding and exercisable as of March 31, 2008 had
no intrinsic value.
The
weighted average grant date fair value of options granted during the nine months ended
March 31, 2008 and March 31, 2007 and the significant assumptions used in determining the
underlying fair value of each option grant on the date of the grant utilizing the Black
Scholes option pricing model are noted in the following table. Expected volatility is based
on historical volatility data of the Company’s stock. As a result of the acquisition
of Empire which significantly changed the size and complexity of the Company, the
volatility of options granted after March 31, 2007 were computed using the average
volatility of competitor companies in the entertainment software industry. Historical stock
prices would not be indicative of their future prices, since the Company itself is so
different from what it was historically. SFAS 123(R) requires the use of expected
volatility in the calculation of the compensation expense of a stock option. While it
allows the use of historical volatility in calculating expected volatility, it does not
require the use of historical volatility and encourages the use of other factors. The
expected term of stock options granted is based on historical data and represents the
period of time that stock options are expected to be outstanding. The risk-free rate of the
stock options is based on the United States Treasury rate in effect at the time of
grant.
|
2008
|
2007
|
Weighted average grant-date fair value of options
granted
|
$.63
|
$.71
|
Assumptions:
|
|
|
Risk free interest rate
|
1.71-5.08%
|
4.65-4.82%
|
Expected life
|
3-4 years
|
2-5 years
|
Expected volatility
|
40-42%
|
48-111%
|
Expected dividend yield
|
0%
|
0%
|
|
|
Share Options
Outstanding
|
|
Weighted Average
Exercise
|
|
Outstanding, beginning of year
|
|
1,510,000
|
|
1.72
|
|
Granted
|
|
885,000
|
|
1.87
|
|
Exercised
|
|
(122,500)
|
|
1.39
|
|
Terminated
|
|
(21,666)
|
|
1.69
|
|
Forfeited
|
|
(20,000)
|
|
.16
|
|
Outstanding March 31, 2008
|
|
2,230,834
|
|
1.81
|
|
NOTE 4.
|
SOFTWARE DEVELOPMENT COSTS
|
As of
March 31, 2008 and June 30, 2007, net capitalized software development costs totaled
$7,832,701 and $5,183,033, respectively. Total costs capitalized during the nine and three
months ended March 31, 2008 were $5,477,619 and $2,397,696, respectively. Accumulated
amortization at March 31, 2008 and June 30, 2007 totaled $3,114,740 and $341,260,
respectively. Capitalized software development costs are amortized over a five-year period
based on weighted average expected sales from the date the title is launched.
9
NOTE 5.
|
INTANGIBLE ASSETS
|
The components of amortizable intangible assets as of March 31, 2008 and
June 30, 2007 are as follows:
|
Estimated
Useful
Life
|
Gross Carrying
Amount
|
Accumulated
Amortization
|
Total
|
Game titles – Strategy First
|
10 years
|
1,693,256
|
472.829
|
1,220,427
|
Game titles – Empire
|
5 years
|
23,195,112
|
8,826,586
|
14,368,526
|
Balance on March 31, 2008
|
|
$24,888,368
|
($9,299,415)
|
$15,588,953
|
|
|
|
|
|
|
Estimated
Useful
Life
|
Gross Carrying
Amount
|
Accumulated
Amortization
|
Total
|
Game titles – Strategy First
|
10 years
|
1,635,552
|
(334,032)
|
1,301,520
|
Game titles – Empire
|
5 years
|
23,437,099
|
(4,127,430)
|
19,309,669
|
Balance on June 30, 2007
|
|
$25,072,651
|
($4,461,462)
|
$20,611,189
|
Intangible assets that are subject to amortization are reviewed for
potential impairment whenever events or circumstances indicate that carrying amounts may
not be recoverable. Assets not subject to amortization are tested for impairment at least
annually.
Game
titles acquired as part of the acquisition of Strategy First are amortized using the
straight-line method over a ten-year period. The game titles of Empire are amortized over a
five-year period based on weighted average expected sales from the date the title is
launched. For titles that have not been launched as of March 31, 2008 a launch date was
estimated to project future amortization. No launch date was estimated for game titles with
a cost basis of $ 8,233,927 at March 31, 2008. The Company is evaluating whether the future
development costs for new versions of these titles warrant the expenditure. In the event
that these titles are not developed into new products these franchises may be sold or
discontinued. The Company has received an indication of interest for the sale of the
largest of these titles which approximates its carrying cost. However, in the event that
these titles are discontinued or their sales price is below their current cost basis the
Company may be forced to reduce the carrying costs of these assets. If the Company decides
to sell these assets the titles will be reclassified on the balance sheet as a current
asset in accordance with SFAS 144.
Amortization expense for intangible assets for the three and nine month
periods ended March 31, 2008 were $1,054,426 and $5,488,688, respectively. Amortization
expense for intangible assets for the three and nine month periods ended March 31, 2007
were $1,929,917 and $2,603,105 respectively. Estimated amortization expense for the rest of
fiscal 2008 and for the succeeding five fiscal years is as follows:
2008
|
$1.077,023
|
2009
|
2,946,287
|
2010
|
1,529,150
|
2011
|
838,694
|
2012
|
419,268
|
2013
|
208,801
|
Thereafter
|
335,733
|
Other
|
8,233,997
|
|
$15,558,953
|
|
|
Nine Months Ended March 31,
|
|
Changes in operating assets and liabilities consist of the
following:
|
|
2008
|
|
2007
|
|
Decrease in accounts receivable
|
|
|
$4,755,500
|
|
|
$412,338
|
|
Decrease in inventories
|
|
|
93,050
|
|
|
217,043
|
|
10
(Increase) decrease in prepaid expenses and current
assets
|
|
|
239,537
|
|
|
(202,085)
|
|
Software development costs capitalized
|
|
|
(5,477,619)
|
|
|
(2,575,675)
|
|
Increase (decrease) in accounts payable
|
|
|
(3,474,507)
|
|
|
1,097,961
|
|
Decrease in refundable deposits
|
|
|
(630,403)
|
|
|
-
|
|
Increase (decrease) in accrued expenses
|
|
|
(2,472,202)
|
|
|
931,412
|
|
|
|
|
($6,966,640)
|
|
|
($119,006)
|
|
Non-cash investing and financing activities were as
follows:
Issuance of shares of common stock for debt
repayment
|
|
|
$3,600,000
|
|
|
-
|
|
Beneficial conversion feature of convertible debt
|
|
|
$621,480
|
|
|
-
|
|
Fair value of warrants for convertible debt
|
|
|
$996,480
|
|
|
-
|
|
Issuance of shares of common stock for payment of
acquisition expenses
|
|
|
-
|
|
|
$723,000
|
|
Issuance of notes payable to former Empire
shareholders
|
|
|
-
|
|
|
$5,208,052
|
|
Con Issuance of earn out notes payable –
acquisition
|
|
|
-
|
|
|
$12,051,061
|
|
Empire Interactive
On
December 4, 2006, the Company announced that it had achieved more than 90% acceptance of
its offer to acquire the shares of Empire. Based on these acceptances, the Company
announced a formal closing of the offer to Empire shareholders and took control effective
December 1, 2006.
The
offer provided for either a cash payment of approximately $.13 per share (£.07 p), or
an earn-out alternative, where the initial payment was approximately $.09 per share
(£.049 p), with a further $.094 per share (£.05 p) in loan notes payable in
October 2007. Additionally, there is an earn-out payable in April 2008. The earn-out was
based on a formula of Empire’s EBITDA (as defined) for the fiscal year ended June 30,
2007. The earn out has been calculated and the Company’s March 31, 2008 balance sheet
includes a liability of approximately $3.95 million (£1.98 million) based on the
March 31, 2008 foreign exchange rate of $1.9951 US dollars to the British pound.
The
aggregate purchase price for Empire’s stock was approximately $17.98 million
(£9.22 million) (after adjusting for the actual earn out payable) based on the
December 1, 2006 foreign exchange rate of 1.9508 US dollar to the UK pound of which amount
approximately $5.2 million are loan notes which matured October 31, 2007 (of which all but
$3 thousand had been repaid as of March 31, 2008) and $3.8 million are loan notes payable
in April 2008 (of which $.00 had been repaid as of March 31, 2007). $.7 million of the
acquisition expenses were paid by the issuance of 406,180 shares of Silverstar’s
Class A common stock. Of this amount 350,000 shares were issued to a consultant to the
Company as a finder’s fee for the transaction pursuant to his consulting contract.
