U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002,
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number
0-28690 SHOPNET.COM, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 13-3871821
------------------------------------ ---------------------------------
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
112 West 34th Street, Suite 902, New York, New York 10120
---------------------------------------------------------
(Address of Principal Executive Offices)
(212) 967-8303
----------------------------- ---------------
(Issuer's Telephone Number, Including Area Code)
14 East 60th Street, Suite 402, New York, NY 10022
------------------------- ---------------------------------------------------
(Former Name, Former Address, and Former Fiscal Year,
if Changed Since Last Report)
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares of each of the issuer's classes of common
equity outstanding as of the latest practicable date: Common Stock, par value
$.001 par value: 7,472,224 shares outstanding as of May 20, 2002.
SHOPNET.COM, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page
Number
---------
Item I. FINANCIAL STATEMENTS
Consolidated balance sheets as of March 31, 2002 (Unaudited) and June 30, 2001 3
Consolidated statements of operations and comprehensive income (Unaudited) for the three and nine
months ended March 31, 2002 and March 31, 2001 4
Consolidated statements of stockholders' equity for the nine months ended March 31, 2002
(Unaudited) 5
Consolidated statements of cash flows for the nine months ended March 31, 2002, and March 31,
2001 (Unaudited) 6
Notes to consolidated financial statements (Unaudited) 7
Item 2. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
20
PART II. OTHER INFORMATION 31
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of March 31, 2002 and June 30, 2001
March 31, June 30,
ASSETS 2002 2001
------
----------------- ---------------
(Unaudited) (Audited)
Current assets:
Cash $ 1,458 $ 24,703
Cash-restricted - 969,582
Accounts receivable, net 97,590 77,706
Other receivables - 62,734
Inventory 1,374,066 796,538
Prepaid expenses 258,668 70,762
Advances to officer 41,971 40,000
----------------- ---------------
Total current assets 1,773,753 2,042,025
----------------- ---------------
Property and equipment, net 73,125 72,137
Film production and distribution costs, net 1,204,728 1,204,728
Costs in excess of net assets of business acquired 674,047 727,261
Investments in movie ventures 246,499 246,439
Deferred tax asset-non-current 202,500 202,500
Other assets 25,335 20,635
Marketable securities-affiliate - 6,350
----------------- ---------------
Total assets $4,199,987 $4,522,075
----------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Due to factor $ 864,930 $1,700,337
Accounts payable 686,123 138,218
Accrued expenses 21,131 21,965
Current portion of lease 7,613 17,953
Other taxes payable 847 743
Deferred tax liability 3,606 3,606
----------------- ---------------
Total current liabilities 1,584,250 1,882,822
----------------- ---------------
Capital lease obligations, net of current portion - 3,758
----------------- ---------------
Total liabilities 1,584,250 1,886,580
----------------- ---------------
Commitments and contingencies
Stockholders' equity
Common stock- $.001 par value, 20,000,000 shares authorized, 7,472,244 shares
issued and outstanding 7,472 7,472
Additional paid in capital 6,638,852 6,638,852
Accumulated deficit (4,030,587) (4,017,179)
Accumulated other comprehensive income - 6,350
----------------- ---------------
Total stockholders' equity 2,615,737 2,635,495
----------------- ---------------
Total liabilities and stockholders' equity $4,199,987 $4,552,075
================= ===============
The accompanying notes should be read in conjunction with the consolidated
financial statements
-3-
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Statement of Operations and Comprehensive Income (Loss)
(Unaudited)
Nine Months Ended Three Months Ended
March 31, March 31, March 31, March 31,
2002 2001 2002 2001
----------- ----------- ----------- -------------
Net sales .......................................... $ 6,313,067 $ 5,692,623 $ 4,612,362 $ 3,653,260
Cost of sales ...................................... 3,927,537 3,709,898 2,828,915 2,437,428
----------- ----------- ----------- -------------
Gross profit ....................................... 2,385,530 1,982,725 1,783,447 1,215,832
----------- ----------- ----------- -------------
Expenses:
Selling, general, and administrative ............... 2,007,246 1,967,230 1,028,099 855,166
Amortization of costs in excess of net assets of
business acquired .............................. 53,214 53,214 17,738 17,738
----------- ----------- ----------- -------------