The consultant was subsequently appointed Chairman of the Board of Empire. Of the remaining
$8.3 million of the purchase price approximately $7.9 million has been paid by utilizing
the Company’s internal cash resources. The remaining $.4 million has been accrued as
a short-term liability.
The
purchase price was allocated on the basis of the estimated fair values of the assets
acquired and liabilities assumed.
11
The fair value of the assets acquired and liabilities assumed
exceeded the purchase price and, therefore, the excess was allocated as a pro-rata
reduction of non-current assets, specifically intangible assets. The acquisition was
accounted for as a purchase. The intangible assets identified in connection with the
acquisition were recorded and are being amortized in accordance with the provisions of SFAS
No. 141 and 142. Details of the purchase price are as follows:
Net assets acquired:
|
|
|
|
|
Current assets
|
|
|
$3,226,228
|
|
Fixed assets
|
|
|
898,804
|
|
Intangible assets
|
|
|
23,238,073
|
|
Other assets
|
|
|
608,650
|
|
Total assets
|
|
|
27,971,755
|
|
Total liabilities
|
|
|
(9,987,976
|
)
|
Purchase price
|
|
|
$17,983,779
|
|
The
following unaudited proforma summary presents consolidated financial information as if the
acquisition of Empire had occurred effective July 1, 2006. The proforma information does
not necessarily reflect the actual results that would have occurred, nor is it necessarily
indicative of future results of operations of the consolidated entities.
|
|
Nine Months Ended
March 31, 2007
|
Net revenues
|
|
$18,276,963
|
|
Net loss
|
|
($6,746,019
|
)
|
Loss per share:
|
|
|
|
Basic and diluted
|
|
($.71
|
)
|
Lines of Credit
In June
2002, the Company obtained a secured line of credit facility for borrowings up to $1.0
million, which is fully secured by cash balances held in the Company’s account. This
liability is due on demand and has a floating interest rate that is based on the prime rate
minus 1.75%. On March 31, 2008, the prime rate was 5.25%. The balance outstanding under
this line of credit at March 31, 2008 and June 30, 2007 was $756,370 and $590,990
respectively.
Empire
has a line of credit secured by its receivables, inventory, and intangible assets. As of
March 31, 2008 and June 30, 2007 the amount outstanding under this facility was $1,446,922
(£725,238) and $2,284,482 (£1,140,018), respectively. The line of credit
accrues interest at an annual rate of 8.25%.
Notes Payable
On
March 31, 2008 the Company owed $2,665 in notes payable to former shareholders of Empire
pursuant to the offer made for the acquisition of Empire. The Company owed $5,475,179 on
these notes at June 30, 2007. This amount included accrued interest at 4% per annum and was
payable on October 31, 2007. All note holders who have tendered their notes have been paid
in full.
The
Company owed $3,953,887 as of March 31, 2008 as earn out consideration based on
Empire’s EBITDA for the fiscal year ended June 30, 2007 and is payable on April 30,
2008. The balance on these notes at June 30, 2007 was $3,847,426. Interest accrued at 4%
per annum beginning November 1, 2007.
The
Company paid off approximately $2,800,000 of this debt in April 2008.
12
NOTE 9.
|
CONVERTIBLE SECURED DEBENTURES
|
On
October 31, 2005, the Company issued to DKR SoundShore Oasis Holding Fund Ltd. (the
“Purchaser”) a $5,000,000 principal amount Variable Rate Secured Convertible
Debenture due October 31, 2008 (the “2005 Debenture”) and a five year warrant
to purchase 791,139 shares of the Company’s common stock at an exercise price of
$1.896 per share (the “Warrant”).
In May
2006, the Company repaid $1,400,000 of the outstanding principal balance along with an
early payment penalty of approximately $210,000. During the nine months ended March 31,
2007, the Purchaser converted the remaining $3,600,000 outstanding principal amount of the
2005 Debenture for 2,164,899 shares of Class A common stock. The Company paid monthly
interest on the outstanding principal amount of the 2006 Debenture at a rate per annum
equal to the prime rate for the applicable interest period plus 1.5%.
On
October 19, 2006, the Company issued to the Purchaser another Variable Rate Secured
Convertible Debenture in the principal amount of $1,400,000 due October 31, 2008 (the
“2006 Debenture”). The 2006 Debenture is convertible at the option of the
Purchaser, into shares of common stock at a conversion price of $1.738 per
share.
The
Company pays monthly interest on the outstanding principal amount of the 2006 Debenture at
a rate per annum equal to the prime rate for the applicable interest period plus 1.5%. The
interest rate for any interest period decreases by 2% to the extent that the volume
weighted average trading price of the common stock for the five consecutive trading days
immediately prior to such interest period (the “Trigger Price”) exceeds the
conversion price by 25% (and shall be decreased by an additional 2% for every successive
25% that the Trigger Price exceeds the then applicable conversion price but in no event
shall the interest rate be less than 0%). All overdue accrued and unpaid interest to be
paid under the 2006 Debenture shall entail a late fee at a rate of 18% per
annum.
The
Purchaser and the Company amended the terms of the 2006 Debenture in June 2007. Under the
terms of the amendment (i) the maturity date of the 2005 Debenture was extended to April
30, 2010; (ii) there will be no amortization of principal under the Debenture; and (iii)
the Debenture will be mandatorily convertible if the closing sale price of the
Company’s common stock equals or exceeds $3.48 per share. This mandatory conversion
is subject to volume requirements.
The
Company’s obligations under the 2006 Debenture are secured by a lien on certain
assets of the Company in favor of the Purchaser, and guaranteed by certain subsidiaries of
the Company. In addition, the obligations of the Company under the 2006 Debenture are
personally guaranteed by Mr. George Karfunkel. Mr. Karfunkel is compensated in
the amount of 5% of the current principal outstanding amount of the 2006 Debenture per
annum.
As
consideration for entering into the amendment, the Company reduced the exercise price of
the Warrant $.10 to $1.7986 per share. The fair value for the reduction in the exercise
price of the Warrant was estimated at the grant date using the Black-Scholes option pricing
model using the following weighted average assumptions: risk-free interest rate of 4.37%,
dividend yields of 0% and a volatility factor of the expected market price of the
Company’s common stock of 106.66%. Based upon the closing price per share of the
Company’s common stock on the date of issuance, the Company estimated the fair value
of the exercise price reduction and allocated $10,490 of the proceeds from the 2005
Debenture to the 2005 Warrant, which is presented as a discount on the 2005 Debenture, net
of amortization to be taken over term of the 2005 Debenture using the effective interest
method. As a result of the June 2007 debt modification the remaining fair values of the
Warrant is being amortized on a straight line method through April 30, 2010.
On March 19, 2008, the Company issued to accredited investors 9% Secured
Convertible Debentures in the aggregate principal amount of $7,500,000 due March 19, 2012
and warrants to purchase an aggregate of 3,124,999 shares of the Company's common stock,
par value $.01 per share at an exercise price of $1.50 per share. The term of the warrants
is five years.
13
The Debentures are convertible at any time, at the option of
the purchasers, into shares of Common Stock at a conversion price of $1.2026 per share.
However, if after the date that a registration statement covering the resale of the shares
issuable upon conversion of the Debentures is effective, the average daily volume weighted
average price of the Common Stock for 30 consecutive trading days exceeds $2.40, the
Company may require the purchasers to convert all or part of their outstanding
Debentures.
The
value of the warrants and the conversion feature of the debentures using the using the
Black-Scholes option pricing model using the following weighted average assumptions:
risk-free interest rate of 2.36%, dividend yields of 0% and a volatility factor of the
expected market price of the Company’s common stock of 43.21% which resulted in the
warrants being valued at $996,480 and the conversion feature being valued at $621,480. The
warrants and the conversion feature are both being amortized using the straight line method
over the term of the Debenture.
The
Company’s obligations under the 2008 Debenture are secured by a lien on certain
assets of the Company in favor of the Purchaser, and guaranteed by all the subsidiaries of
the Company (except Empire Interactive PLC and Strategy First Inc.) and the Purchasers, and
guaranteed by certain subsidiaries of the Company. In addition, the obligations of the
Company under the 2008 Debenture are personally guaranteed by Mr. George Karfunkel.
Mr. Karfunkel is compensated in the amount of 6% of the current principal outstanding
amount of the 2008 Debenture per annum.
During
the nine months ending March 31, 2008 the Purchaser converted an aggregate amount of
$3,600,000 of their 2005 Debenture in exchange for 2,164,899 shares of Class A common
stock,
The
balance of the notes as of March 31, 2008 and June 30, 2007, net of unamortized discounts
was as follows:
|
|
|
March 31
|
|
|
June 30,
|
|
|
|
|
2008
|
|
|
2007
|
|
Principal amount of notes
|
|
|
$8,900,000
|
|
|
$5,000,000
|
|
Discounts for beneficial conversion features
|
|
|
(629,737
|
)
|
|
(58,765
|
)
|
Discounts for fair value of warrants and
Options
|
|
|
(1,024,025
|
)
|
|
(150,456
|
)
|
Balance, net of unamortized discounts
|
|
|
$7,246,238
|
|
|
$4,790,779
|
|
Less current portion
|
|
|
—
|
|
|
—
|
|
Long-term portion
|
|
|
$7,246,238
|
|
|
$4,790,779
|
|
Scheduled maturities of the convertible debentures as of March 31, 2008 are
as follows:
1 Year or less
|
|
|
-
|
April 30, 2010
|
|
|
$1,400,000
|
March 19, 2012
|
|
|
7,500,000
|
Total
|
|
|
$8,900,000
|
Interest
expense related to the notes amounted to $115,041 and $36,857 during the nine and three
months ended March 31, 2008, respectively.
Amortization of discounts for the beneficial conversion features and
warrants resulted in charges to Amortization of Convertible Debt Discounts and Issuance
Costs totaling $173,418 and $17,110 during the nine and three months ended March 31, 2008
respectively The Company also incurred loan costs of $2,205,144 directly related to
securing these notes, which includes $1,020,000 paid for personal guarantees on the
outstanding balances. The annual guarantees are equal to 5% of the outstanding loan balance
on the Convertible debt that was modified in June of 2007 and 6% of the March 19, 2008
debenture. The loan costs were originally amortized over the term of the notes. As a result
of the June 2007 debt modification the remaining loan issuance costs are being amortized on
a straight line method through April 30, 2010. Loan costs incurred in connection with the
March 19, 2008 debenture are being amortized on a straight line method through March 19,
2012.The annual guarantee fees are amortized over twelve months. Amortization expenses for
the guarantee and debt issuance costs totaled $444,571 and $45,963 for the nine and three
months ended March 31, 2008 respectively.
14
NOTE 10.
|
COMMITMENTS, CONTINGENCIES AND LEGAL
MATTERS
|
In
April 2006, the Company’s First South African subsidiary received a letter from the
South African Revenue Service (“SARS”) challenging certain tax treatment of
dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently
SARS issued two tax assessments for approximately $2.9 million. The Company had contended
that its South African tax filings were in full compliance with all applicable laws and had
vigorously defended its position in this regard. The Company had retained an amount of cash
equal to the assessments in South Africa to satisfy any potential liability that may
arise.
In May
2007, the Company through an arbitration procedure with SARS reached an agreement whereby
SARS agreed in principle to drop the larger of its two assessments. The Company conceded
the principle of SARS second assessment. On August 31, 2007, the Company paid approximately
$300,000 to SARS in regard to this assessment. The Company is vigorously disputing a
further amount of R5,394,708 (approximately $658,373 based on the March 31 foreign exchange
of $.12355 US dollars to one South African Rand) and believes it has strong arguments in
this regard based on among other factors, computational errors made by SARS in its
assessment. Based on its payments to SARS, the Company has reduced its estimated liability
to R2,216,286 (approximately $271,685). The Company believes its remaining liability to
SARS is lower than this amount, however, in the event its arguments are unsuccessful, it
may be forced to increase this liability. In April 2008 the Company brought a request
seeking a court order to dismiss SARS’ claims in this regard. A ruling on this
request should be made within the next few months.
In
August 2007, Empire was served with a lawsuit brought by a former distributor in Portugal.
The lawsuit claims that Empire had no right to utilize other distributors in Portugal and
seeks 630,000 euros (approximately $995,400 based on the March 31, 2008 foreign exchange
rate of $1.5800 US dollars to one Euro) in damages. Empire believes this claim has no merit
as its distribution agreements are tailored for individual products only and do not give
blanket distribution rights to outside distributors. Empire intends to vigorously defend
itself.
Commitments and Contingencies
During
the first quarter of fiscal 2006, the Company entered into agreements with two of Strategy
First’s game developers to guarantee certain of their royalty payments. The guarantee
is limited to $100,000. Royalties owed to these developers as of March 31, 2008 are less
than $20,000.
The
Company anticipates that Strategy First will pay the royalties due to its developers when
earned and does not anticipate having to make any payments under these
guarantees.
On
March 29, 2006, Strategy First entered into an agreement to acquire certain intellectual
property rights for $200,000 in cash and the issuance of options to acquire 100,000 shares
of the Company’s common stock at an exercise price of $1.50. The options vest when
net sales, as defined in the purchase agreement, exceed $750,000 and expire on December 31,
2008. The agreement also provides for commissions of twenty-five percent of net sales in
the event they exceed $500,000 through December 31, 2008. As of March 31, 2008 revenues
earned since inception under this agreement totaled approximately $360,000.
15
On
December 4, 2006, the Company announced that it had achieved more than 90% acceptance of
the Company’s offer to acquire the shares of Empire. Based on these acceptances, the
Company announced a formal closing of the offer to Empire shareholders effective December
1, 2006. The Company paid consideration to the shareholders as follows: approximately $6.8
million paid at closing; an additional $5.5 million in loan notes payable on October 31,
2007; and further contingent consideration of $3.9 million based on Empire’s EBIDTA
for the 12 months ended June 30, 2007 and due on April 30, 2008. As of March 31, 2008 all
amounts have been satisfied except for the April 30, 2008 payment of approximately $3.95
million and approximately $3 thousand on the loan notes payable that were due October 31,
2007.
NOTE 11.
|
NEW ACCOUNTING PRONOUNCEMENTS
|
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial
Instruments, an amendment of FASB Statements No. 133 and 140.” This statement permits
fair value remeasurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation, and eliminates a restriction on the
passive derivative instruments that a qualifying special-purpose entity (SPE) may hold. The
statement is effective for fiscal years beginning after September 15, 2006. The Company
does not believe this standard will have a material effect on its financial position or
results of operations.
In
July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” This
Interpretation prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. This Interpretation also provides guidance on de-recognition,
classification, interest and penalties, accounting in interim periods, disclosure, and
transition. The Interpretation is effective for fiscal years beginning after December 15,
2006. The Company has evaluated the potential impact of FIN 48 on its consolidated
financial statements and has not identified any material uncertain tax positions requiring
disclosure under this interpretation.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This
Statement defines fair value, establishes a framework for measuring fair value and expands
disclosure about fair value measurements, and is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within those fiscal
years. The Company is currently evaluating the effect that the adoption of this Statement
will have on its consolidated results of operations and financial condition.
On
February 15, 2007, the FASB issued Statement of Financial Accounting Standards No. 159,
“The Fair Value Option for Financial Assets and Financial Liabilities –
including an Amendment of FASB Statement No. 115” (“FASB 159”). This
standard permits an entity to measure financial instruments and certain other items at the
estimated fair value. Most of the provisions of SFAS No. 159 are elective; however, the
amendment to FASB No. 15, “Accounting for Certain Investments in Debt and Equity
Securities,” applies to all entities that own trading and available-for-sale
securities. The fair value option created by SFAS 159 permits an entity to measure eligible
items at fair value as of specified election dates. The fair value option (a) may generally
be applied instrument by instrument, (b) is irrevocable unless a new election date occurs,
and (c) must be applied to the entire instrument and not to only a portion of the
instrument. SFAS 159 is effective as of the beginning of the first fiscal year that begins
after November 15, 2007. Early adoption is permitted as of the beginning of the previous
fiscal year provided that the entity (i) makes that choice in the first 120 days of that
year, (ii) has not yet issued financial statements for any interim period of such year, and
(iii) elects to apply the provisions of FASB 157. The Company is currently evaluating the
impact of SFAS 159, if any, on its consolidated financial statements.
In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations, or SFAS 141(R).