Total expenses ..................................... 2,060,460 2,020,444 1,045,837 872,904
----------- ----------- ----------- -------------
Income (loss) before other income (expenses) and
provision for income taxes ......................... 325,070 (37,719) 737,610 342,928
----------- ----------- ----------- -------------
Other income (expenses):
Equity in earnings (loss) of affiliate ............. (595) (4,837) (532) (547)
Write down of film costs ........................... -- (208,564) -- --
Rental income ...................................... 9,050 18,106 -- 6,935
Interest and financial expense ..................... (357,941) (339,171) (202,022) (156,746)
Interest income .................................... 11,008 59,478 75 15,227
----------- ----------- ----------- -------------
Total other income (expense) ....................... (338,478) (474,988) (202,479) (135,131)
----------- ----------- ----------- -------------
Income (loss) before provision for income taxes
(13,408) (512,707) 535,131 207,797
Provision (benefit) for income taxes ............... -- (16,974) -- --
----------- ----------- ----------- -------------
Net income (loss) .................................. (13,408) (495,733) 535,131 207,797
----------- ----------- ----------- -------------
Other items of comprehensive income (loss) ......... (6,350) (254,000) -- (95,250)
----------- ----------- ----------- -------------
Comprehensive (loss) ............................... $ (19,758) $ (749,733) $ 535,131 $ 112,547
----------- ----------- ----------- -------------
Basic:
Net income loss per share .......................... $ (Nil) $ (.07) $ .07 $ .03
=========== =========== =========== =============
Weighted average number of common shares outstanding
7,472,244 7,472,244 7,472,244 7,472,244
=========== =========== =========== =============
The accompanying notes should be read in conjunction with the consolidated
financial statements
-4-
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For The Nine Months Ended March 31, 2002
(Unaudited)
Accumulated
Additional Other Total
Common Stock Paid-in Accumulated Comprehensive Stockholders'
Shares Amount Capital Deficit Income (loss) equity
----------- ----------- ----------- ----------- ----------- -----------
Balances at June 30, 2001 (Audited) 7,472,244 $ 7,472 $ 6,638,852 $(4,017,179) $ 6,350 $ 2,635,495
Net loss (Unaudited) .............. (13,408) (13,408)
Comprehensive loss ................ -- -- -- -- $ (6,350) (6,350)
----------- ----------- ----------- ----------- ----------- -----------
Balances at March 31, 2002, ....... $ 7,472,244 $ 7,472 $ 6,638,852 $(4,030,587) $ -- $ 2,615,737
=========== =========== =========== =========== =========== ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
-5-
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Statement of Cash Flows
For The Nine Months Ended March 31, 2002 And 2001
(Unaudited)
March 31, March 31,
2002 2001
--------------- ---------------
Cash flows from operating activities:
Net loss ....................................................................... $ (13,408) $ (495,733)
Adjustments to reconcile net income to net cash used in operating activities:
Equity in loss of affiliate ............................................... 595 4,837
Amortization and depreciation ............................................. 73,857 83,491
Decrease (increase) in:
Accounts receivable ....................................................... (19,884) (47,556)
Other receivables ......................................................... 62,734 (9,173)
Inventory ................................................................. (577,528) (1,138,000)
Prepaid expenses .......................................................... (187,906) (8,293)
Advances to officer ....................................................... (1,971) --
Other assets .............................................................. (4,700) (54)
Investment in securities available for sale ............................... -- 266,700
Marketable securities affiliate ........................................... 6,350 (12,700)
Increase (decrease) in:
Due to factor ............................................................. (835,407) 786,162
Accounts payable .......................................................... 547,905 297,523
Accrued expenses .......................................................... (834) 19,809
Other taxes payable ....................................................... 104 955
----------- -----------
Net cash used in operating activities ............................................. (950,093) (252,032)
----------- -----------
Cash flows from investing activities:
Acquisition of property and equipment .......................................... (28,636) (14,570)
----------- -----------
Net cash used in investing activities ............................................. (28,636) (14,570)
----------- -----------
Cash flows from financing activities:
Principal payments on capital leases ............................................ (14,098) (42,062)
Reduction in line of credit ..................................................... -- (213,894)
----------- -----------
Net cash used in financing activities ............................................. (14,098) (255,956)
----------- -----------
Net decrease in cash and restricted cash .......................................... (992,827) (522,558)
Cash and restricted cash, beginning of period ..................................... 994,285 1,642,832
----------- -----------
Cash and restricted cash, end of period ........................................... $ 1,458 $ 1,120,274
=========== ===========
Supplemental disclosure of cash flow information: cash paid during the period for :
Interest .................................................................. $ 282,737 $ 339,171
=========== ===========
Income taxes .............................................................. $ -- $ --
=========== ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
-6-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 1- ORGANIZATION
Shopnet.com, Inc. ("Shopnet" or the "Company") was
incorporated in the State of Delaware on December 1, 1995
under the name of Hollywood Productions, Inc. It was formed
for the purpose of acquiring screenplays and producing motion
pictures. On May 10, 1999, the Company filed an amendment to
its Articles of Incorporation to change its name to
Shopnet.com. Inc. On May 12, 1999, Shopnet incorporated a new
wholly owned subsidiary, Hollywood Productions, Inc.
("Hollywood"), to which the Company assigned all of its film
rights. Accordingly, Shopnet is considered a holding company.
During September 1996, simultaneously with the completion of
its Initial Public Offering ("IPO"), Shopnet acquired all of
the capital stock of Breaking Waves, Inc. ("Breaking Waves").
Breaking Waves designs, manufactures, and distributes private
and brand name labels of children's swimwear nationally. As of
June 30, 2001, Shopnet and all of its subsidiaries changed
their financial year end from December 31 to June 30.
NOTE 2- INTERIM RESULTS AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements
as of March 31, 2002 and for the nine month periods ended
March 31, 2002 and March 31, 2001 and for the three month
periods ended March 31, 2002 and March 31, 2001 have been
prepared in accordance with generally accepted accounting
principles for interim financial information and with the
instructions to Form 10-QSB and Items 303 and 310 of
Regulation S-B. In the opinion of management, the unaudited
financial statements have been prepared on the same basis as
the annual financial statements and reflect all adjustments,
which include only normal recurring adjustments, necessary to
present fairly the financial position as of March 31, 2002 and
the results of operations and cash flows for the nine month
periods ended March 31, 2002 and March 31, 2001 are not
necessarily indicative of the results to be expected for any
subsequent quarter or the entire fiscal year. The balance
sheet at June 30, 2001 has been derived from the audited
financial statements at that date.
Certain information and footnote disclosures normally included
in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted
pursuant to the Securities and Exchange Commission's rules and
regulations. The Company believes, however, that the
disclosures in this report are adequate to make the
information presented not misleading in any material respect.
The accompanying consolidated financial statements should be
read in conjunction with the audited financial statements of
Shopnet.com, Inc. and Subsidiaries as of June 30, 2001 and for
the six month period then ended and notes thereto included in
the Company's report on Form 10-KSB filed on October 15, 2001.
The Company in the quarter ended March 31, 2002 has
implemented a number of initiatives which it believes will
reduce its costs of operations and alleviate in the following
three months its working capital deficiency. In particular,
the Company believes that the repayment of its indebtedness to
Century (See Note 7 (b)) and the recent reductions in interest
rates will reduce interest expense.
-7-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 2- INTERIM RESULTS AND BASIS OF PRESENTATION (continued)
In December 2001, the Company consolidated all of its
operation's in the New York metropolitan region into one new
facility (See Note 9(a) ), creating a savings through
synergies in office expense and decrease in rent and salaries.