SFAS 141(R) establishes principles and requirements for how the acquirer of a business
recognizes and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any non-controlling interest in the acquiree. SFAS 141(R) also
provides guidance for recognizing and measuring the goodwill acquired in the business
combination and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business combination. The
provisions of SFAS 141(R) are effective for financial statements issued for fiscal years
beginning after December 15, 2008. We are currently assessing the financial impact of
SFAS 141(R) on our consolidated financial statements.
16
In
December 2007, the FASB issued SFAS 160, Non-controlling Interests in Consolidated
Financial Statements — An Amendment of ARB No. 51, or SFAS 160. SFAS 160 amends
Accounting Research Bulletin No. 51, “Consolidated Financial Statements,”
or ARB 51, to establish accounting and reporting standards for the non-controlling interest
in a subsidiary and for the deconsolidation of a subsidiary. This statement also amends
certain of ARB 51’s consolidation procedures for consistency with the requirements of
SFAS 141(R). In addition, SFAS 160 also includes expanded disclosure requirements regarding
the interests of the parent and its non-controlling interest. The provisions of SFAS 160
are effective for fiscal years beginning March 1, 2009. Earlier adoption is
prohibited. We are currently assessing the financial impact of SFAS 160 on our consolidated
financial statements.
In March
2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging
Activities—an amendment of FASB Statement No. 133. SFAS 161 amends SFAS 133 and
changes the disclosure requirements for derivative instruments and hedging activities.
Entities are required to provide enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity’s financial position, financial
performance, and cash flows. The Statement is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early application
encouraged. We are currently assessing the financial impact of SFAS 161 on our consolidated
statements
NOTE 12.
|
PRIVATE PLACEMENT
|
Pursuant to a purchase agreement, dated July 2, 2007, by and among the
Company and certain accredited investors, the Company sold an aggregate of 6,206,891 shares
(the “Shares”) of its common stock and warrants (the “Warrants”) to
purchase up to 4,344,826 shares of its common stock at an exercise price of $2.10 per
share, at a price per unit of $1.45.
The sale
an issuance of the Shares and Warrants was structured to close in two closings. The first
closing was completed on July 5, 2007, pursuant to which the Company sold and issued an
aggregate of 2,057,495 Shares and Warrants to purchase up to an aggregate of 1,440,234
shares of its common stock. The second closing was completed on September 6, 2007, pursuant
to which the Company sold and issued an aggregate of 4,149,396 shares of its common stock
and Warrants to purchase up to 2,904,592 shares of its common stock at the second closing.
Net proceeds received from the sale of the Shares and Warrants under this agreement totaled
$7,915,264 which consisted of gross proceeds from the sale of stock and warrants of
$8,995,995 less issuance costs of $1,089,726.
NOTE 13.
|
SALE OF REAL PROPERTY
|
Empire
Interactive (Europe), Ltd. owned a freehold commercial business premises at Unit 2, Kings
Meadow, Olney Mead, Oxford OX2 0ES. The premises occupy 3,514 square feet and were vacant
since November 2006. The sale of this property was finalized on November 30, 2007. The
property was recorded on the balance sheet as a current asset at June 30, 2007 in
accordance with SFAS 144. Net proceeds from the sale of this property were $646,973 and the
gain recognized totaled $93,918.
NOTE 14.
|
SUBSEQUENT EVENTS
|
On April
14, 2008 stock options valued at $335,236 were granted to former Empire shareholders in
consideration for their reduction of the value of their earn out notes payable. These
options vest immediately and expire on December 31, 2010. The details of the options
granted are as follows:
17
Weighted average grant-date fair value of options
granted
|
$.84
|
Assumptions:
|
|
Risk free interest rate
|
1.88%
|
Expected life
|
2.71 years
|
Expected volatility
|
39.91%
|
Subsequent
to March 31, 2008, Empire signed a letter of intent to establish a lease for new office
space in London. The Company will be the guarantor on the lease. The term planned will be
five years (with a five-year option) with the rent expected to range from $261,000 to
$285,000 annually. Once the lease is executed, Empire plans to move within four months and
will then vacate their present space.
18
ITEM 2
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
|
The
following discussion should be read in conjunction with the Company’s condensed
consolidated financial statements and the related notes included therein and the
Company’s Annual Report on Form 10-K for the year ended June 30, 2007.
This
Management’s Discussion and Analysis of Financial Condition and Results of Operations
include forward-looking statements. We have based these forward-looking statements on our
current plans, expectations and beliefs about future events. Actual results could differ
materially because of factors discussed in “Risk Factors” in Part I,
Item 1A of our Annual Report on Form 10-K for the year ended June 30, 2007.
Background and History
We were
incorporated in September 1995. Our business plan is to actively manage and grow our
presence in the interactive software entertainment industry both organically and through
acquisitions.
We sold
our last remaining South African operations in November 2000 although we still have
significant assets that are denominated in South African Rand. The assets include cash and
notes receivables. Currently we do not have a financial hedging program to protect against
the depreciation of the South African Rand against the US dollar and, therefore, as long as
we hold assets denominated in South African Rand we will continue to record income
statement gains or losses to the extent that the South African Rand’s value
fluctuates relative to the US dollar.
On
April 21, 2005, we acquired Strategy First, a leading worldwide publisher of entertainment
software for the PC. We acquired Strategy First through the jurisdiction of the Montreal
bankruptcy court. Pursuant to the approved plan of arrangement, we paid (i) cash
consideration to the creditors of Strategy First of $609,000; (ii) issued 377,000 shares of
our common stock; (iii) issued warrants to purchase 200,000 shares of our common stock; and
(iv) assumed approximately $400,000 in existing bank debt, as well as contingent
consideration based on the future profitability of Strategy First.
On
December 4, 2006, we announced that we had achieved more than 90% acceptance of our offer
to acquire the shares of Empire. Based on these acceptances, we announced a formal closing
of the offer to Empire shareholders effective December 1, 2006. We paid consideration to
the shareholders as follows: approximately $6.8 million paid at closing and an additional
$5.5 million in loan notes which were paid in full during this quarter. Additionally,
further contingent consideration of approximately $3.8 million based on Empire’s
EBIDTA for the 12 months ended June 30, 2007 and this is due on April 30, 2008.
19
Quarter Ended March 31, 2008 As Compared to Quarter Ended March 31,
2007
Revenues
Revenues increased $1.258 million to $5.861 million during the third quarter
of fiscal 2008 as compared to $4.603 million in the comparable quarter of the previous
year. This increase was primarily the result of higher unit sales due to increased title
releases during the quarter versus the same period last fiscal year. Empire’s revenue
in the comparable quarter was $3.630 million as compared to $5.565 for this quarter.
Strategy First’s revenue for this quarter was $.295 million versus $.973 million in
the comparable quarter last year. Strategy First generated significant additional online
revenue during the quarter ended March 31, 2007 primarily due to a contractual agreement
with Turner Gametap as well as online offerings. Empire’s revenue is derived
primarily from sales of console games and PC games while Strategy First solely sells PC
games.
Cost
of Sales
The
cost of sales was $2.371 million in the third quarter of fiscal 2008, or 40.4% of total
revenues. For the comparable quarter of the previous year, cost of sales was $1.783 million
or 38.7% of revenues. This increase was primarily the result of a higher proportion of
console game sales which have a lower margin than PC titles. Cost of goods sold consists
primarily of the actual tangible costs of the product along with any labor and overhead
costs.
Development and Royalties
Development and royalty costs decreased $.072 million for the third quarter
of fiscal 2008 over the comparable quarter in the previous year. The decrease primarily
relates to increased sales of Company owned intellectual property in the current quarter as
opposed titles supplied by outside parties. These products have lower royalty rates than
those supplied by third parties.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the third quarter of fiscal
2008 were $3.147 million, or 53.7% of sales, as compared to $2.690 million, or 58.4% of
sales, for the comparable quarter of the previous year. Of this $.458 million variance,
corporate overhead increased $.183 million due to non cash compensation and increased
payroll expenses as we have added management level employees to oversee our significantly
increased business. The balance of the increase of $.274 million was due primarily to
increased sales costs and additional personnel at the Empire subsidiary. Empire’s
SG&A consists mostly of administrative, marketing and sales staff primarily in the
United Kingdom.