The Company has, also, recently refocused its sales efforts,
to the extent possible, to eliminate unprofitable or low
margin sales and has had improved sales and orders for the
current fiscal year.
NOTE 3- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) Recently adopted accounting principles - Film accounting
Pursuant to SFAS no. 139, the Company adopted Statement of
Position ("SOP") 00-2, "Accounting by Producers or
Distributors of Films" during the nine months ended March 31,
2002. SOP 00-2 established new film accounting standards,
including changes in revenue recognition and accounting for
advertising, development and overhead costs. Specifically, SOP
00-2 requires advertising costs for theatrical and television
products to be expensed as incurred. This compares to the
Company's previous policy of first capitalizing these costs
and then expensing them over the related revenue streams. In
addition, SOP 00-2 requires development costs for abandoned
projects and certain indirect overhead costs to be charged to
film costs, which was required under the previous accounting
rules, SOP 00-2 also in other areas, such as revenue
recognition, generally are consistent with the Company's
existing accounting policies. SOP-002 was adopted as of July
1, 2001, and had no effect on the Company's consolidated
results of operations, financial position or cash flows.
b) Recently issued accounting pronouncements
The Company does not believe that any recently issued but not
yet effective accounting standards, have a material effect on
the Company's consolidated financial position, results of
operations or cash flows except for the effect of adoptions of
SFAS No. 142, " Goodwill and Other Intangible assets". It
addresses how intangible assets that are acquired individually
or with a group of other assets (but not those acquired in a
business combination) should be accounted for in financial
statements upon their acquisition. SFAS 142 also addresses how
goodwill and other intangible assets should be accounted for
after they have been initially recognized in the financial
statements.
During June 2001, SFAS No. 141, "Business Combinations" ("SFAS
No. 141") was released. This standard addresses financial
accounting and reporting for business combinations. All
business combinations within the scope of SFAS 141 are to be
accounted for using one method-the purchase method. The
provisions of SFAS 141 apply to all business combinations
initiated after June 30, 2001. Use of the pooling-of-interests
method for those business combinations is prohibited. It also
applies to all business combinations accounted for using the
purchase method for which the date of acquisition is July 1,
2001 or later.
-8-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 4- ACQUISITION OF BREAKING WAVES, INC.
Pursuant to a stock purchase agreement dated May 31, 1996 (the
"Agreement"), on September 24, 1996, the Company issued
110,000 shares of common stock in exchange for all of the
issued and outstanding capital stock of Breaking Waves. The
transaction was accounted for using the purchase method of
accounting. As a result of this transaction, excess of cost
over net assets acquired totaling $1,064,283 was recorded and
is being amortized over the useful lives of the related assets
which is fifteen years. Amortization expense totaled $53,214
for each of the nine months ended March 31, 2002 and 2001.
NOTE 5- INVESTMENTS IN MOVIE VENTURES
a) Battle Studies
Pursuant to a co-production agreement dated April 17, 1998
with North Folk Films, Inc., the Company invested through
March 31, 2002, $218,165 for a 50% interest in a new entity,
Battle Studies Productions, LLC ("Battle Studies") a limited
liability company. Battle Studies will be treated as a joint
venture in order to co-produce motion pictures and to finance
the costs of production and distribution of such motion
pictures. The joint venture retains all rights to the motion
pictures, the screenplays, and all ancillary rights attached
thereto.
b) The Girl
Pursuant to an agreement dated July 1, 1999 with Artistic
License Films Inc., Hollywood invested through March 31, 2002
$35,000 for a 22.533% interest in a new entity, The Girl, LLC
("The Girl") a limited liability company. In return for its
participation in The Girl, Hollywood is entitled to receive a
non-contested, non-dilutable 22.533% ownership interest in The
Girl, a recoupment of its investment on no less favorable
terms than any other investor and 22.533% of 100% of any
contingent compensation which shall be actually received by
The Girl. The Girl retains all rights to the motion pictures,
the screenplays, and all ancillary rights attached thereto.
The Company accounts for the investments in Battle Studies and
The Girl under the equity method. For the nine months ended
March 31, 2002 and 2001, the Company recorded $595 and $0,
respectively, in net equity losses.
NOTE 6- MARKETABLE SECURITIES- AFFILIATE
Breaking Waves owns 1,270,000 unregistered common
shares of Play Co. Toys & Entertainment Corp. ("Play Co."),
a toy retailer and a publicly traded company whose Chairman
of the Board is also the President of Shopnet and Breaking
Waves.
Breaking Waves' ownership percentage is approximately
1.5% of Play Co. The investment in Play Co. is accounted for
under the requirements of SFAS No. 115, "Accounting for
Certain investments in Debt and Equity Securities." Under
SFAS No. 115, the securities are considered available for
sale and therefore the carrying value is based on the fair
market value of the securities at March 31, 2002 and 2001
which amounted to $0 and $337,000, respectively.
-9-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 6- MARKETABLE SECURITIES- AFFILIATE (continued)
The change in the fair market value of the securities during
the periods are recorded as an unrealized gain or loss as a
component of comprehensive income. The Company pledged such
shares as collateral for a standby letter of credit in
connection with Breaking Waves entering into a new factoring
agreement with Century Business Credit Corporation ("Century")
and are therefore considered non-current (See Note 6 (b)).
On March 28, 2001 Play Co. filed for protection under Chapter
Eleven of the United States Code with the United States
Bankruptcy Court for the Southern District of New York. The
filing was converted into a Chapter Seven filing on August 28,
2001.
NOTE 7- DUE TO FACTOR
a) CIT Group
On August 20, 1997, Breaking Waves entered into a factoring
and revolving Inventory loan and security agreement (as
amended December 9,1998) with CIT Group (formerly, Heller
Financial, Inc. "CIT") to sell their interest in all present
and future receivables without recourse. Breaking Waves paid
CIT a factoring commission of .85% of the first $5,000,000 of
receivables sold and .65% of receivables sold in excess of
$5,000,000 for each year.
Breaking Waves took advances of up to 85% of the receivables,
with interest at the rate of 1 3/4% over prime. In connection
with the factoring agreement, the Company agreed to maintain
$1,150,000 of cash in a segregated account in order to
collateralize standby letters of credit. In addition, during
1999, Breaking Waves was required to transfer an additional
$200,000 of cash as collateral for the standby letter of
credit.
On or about September 12, 2000 the agreement with CIT was
cancelled and a new factoring agreement was entered into as
discussed below.
b) Century Business Credit Corporation
On or about September 12, 2000, Breaking Waves entered into a
factoring and revolving inventory loan and security agreement
("factoring agreement") with Century Business Credit
Corporation ("Century") to sell its interest in all present
and future receivables without recourse. Breaking Waves
submits all sales offers to Century for credit approval prior
to shipment, and pays a factoring commission of .75% of
receivables sold. Century retains from the amount payable to
Breaking Waves a reserve for possible obligations such as
customer disputes and possible credit losses on unapproved
receivables. Breaking Waves may take advances of up to 85% of
eligible receivables and up to 50% of the value of finished
goods in inventory, with interest payable monthly at the rate
of 1 3/4% over prime.
-10-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 7- DUE TO FACTOR
b) Century Business Credit Corporation (continued)
Pursuant to the terms of a Reimbursement and Compensation
Agreement, a trust ("Trust"), the beneficiary of which is a
relative of the Company's President and Chief Executive
Officer ("CEO") and a relative of a principal stockholder,
pledged assets as collateral for securing a $250,000 letter of
credit to replace a portion of a letter of credit previously
pledged by the Company. Accordingly, on December 20, 2000 the
original agreement with the factor was amended to allow such
replacement of collateral. Breaking Waves' Loan and Security
Agreement with Century dated December 20, 2000 requires the
provision of one or more letters of credit in the aggregate
amount of $1,150,000 to partially secure the line of credit.
On September 15, 2001, Century required the Company to
increase the amount of collateralized standby letters of
credit by $300,000 raising such amount to $1,450,000.