Amortization and Depreciation
Amortization of software development costs and intangible assets in the
third quarter of fiscal 2008 increased by $.318 million versus the comparable quarter of
the previous year. Intangible amortization decreased by $.875 million primarily due to
accelerated amortization of intangible assets acquired in the Empire acquisition which
declines over time. $1.247 million of Empire’s software development costs were
amortized in this period as opposed to $.054 million of software development costs in the
comparable period last year. This was due primarily to the fact that the Company began
capitalizing software development costs during this period in 2007 and, therefore, had
minimal amortization expenses at that time. Depreciation expense was $50 thousand for the
third quarter of fiscal 2008 and $62 thousand in the comparable quarter of the previous
year, a decrease of $12 thousand. Empire’s assets comprise primarily of computers and
furniture and fixtures.
20
Foreign Currency Gains (Losses)
Foreign
currency gains or losses are the result of subsidiaries of the Company using different
functional currencies and arise from fluctuations of the subsidiaries base currency against
the US dollar. The functional currency of Empire interactive and Strategy First are the
British pound and the Canadian dollar respectively. Gains (losses) from discontinued South
African operations are the result of fluctuations of the South African Rand against the US
dollar. Foreign currency losses during the third quarter of fiscal 2008 were $.280 million
and consisted of losses of $.370 million related to the remaining assets from the sale of
discontinued South African operations and gains of $.090 million recognized by our
operating subsidiaries. Foreign currency losses during the third quarter of fiscal 2007
were $.088 million and consisted of losses of $.093 million related to the remaining assets
from the sale of discontinued South African operations and gains of $.005 million
recognized by our operating subsidiaries.
Amortization of Convertible Debt Discounts and Issuance
Costs
Amortization of convertible debt discounts and issuance costs were $.063
million in the third quarter of fiscal 2008 as compared with $.173 million during the
comparable quarter in the previous year. These expenses relate to the issuances of our $5
million convertible debenture in October 2005 and the issuance of our $7.5 million
convertible debenture in March 2008. The decrease of $.11 million is due primarily to the
conversion of $3.6 million of debentures into approximately 2,150,000 shares of common
stock during fiscal 2008. Amortization of convertible debt discounts and issuance costs
related to our 2008 $7.5 million convertible debenture began March 19, 2008.
Interest Income
Interest income of $41,000 was recorded for the third quarter of fiscal 2008
as compared to interest income of $90,000 for the comparable quarter of the previous year.
The decrease of $49,000 is primarily the result of the Company’s lower average cash
balances.
Interest Expense
Interest expense of $129,000 was recorded for the third quarter of fiscal
2008 as compared to $254,000 in the comparable quarter of the previous year. Interest
expense decreased primarily as the result of lower interest charges on the convertible
debenture security due to lower principal amounts outstanding.
Provision for Income Taxes
We are
registered in Bermuda, where no income tax laws are applicable. Three of our subsidiaries
are subject to US income taxes, three subsidiaries are subject to United Kingdom income
taxes, one subsidiary is subject to Canadian income taxes and one is subject to South
African income taxes. None of them has had significant taxable income and overall the
Company has incurred losses for tax purposes. The deferred tax asset generated by the tax
losses and temporary differences has been fully reserved with the exception of
approximately $622,000 carried as a long-term asset that will be offset against future
taxable earnings of Empire in the UK.
In
April 2006, our First South African subsidiary received a letter from the South African
Revenue Service (“SARS”) challenging certain tax treatment of dividends and
operating loss carry forwards for the years 2002 through 2004. Subsequently SARS issued two
tax assessments for approximately $2.9 million. The Company had contended that its South
African tax filings were in full compliance with all applicable laws and had vigorously
defended its position in this regard. The Company had retained an amount of cash equal to
the assessments in South Africa to satisfy any potential liability that may
arise.
In May,
2007, the Company through an arbitration procedure with SARS reached an agreement whereby
SARS agreed in principle to drop the larger of its two assessments. The Company conceded
the principle of SARS second assessment. On August 31, 2007, the Company paid approximately
$300,000 to SARS in regard to this assessment. The Company is vigorously disputing a
further amount of approximately $770,000 and believes it has strong arguments in this
regard based on among other factors, computational errors made by SARS in its assessment.
Based on its payments to SARS, the Company has reduced its estimated liability to
approximately $271,000. The Company believes its remaining liability to SARS is lower than
this amount, however, in the event its arguments are unsuccessful, it may be forced to
increase this liability. In April 2008 the Company brought a request seeking a court order
to dismiss SARS’ claims in this regard. A ruling on this request should be made
within the next few months.
21
Net
Loss
We have
recognized a net loss of $2.767 million during third quarter of fiscal 2008 compared to a
net loss of $2.751 million during the comparable quarter in the previous year. During the
quarter ended March 31, 2007 the Company capitalized $.690 million of software development
costs previously expensed. This had the effect of reducing the loss for the March 2007
quarter by $.690 million. The major component of this operating loss was amortization of
acquired intangibles and software development costs of $4.394 million. For the quarter
ended March 31, 2008, there was non-cash stock compensation of $.112 million as well as
common shares issued for services of $.021 million. Operating EBITDA Income was $.148
million and $.090 million for the quarters ended March 31, 2008 and March 31, 2007,
respectively.
|
Quarters Ended March 31,
|
|
|
2008
|
|
2007
|
|
Operating EBITDA reconciliation:
|
|
|
|
|
Operating loss
|
($2,335,435)
|
|
($2,315,205
|
)
|
Depreciation
|
50,238
|
|
62,458
|
|
Amortization of intangibles
|
1,054,426
|
|
1,919,917
|
|
Amortization of software development costs
|
1,246,772
|
|
53,617
|
|
Stock -based compensation
|
111,861
|
|
119,239
|
|
Shares issued for services
|
20,676
|
|
250.000
|
|
Operating EBITDA
|
$148,538
|
|
$90,026
|
|
Operating EBITDA per share
|
$.01
|
|
$.01
|
|
Weighted average number of shares outstanding
|
19.806,117
|
|
10,119,824
|
|
See
Note 4 to the financial statements for the amount of software development costs capitalized
during the period.
22
Nine
Months Ended March 31, 2008 As Compared to Nine Months Ended March 31, 2007
Revenues
Revenues increased $12.694 million to $20.537 million during the first nine
months of fiscal 2008 as compared to $7.843 million in the comparable nine months of the
previous year. This increase was primarily the result of the increased revenue of Empire
Interactive PLC. Fiscal 2008 year to date revenues include the operations of Empire for
nine months versus four month of operations in the comparable period of the prior fiscal
year. Empire’s revenue’s increased $13.481 million from $5.670 million during
the four month period in fiscal year 2007 to $19.151 million for the nine months ended
March 31, 2008. Empire’s revenue is derived primarily from sales of console games and
PC games while Strategy First solely sells PC games.
Cost
of Sales
Cost of
sales was $8.187 million for the first nine months of fiscal 2008, or 39.8% of total
revenues. For the comparable nine months of the previous year, cost of sales was $3.154
million or 40.2% of revenues. Of this increase Empire accounted for $5,127 million for the
nine months and Strategy First had decreased cost of sales during the same period of $.094
million due to decreased sales. Cost of goods sold consists primarily of the actual
tangible costs of the product along with any labor and overhead costs.
Development and Royalties
Development and royalty costs decreased $113,000 for the first nine months
of fiscal 2008 over the comparable period in the previous year. Development and royalty
costs for Strategy First decreased approximately $221,000 from $447,000 during the nine
months ended March 31, 2007 to $226,000 during the same period in the current fiscal year.
Empire’s development and royalty costs increased approximately $107,000 during the
nine months ended March 31, 2008 as compared to the four months of activity that was
included in the same period of the prior fiscal year. Development costs and royalties when
measured as percentage of sales decreased to 5.8% from 17.8% in the comparable period of
the prior fiscal year. The decrease in the percentage of development and royalty costs for
both Strategy First and Empire was primarily caused by variances in the royalty percentages
due to outside parties and changes in the product mix. The development and royalty expense
consists primarily of royalty expenses due to third party holders of intellectual property
rights. Additionally it includes certain development costs which are not capitalized. These
costs are primarily related to the oversight and quality control of development projects.