On May 3, 2001, the Agreement with the Trust was amended so
that the letter of credit secured by the Trust was increased
to $400,000. As a condition of the amendment, the Company
entered into a guarantee agreement with Gal Capital Corp.,
whose President is a relative of the Company's President and
CEO and a principal stockholder of the Company to act as
guarantor of the obligation to the Trust up to $400,000 in
exchange for a fee of $42,500 which the Company paid on May 3,
2001. The amended letter of credit expired on September 1,
2001 and was subsequently amended on September 15, 2001.
On September 15, 2001, the Amended and Restated Reimbursement
and Compensation Agreement was entered into and further
amended the agreement with the Trust, so that the letter of
credit secured by the Trust was increased to $750,000. The
amended letter of credit expires on September 1, 2002 but can
be extended year to year at the Company's option for a period
of ten years. Breaking Waves agreed to reimburse the Trust for
any and all losses, fees, charges and expenses to the Trust in
the event the letter of credit is called by Century and / or
the issuing bank demands reimbursement from the Trust.
Breaking Waves' obligations are guaranteed by the Company in
addition to being secured by a first security interest in all
of the assets of the Company and a subordinate security
interest in all of the assets of Breaking Waves.
On September 15, 2001, the Company entered into a
Reimbursement Agreement with relatives of a principal
stockholder who is related to the President and CEO of the
Company ("RAYA") who pledged assets as collateral for securing
a $300,000 letter of credit as additional collateral to secure
Breaking Waves' Loan and Security Agreement with Century.
Absent any default, the letter of credit will remain in effect
for ten years. The Agreement is guaranteed by Shopnet under a
separate Security Agreement dated September 15, 2001.
-11-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 7- DUE TO FACTOR
b) Century Business Credit Corporation (continued)
In exchange for the letters of credit, the Trust and RAYA will
proportionately, based on the total outstanding letters of
credit, receive a fee of one and one quarter percent (1-1/4%)
of net sales of Breaking Waves through June 30, 2002 and
thereafter one and three quarters percent (1-3/4%) of net
sales through September 30, 2011. In October 2001, the Trust
and RAYA received advance payments to be applied towards
future fees of $24,500 and $12,250, respectively. All future
payments are payable forty five days after the close of each
fiscal quarter. The fees are effective October 1, 2001.
In September 2001, the Company and Breaking Waves retained Arc
Financial Corp. ("ARC"), a British Virgin Island company, for
a ten year term to provide financial consulting services.
Pursuant to the terms of a consulting services. Pursuant to
the terms of a consulting agreement ("ARC Consulting
Agreement"), ARC was retained to assist the Company in the
acquisition of financing to acquire inventory and for other
corporate purposes ("Financing"), as well as consult with the
Company with regard to its ongoing operations, promote sales
of Breaking Waves' products and improving production. Pursuant
to the terms of the ARC Consulting Agreement, the Company and
Breaking Waves agreed to compensate ARC (i) an annual fee of
$20,000 ("Base Fee") and (ii) a percentage of annual net sales
in the amount of 1-1/4% through June 30, 2002 and 1-3/4% of
net sales for each year of the term thereafter through
September 30, 2011 ("ARC Percentage Fee"), payable 45 days
after the closing of each fiscal quarter. In October 2001, ARC
received (i) a lump sum payment of $209,000 reflecting full
advance payment of the Base Fee and (ii) $36,750 reflecting
advance payment of the Arc Percentage Fee. The agreement with
Arc expires September 30, 2011. The Company and Breaking Waves
are entitled to terminate the ARC Consulting Agreement any
time after September 30, 2006, in which event all prepaid fees
are forfeited.
Interest expense related to the factor agreement totaled
$190,908 and $256,510 for the nine months ended March 31, 2002
and 2001, respectively. Century has a secured interest in
Breaking Waves' inventory as collateral for the advances. As
of March 31, 2002, the net advances to Breaking Waves from
Century amounted to $864,930.
During October 2001, Century released the Company from its
requirement of maintaining a minimum cash balance as a result
of the events discussed in Note 7 (b). Upon Century removing
the restriction, the Company paid and reduced the amount due
to Century in October and November 2001 by an aggregate of
$620,000.