These costs are primarily reflected in the Company’s payroll expenses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the first nine months of
fiscal 2008 were $10.300 million, or 50.2% of sales, as compared to $4.755 million, or
60.6% of sales, for the comparable period of the previous year. Of this variance $5.063
million was due to the inclusion of Empire for nine months versus four months in the
comparable period last year. Empire’s SG&A consists mostly of administrative,
marketing and sales staff primarily in the United Kingdom. Corporate overhead expenses
increased $.697 million primarily as the result of increased non-cash compensation, and
increased payroll expenses as we have added management level employees to oversee our
significantly increased business.
Amortization and Depreciation
Amortization of software development costs and intangible assets in the
first nine months quarter of fiscal 2008 increased $5.627 million over the comparable
period of the previous year due to the inclusion of $5.489 million of amortization of
intangible assets acquired in the Empire acquisition and $2.795 million of Empire’s
software development costs amortized in this period as opposed to $2.603 million of
amortization of intangibles and $.054 million amortization of software development costs in
the comparable period last year. The acquisition of Empire was completed in December of
2006 therefore in
23
the
comparable period there was only 4 months of intangible amortization as opposed to nine
months of amortization in this period. Additionally, due to a change in accounting for
software development costs in the third quarter of last year there was comparatively little
amortization in the comparable prior period versus a full nine months of amortization in
this period. Depreciation expense was $141,000 for the first nine months of fiscal 2008 and
$95,000 in the comparable period of the previous year, an increase of $46,000. This was due
to including depreciation of Empire’s assets for a full nine months versus four
months in the comparable period. Empire’s assets comprise primarily of computers and
furniture and fixtures.
Foreign Currency Gains (Losses)
Foreign
currency gains or losses are the result of subsidiaries of the Company using different
functional currencies and arise from fluctuations of the subsidiaries base currency against
the US dollar. The functional currency of Empire interactive and Strategy First are the
British pound and the Canadian dollar respectively. Gains (losses) from discontinued South
African operations are the result of fluctuations of the South African Rand against the US
dollar. Foreign currency losses during the nine months ended March 31, 2008 were $.0227
million and consisted of losses of $.303 million related to the remaining assets from the
sale of discontinued South African operations and gains of $.06 million recognized by our
operating subsidiaries. Foreign currency gains during the nine months ended March 31, 2007
were $.007, million and consisted of losses of $83,000 related to the remaining assets from
the sale of discontinued South African operations and gains of $90,000 recognized by our
operating subsidiaries.
Amortization of Convertible Debt Discounts and Issuance
Costs
Amortization of convertible debt discounts and issuance costs were $.618
million in the first nine months of fiscal 2008 as compared with $.504 million during the
comparable period in the previous year. These expenses relate to the issuance of our $5
million convertible debenture to DKR SoundShore Oasis in October 2005 and our $7.5 million
convertible debenture with certain accredited investors in March 2008 The increase of $.114
million is due primarily to the accelerated amortization upon the conversion of $3.6
million of debentures into approximately 2,150,000 shares of common stock during the nine
months ending March 31, 2008.
Interest Income
Interest income of $187 thousand was recorded for the first nine months of
fiscal 2008 as compared to interest income of $405 thousand for the comparable nine months
of the previous year. The decrease of $218 thousand is primarily the result of the
Company’s average lower cash balances.
Interest Expense
Interest expense of $.431 million was recorded for the first nine
months of fiscal 2008 as compared to $.615 million in the comparable nine months of the
previous year. Interest expense decreased primarily as the result of lower interest charges
on the 2005 convertible debenture security due to lower average principal amounts
outstanding and lower effective interest rates during the nine months ending March 31,
2008.
Provision for Income Taxes
We are
registered in Bermuda, where no income tax laws are applicable. Two of our subsidiaries are
subject to US income taxes, one subsidiary is subject to Canadian income taxes and one is
subject to South African income taxes. Up to this date, none of them has had taxable income
as they have incurred losses for tax purposes. The deferred tax asset generated by the tax
losses and temporary differences has been fully reserved.
24
In
April 2006, the Company’s First South African subsidiary received a letter from the
South African Revenue Service (“SARS”) challenging certain tax treatment of
dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently
SARS issued two tax assessments for approximately $2.9 million. The Company had contended
that its South African tax filings were in full compliance with all applicable laws and had
vigorously defended its position in this regard. The Company had retained an amount of cash
equal to the assessments in South Africa to satisfy any potential liability that may
arise.
In May
2007, the Company through an arbitration procedure with SARS reached an agreement whereby
SARS agreed in principle to drop the larger of its two assessments. The Company conceded
the principle of SARS second assessment. On August 31, 2007, the Company paid approximately
$300,000 to SARS in regard to this assessment. The Company is vigorously disputing a
further amount of R5,394,708 (approximately $658,373 based on the March 31 foreign exchange
of $.12355 US dollars to one South African Rand) and believes it has strong arguments in
this regard based on among other factors, computational errors made by SARS in its
assessment. Based on its payments to SARS, the Company has reduced its estimated liability
to R2,216,286 (approximately $271,685). The Company believes its remaining liability to
SARS is lower than this amount, however, in the event its arguments are unsuccessful, it
may be forced to increase this liability. In April 2008 the Company brought a request
seeking a court order to dismiss SARS’ claims in this regard. A ruling on this
request should be made within the next few months.
Net
Loss
We have
recognized a net loss of $8.728 million for the nine months ended March 31, 2008 as
compared to a net loss of $4.994 million during the comparable period in the previous year.
The comparable period in the prior year only included Empire’s results of operations
for four months. The major component of this operating loss was amortization of acquired
intangibles and software development costs of $8.284 million. There was non-cash stock
compensation $.346 million as well as common shares issued for services of $.045 million.
Operating EBITDA income (loss) was $1.099 million for the nine months ended March 31, 2008
and ($1.017) million for the nine months ended March 31, 2007.
|
|
Nine Months Ended March 31,
|
|
|
|
2008
|
|
2007
|
|
Operating EBITDA reconciliation:
|
|
|
|
|
|
Operating loss
|
|
($7,717,460)
|
|
($4,273,994)
|
|
Depreciation
|
|
141,065
|
|
95,136
|
|
Amortization of intangibles
|
|
5,488,688
|
|
2,603,105
|
|
Amortization of software development costs
|
|
2,795,404
|
|
53,617
|
|
Stock-based compensation
|
|
346,492
|
|
196,824
|
|
Shares issued for services
|
|
45,067
|
|
308,740
|
|
Operating EBITDA
|
|
$1.099,256
|
|
($1,016,572)
|
|
Operating EBITDA per share
|
|
$.06
|
|
($.11)
|
|
Weighted average number of shares
Outstanding
|
|
17,889,808
|
|
9,566,842
|
|
See Note
4 to the financial statements for the amount of software development costs capitalized
during the period.
Financial Condition, Liquidity and Capital Resources
Cash
increased by approximately $3.715 million from $3.693 million at June 30, 2007 to $7.408
million at March 31, 2008 as a result of securing additional long term financing in March
2008.
25
The
cash balances are being held for repayment of earn out notes, and working capital purposes.
Included in this amount is $.756 million which is classified as restricted cash. This
amount relates to cash used to guarantee a line of credit for our subsidiary, Strategy
First.
Working
capital deficit was $2.048 million at March 31, 2008 compared to a deficit of $12.700
million at June 30, 2007. This improvement of $10.652 million is primarily due to the
result of net proceeds from a private placement sale of common stock of approximately $7.91
million as well as repayment of a portion of notes payable to former Empire shareholders of
approximately 5.4 million. The company also received net proceeds of approximately 6.56
million from the issuance of a $7.50 million debenture in March 2008.
At
March 31, 2008 we had net borrowings of $2.200 million which consisted of advances against
the two lines of credit one secured by the Company’s cash the other secured by
Empire’s receivables, inventory, and intangible assets. Additionally, we have $1.400
million face amount outstanding in our convertible debenture issued to DKR SoundShore
Oasis. The carrying value of this debenture at March 31, 2008 net of unamortized warrants
and stock conversion features is approximately $1.353 million. We currently pay monthly
interest on this amount at a rate of prime plus 1.5%. However, there is an offset of this
interest based on share price. This debenture matures April 30, 2010. During March 2008 the
nominal interest rate was approximately 7%.
During
March, 2008 we issued $7.500 million of debentures with a carrying value of $5.894 million
as of March 31, 2008. We currently pay monthly interest on this amount at a rate of 9%.
These debentures mature on March 19, 2012. We also had seller note obligations of
approximately $3.9 million at March 31, 2008. We paid off approximately $2,800,000 of this
debt in April 2008 and expect to satisfy this obligation in full by June 30,
2008.
Historically, we have met our cash flow requirements through the sale of
debt or equity securities, the sale of assets, or through operating cash flow. However,
there is no guarantee that we will be successful in meeting our cash flow requirements
going forward. We anticipate meeting our cash flow requirements through one or a
combination of the following:
|
•
|
Generate significant short term operating earnings and cash
flow primarily through our Empire subsidiary. Empire’s title release
schedule for the next 12 months includes several multi-platform games most
notably Hello Kitty and PipeMania. We anticipate that the launch of these
games, along with Empire’s ongoing business will generate operating
profits and cash flow in the short term. Empire continues to explore US
distribution agreements with major entertainment publishers which would
provide significant short term cash flow to us.
|
|
•
|
Raise additional capital through the exercise of existing
warrants and the sale of equity or debt securities. The Company currently
has approximately 7.78 million warrants outstanding with exercise prices
ranging from $1.50 to $2.50. The company has a continuing relationship with
an investment banking firm to assist it should it decide to raise
additional capital in the future.
|
|
•
|
Raise additional capital through the sale of certain
intellectual property. The company has had preliminary discussions with a
third party to sell certain of its intellectual property and would
entertain the sale of such intellectual property should the sales price
justify a transaction.
|
|
•
|
The Company has approximately $658,000 of restricted cash
set aside to match our current South African tax assessment. We believe
that we have strong arguments to set aside this assessment. If this
assessment is set aside, this cash would be available for
operations.
|
The
Company believes that these actions and others to be taken by us will improve liquidity and
achieve positive cash flow. However, there can be no assurance that any of these events
will occur.
26
Critical Accounting Policies
The
following is a discussion of the accounting policies that we believe are critical to our
operations:
Revenue Recognition
We
distribute the majority of its products through third-party software distributors to
mass-merchant and major retailers and directly to certain PC software retailers, all of
which have traditionally sold consumer entertainment software products. Additionally, we
may license its products to distributors in exchange for royalty payments. The distribution
of products is governed by purchase orders, distribution agreements or direct sale
agreements, most of which allow for product returns and price markdowns. On a product by
product basis, based on historical data we record a provision from 4% to 30% for product
returns and price markdowns as a reduction of gross sales at the time the product passes to
these distributors or retailers.
The
provision for anticipated product returns and price markdowns is primarily based upon our
analysis of historical product return and price markdown results. Should product
sell-through results at retail store locations fall significantly below anticipated levels
the adequacy of this allowance may be insufficient. We will review the adequacy of our
allowance for product returns and price markdowns and if necessary will make adjustments to
this allowance on a quarterly basis. In the case of royalty income, we will record this
income when earned based on sales reports from our distributors. In many cases, the company
receives guaranteed royalty income and these revenues are recorded upon signing of the
royalty agreements. These amounts are carried as accounts receivable until paid.
Development Costs
Under
SFAS No. 86 software development cost should be capitalized once technical feasibility is
achieved. In the case of Empire this would be when the product is commercially viable
(“commercial feasibility). We have determined to our satisfaction that there is a
clearly defined decision point quite early in development where a product passes from
concept to commercial feasibility. This decision point is either reached with the consent
of outside parties such as Sony or Microsoft or through an internal process where
management decides to move forward with a product’s development once a game concept
has been approved. To date, there has been no material instance where concept approval has
been given and a game has not become a commercial product. We have, therefore, decided to
capitalize software development costs after concept approval.
At
December 31, 2006 we were performing an analysis to determine when technical feasibility is
achieved. December 2006 software development costs of $693,268 were expensed during the
quarter ended December 31, 2006. Upon completion of the analysis, we capitalized these
December 2006 software development costs which resulted in our capitalizing $2,575,675 in
research and development costs during the quarter ended March 31, 2007.
The
table sets forth below the effect on the quarterly earnings for the nine and three months
ending March 31, 2007 had we capitalized our software development costs starting on
December 1, 2006.
|
|
Nine Months
|
Quarter
|
Quarter
|
Quarter
|
|
|
Ended
|
Ended
|
Ended
|
Ended
|
|
|
3/31/2007
|
3/31/2007
|
12/31/2006
|
9/30/2006
|
|
|
|
|
|
|
Net loss as reported
|
|
($4,994,137)
|
($2,751,028)
|
($1,301,671)
|
($941,438)
|
Effect of change in estimate
|
|
3,026
|
(690,242)
|
693,268
|
-
|
Net loss assuming
capitalization
starting December 1, 2006
|
|
($4,991,111)
|
($3,441,270)
|
($608,403)
|
($941,438)
|
Loss per share as reported:
|
|
|
|
|
|
Basic and diluted
|
|
($.52)
|
($.27)
|
($.14)
|
($.10)
|
Loss per share assuming capitalization
starting December 1, 2006:
|
|
|
|
|
Basic and diluted
|
|
($.52)
|
($.34)
|
($.06)
|
($.10)
|
|
|
|
|
|
|
27
Goodwill Valuation
Goodwill
represents the excess of the purchase price over the fair market value of net assets
acquired. The process of determining goodwill requires judgment. Evaluating goodwill for
impairment involves the determination of the fair value of our reporting units. Inherent in
such fair value determinations are certain judgments and estimates, including the
interpretation of current economic indicators and market valuations, and our strategic
plans with regard to our operations. To the extent additional information arises or our
strategies change, it is possible that our conclusion regarding goodwill impairment could
change, which could have a material effect on our financial position and results of
operations. For those reasons, we believe that the accounting estimate related to goodwill
impairment is a critical accounting estimate.
We
review goodwill annually (or more frequently under certain conditions) for impairment in
accordance with SFAS No. 142, goodwill and other intangible assets. We perform our annual
impairment test of goodwill in the fourth quarter of our fiscal year. While we believe that
no impairment existed as of December 31, 2007, there can be no assurances that future
economic or financial developments might not lead to an impairment of goodwill.
I
ntangible Assets
Intangible assets include software game titles. Intangible assets, excluding
goodwill and Empire game titles are stated on the basis of cost and are amortized on a
straight-line basis over estimated lives of three to ten years. Empire game titles are
amortized over a five-year period based on weighted average expected sales from the date
the title is launched. For titles that have not yet been launched as of March 31, 2008 a
launch date was estimated to project future amortization Intangible assets with indefinite
lives are not amortized but are evaluated for impairment annually unless circumstances
dictate otherwise. Management periodically reviews intangible assets for impairment based
on an assessment of undiscounted future cash flows, which are compared to the carrying
value of the intangible assets. Should these cash flows not equal or exceed the carrying
value of the intangible, a discounted cash flow model is used to determine the extent of
any impairment charge required.
Forward-Looking Information
We make
numerous forward-looking statements throughout this report including statements with
respect to our expected income, acquisitions and other growth opportunities, performance of
investments that we have made, and operating expenses. Frequently these statements are
introduced with words such as “expect,” “likely,”
“will,” “believe,” “estimate,” “project,”
“anticipate,” or “predict.” Actual results may differ materially
from those suggested by the forward-looking statements that we make for a number of reasons
including those described in Part II, Item 1A, “Risk Factors” of our report on
Form 10-K for the year ended June 30, 2007.
We
expressly disclaim any obligation to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise, except as required by
law.
28
ITEM
3
QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The
Company does not ordinarily hold market risk sensitive instruments for trading purposes.
The Company does however recognize market risk from interest rate and foreign currency
exchange exposure.
Interest Rate Risk
At
March 31, 2008, our cash resources earned interest at variable rates. Accordingly, our
return on these funds is affected by fluctuations in interest rates. We also have
significant debt that is tied to interest rates and, therefore, any increase in interest
rates will have a negative effect on our interest payments. At March 31, 2008, we had two
convertible notes outstanding amounting to $8,900,000. The interest on $1.4 million of
these convertible notes is based on a floating rate equal to prime plus 1.5%. A
hypothetical 100 basis point change in interest rates would result in an approximately
$14,000 change in annual interest expense.
Approximately $2.2 million of our debt accrues interest at rates that vary
with changes in the US and UK prime rates. We estimate that, at our current level of debt,
for each 1% increase in the average annual prime interest rate, our annual interest expense
would increase by approximately $22,000.