-12-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 8- OTHER EVENTS
On January 23, 2002, the Company notified the Nasdaq Stock
Market, Inc. ("Nasdaq") of the withdrawal of its listing from
the SmallCap Market, effective with that date.
The Company previously received notification from Nasdaq in
late November 2001, advising that it did not satisfy the
minimum net tangible assets or equity standards for continued
listing on the Nasdaq SmallCap Market.
The Company explored its options in this regard, and
determined that its resources would best be allocated in areas
that could improve its results of operations. The Company's
common stock and warrants had traded on the Nasdaq SmallCap
Market since September 1996.
Following the delisting from Nasdaq, the Company's securities
began trading on the OTC Bulletin Board.
NOTE 9- COMMITMENTS AND CONTINGENCIES
a) Lease commitments
Shopnet and Breaking Waves have entered into lease agreements
for their administrative offices. Shopnet leased its
administrative office pursuant to a 5-year lease that expired
on November 30, 2001 at annual rent amounting to approximately
$70,000, before annual escalations. Breaking Waves terminated
its lease effective November 30, 2001. A new 6 year lease
expiring September 30, 2007 was signed in July 2001, becoming
effective beginning December 1, 2001.Annual rent under the new
lease is $84,915 through December 31, 2004 and $95,760 for the
remainder of the lease. Lastly, Breaking Waves leases an
offsite office for one of its designers on a month to month
basis with annual payments approximating $11,000. The Company
and Breaking Waves' approximate future minimum rentals under
non-cancelable operating leases in effect on March 31, 2002
are as follows:
2002 $ 85,480
2003 84,915
2004 84,915
2005 90,338
2006 95,760
Thereafter 119,700
--------
$561,108
========
Rent expense for the nine months ended March 31, 2002 and 2001
amounted to $94,508 and $128,130, respectively.
-13-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 9- COMMITMENTS AND CONTINGENCIES (continued)
b) Significant vendors and customers
Breaking Waves purchases 100% of its inventory from two
vendors, one in Indonesia and the other in South Korea.
Breaking Waves believes other sources and vendors are
available and that it is not dependent exclusively on these
vendors.
c) Seasonality
Breaking Waves' business is considered seasonal with a large
portion of its revenues and profits being derived between
November and March. Each year from April through October,
Breaking Waves engages in the process of designing and
manufacturing the following season's swimwear lines, during
which time it incurs the majority of its production costs with
limited revenues and also engages in the sale of product at
negative gross margins to remove slow moving items and
decrease its carrying cost.
d) License agreements
i) On October 16, 1995, Breaking Waves entered into a
license agreement with Beach Patrol, Inc. ("Beach") for the
exclusive use of certain trademarks in the United States.
The agreement covered a term from January 1, 1996 to June
30, 1998 and contained a provision for an additional
three-year extension, at the option of Breaking Waves,
through and until June 30, 2001. Breaking Waves had
exercised this option, thereby so extending the agreement.
The agreement called for minimum annual royalties of $75,000
to $200,000 over the life of the agreement with options
based on sales levels from $1,000,000 for the first year to
$4,000,000 in the sixth year. Breaking Waves has negotiated
an additional two-year extension thereby extending the
agreement through and until June 30, 2003, and it contains a
provision for an additional two-year extension, at the
option of Breaking Waves, through and until June 30, 2005.
The new agreement signed February 28, 2001 and effectively
July 1, 2001 calls for minimum annual royalties of $50,000
to $87,500 over the life of the extension with option based
on sales levels from $1,000,000 for the seventh year to
$1,750,000 in the tenth year. Breaking Waves recorded
royalties under this agreement totaling $30,000 and $138,897
during the nine months ended March 31, 2002 and 2001
respectively.
ii) During June 2000, Breaking Waves entered into a license
agreement with an effective date of November 1, 2000 with
Gottex Models Ltd., as Israeli corporation and Gottex Models
(USA) Corp., a New York corporation for the use of the
trademark "Gottex" in the United States of America for
children's swimwear. The agreement calls for a royalty fee
of 7% of net sales with guaranteed minimum annual royalties
of $70,000 to $140,000 over the life of the agreement.