Foreign Currency Risk
Empire
is incorporated in the United Kingdom and sells products throughout Europe, the United
States and Canada. Its functional currency is the British pound. This has exposed the
Company to market risk with respect to fluctuations in the relative value of the Euro,
the Canadian dollar, and the US dollar.
Strategy First is incorporated in Canada and sells products throughout the
United States and Europe. Its functional currency is the Canadian dollar. This has exposed
the company to market risk with respect to fluctuations in the relative value of
the Euro, British Pound, the Canadian dollar, and the US dollar.
Certain
of our cash balances and the remaining proceeds from the sale of its South African
subsidiaries are denominated in South African Rand. This has exposed us to market risk with
respect to fluctuations in the relative value of the South African Rand against the US
dollar.
We
currently do not hedge our South African Rand exposure. At March 31, 2008, we had assets
denominated in South African Rand of R 12. Million ($1.4 million).
29
ITEM 4.
|
CONTROLS AND PROCEDURES
|
At the
end of the period covered by this report, the Company carried out an evaluation, with the
participation of management of the Company, including the Company’s Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and operation of
the Company’s disclosure controls and procedures. Based on the Company’s
evaluation, the Company’s Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures were effective. There
was no change in the Company’s internal control over financial reporting during the
quarter ended March 31, 2008 that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
30
PART
II. OTHER INFORMATION
ITEM 1.
|
LEGAL PROCEEDINGS
|
Other
than as set forth below we are not currently a party to any material legal proceedings. We
may become from time to time involved in legal proceedings in the ordinary course of
business. We may not be successful in defending these or other claims. Regardless of the
outcome, litigation can result in substantial expense and could divert the efforts of our
management.
In
April 2006, the Company’s First South African subsidiary received a letter from the
South African Revenue Service (“SARS”) challenging certain tax treatment of
dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently
SARS issued two tax assessments for approximately $2.9 million. The Company had contended
that its South African tax filings were in full compliance with all applicable laws and had
vigorously defended its position in this regard. The Company had retained an amount of cash
equal to the assessments in South Africa to satisfy any potential liability that may
arise.
In May
2007, the Company through an arbitration procedure with SARS reached an agreement whereby
SARS agreed in principle to drop the larger of its two assessments. The Company conceded
the principle of SARS second assessment. On August 31, 2007, the Company paid approximately
$300,000 to SARS in regard to this assessment. The Company is vigorously disputing a
further amount of R5,394,708 (approximately $658,373 based on the March 31 foreign exchange
of $.1235 US dollars to one South African Rand) and believes it has strong arguments in
this regard based on among other factors, computational errors made by SARS in its
assessment. Based on its payments to SARS, the Company has reduced its estimated liability
to R 2,216,286 (approximately $271,685). The Company believes its remaining liability to
SARS is lower than this amount, however, in the event its arguments are unsuccessful, it
may be forced to increase this liability. In April 2007 the Company brought a request
seeking a court order to dismiss SARS’ claims in this regard. A ruling on this
request should be made within the next few months.
In
January 2006, we brought an action against JoWood Software Productions AG seeking damages
in the amount of approximately $850,000 for expenses incurred in connection with our
unsuccessful acquisition of shares of JoWood. On October 4, 2007 the Vienna Municipal Court
dismissed the Company’s claims against JoWood. The Company has decided not to file an
appeal in this matter.
In
August 2007, Empire was served with a lawsuit brought by a former distributor in Portugal.
The lawsuit claims that Empire had no right to utilize other distributors in Portugal and
seeks 630,000 euros (approximately $995,400 based on the March 31, 2008 foreign exchange
rate of $1.58 US dollars to one Euro) in damages. Empire believes this claim has no merit
as its distribution agreements are tailored for individual products only and do not give
blanket distribution rights to outside distributors. Empire intends to vigorously defend
itself.
There
have been no material changes in the risks facing the Company as described in the
Company’s Form 10-K for the year ended June 30, 200 7 apart from the
following:
We
are subject to significant working capital requirements for the acquisition or development
of new products and there is no assurance that we will have sufficient free working capital
to acquire or develop sufficient products to sustain overall corporate
profitability.
31
Among
the issues that effect our working capital requirements is the fact that we both acquire
third party products for publishing as well as develop our own products for future sale.
The acquisition of third party products usually requires an upfront royalty guarantee as
well as subsequent royalty payments. There is no assurance that we will have sufficient
financial resources to successfully compete with other publishers to acquire third party
titles. Furthermore our developed products are subject to development risks which could
result in delays and additional costs, and we must adapt to changes in software
technologies.
We
depend on third party software developers and our internal development department to
develop new interactive entertainment software within anticipated release schedules and
cost projections. The development cycle for new titles ranges from 12 to 24 months.
Development times and costs of next-generation software have increased substantially as a
result of the additional and enhanced features available in the newest games. After
development of a product, it may take between nine to 12 additional months to develop the
product for other hardware platforms. If developers experience financial difficulties,
additional costs or unanticipated development delays, we will not be able to release titles
according to our schedule and at budgeted costs. There can be no assurance that the
products so developed will be sufficiently successful so that we can recoup these costs or
make a profit on these products.
Additionally, in order to stay competitive, our internal development
department must anticipate and adapt to rapid technological changes affecting software
development. The introduction of the new generation platforms has required the development
of new software to play on such consoles and new technologies to create such software.
Because the new generation consoles have greater complexity and capabilities than the
predecessor platforms, costs are higher to develop games for new generation consoles.
Greater costs can lead to lower operating margins, negatively affecting our
profitability.
We
currently are disputing a tax liability with the South African revenue service and we may
be forced to expense additional amounts in this matter
In April
2006, our subsidiary, First South African Holdings, received a letter from the South
African Revenue Service (“SARS”) challenging certain tax treatment of dividends
and operating loss carry forwards for the years 2002 through 2004. On May 4, 2007, SARS
agreed in principle to drop the larger of its two assessments and on May 25 2007, SARS
formally approved this decision. We conceded the principle of SARS second assessment but
will continue to negotiate the ultimate liability due under this assessment. On August 31,
2007, we paid approximately $300,000 to SARS in regard to this assessment. We are
vigorously disputing a further amount of approximately $770,000 and believe we have strong
arguments in this regard based on among other factors, computational errors made by SARS in
its assessment. Based on its payments to SARS, the Company has reduced its estimated
liability to approximately $270,000. The Company believes its remaining liability to SARS
is lower than this amount, however, in the event its arguments are unsuccessful, it may be
forced to increase this liability
ITEM 2.
|
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
|
None.
ITEM 3.
|
DEFAULTS UPON SENIOR SECURITIES
|
None.
ITEM 4.
|
SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
|
(a)
|
The 2007 Annual Meeting of Stockholders of the Company (the
“Annual Meeting”) was held on
March 27,
2008.
|
|
|
|
|
(b)
|
See item 4 (c)(i) below.
|
|
|
|
|
(c)
|
The following matters were voted on at the Annual
Meeting:
|
32
|
(i)
|
The election of five directors to serve until the next
annual meeting of stockholders and the
election and
qualification of their respective successors:
|
|
Name of Director
|
Votes For Election
|
Authority to Vote Withheld
|
|
Michael Levy
|
11,593,249
|
1,193,854
|
|
Clive Kabatznik
|
11,998,218
|
788,885
|
|
Cornelius Roodt
|
12,044,446
|
742,657
|
|
Edward Roffman
|
12,044,446
|
742,657
|
|
Edward Bernstein
|
12,044,196
|
742,907
|
|
(ii)
|
The ratification of the appointment of Rachlin LLC as
independent accountants of the
Company.
|
|
Votes for: 12,445,136
|
Votes Against:
272,392
|
Abstentions: 69,574
|
|
|
|
|
|
Broker Non-Votes:
196,034
|
|
|
ITEM 5.
|
OTHER INFORMATION
|
None.
33
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 duly authorized.
Date: May
15, 2008
SILVERSTAR HOLDINGS, LTD.
|
|
/s/ Clive Kabatznik
|
Clive Kabatznik
|
Chief Executive Officer
|
|
/s/ Lawrence Litowitz
|
Lawrence Litowitz
|
Chief Financial Officer
|
34
Grafico Azioni Silverstar (NASDAQ:SSTR)
Storico
Da Giu 2024 a Lug 2024
Grafico Azioni Silverstar (NASDAQ:SSTR)
Storico
Da Lug 2023 a Lug 2024