Breaking Waves recorded royalties under the agreement
totaling $68,430 and $23,746 for the nine months ended March
31, 2002 and 2001, respectively.
-14-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 9- COMMITMENTS AND CONTINGENCIES (continued)
e) Co-production and property purchase agreements
Pursuant to co-production and property purchase agreements
dated March 15, 1996, as amended, the Company acquired the
rights to co-produce a motion picture and to finance the costs
of production and distribution of such motion picture with the
co-production. The Company retains all rights to the motion
picture with the co-producer agreeing to finance $100,000 of
the cost of production. The Company retains all rights to the
motion picture, the screenplay, and all ancillary rights
attached thereto. The motion picture was completed during the
latter part of 1996 and, accordingly, the Company commenced
the marketing and distribution process.
As of March 31, 2002, the Company invested $1,971,956 for the
co-production and distribution of such motion pictures whereas
the co-producers have invested $100,000. For the nine months
ended March 31, 2002 and 2001, the Company derived no revenue
from the motion picture and amortized no film costs.
For the nine months ended March 31, 2002 and 2001 the Company
has written down its film production and distribution costs by
$0 and $50,000, respectively, in order to reduce the asset to
its estimated net realizable value.
f) Litigation-
On or about June of 2000, an action was brought in the Queens
County Supreme Court against the Company and several others
claiming, among other things, that the Company allegedly
breached a contract and engaged in fraudulent statements
(including supposedly promising the plaintiff options and then
not allowing the plaintiff to exercise these options). The
plaintiff seeks, among other things, compensatory damages in
the amount of $497,500, punitive damages in the amount of
$995,000, together with costs and attorney's fees. The
complaint was recently amended. The defendants including the
Company have made a motion to dismiss the complaint. There can
be no assurance that this motion will be granted. The Company
intends to contest the action vigorously and believes that
such claims against it are baseless and without merit.
In or about December 2001, a group of over 275 foreign
plaintiffs commenced an action entitled Abeln v. Arbel, et. al
in the United States District Court for the Southern District
of New York naming the Company, along with over 30 other
entities and individuals as defendants. The Company has not
yet been served with the summons and complaint, and cannot
discern if such service will be effectuated. Thus, the Company
is not yet a party to the suit.
The Complaint purports to state claims, among others, for
securities fraud, RICO, breach of contract, common law fraud
and breach of fiduciary duty allegedly arising out of the
defendants' supposed involvement with the preferred stock of
Europe American Capital Corporation ("EACC"). The complaint is
unclear but it appears that only the RICO and common law fraud
claim are alleged as against the Company.
-15-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 9- COMMITMENTS AND CONTINGENCIES (continued)
f) Litigation (continued)
Among other things, the plaintiffs claim that a large amount
of EACC's funds have been invested in the Company. The
plaintiffs allege that they incurred losses and damages in
excess of $25,000,000. The action seeks an unstated amount of
monetary damages together with punitive damages.
This matter has been delayed by the court because of an
apparent dispute regarding who will represent the plaintiffs.
Should the Company be served, it anticipates seeking Court
approval to make a motion to dismiss the complaint for among
other reasons, failure to state a claim.
In light of the early stage of this action, the Company's
counsel is unable to form an opinion as to the likelihood of
an unfavorable outcome.
NOTE 10- STOCKHOLDERS' EQUITY
a) Earnings per share
Earnings per common share is computed pursuant to Statement of
Financial Accounting Standards (SFAS) No. 128 "Earnings Per
Share" ("EPS"). Basic earnings per share is computed as net
income (loss) available to common shareholders divided by the
weighted average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution that could
occur from common shares issuable through stock options,
warrants and other convertible securities. Diluted EPS is not
presented since the effect would be anti-dilutive.
b) Warrants
i) Initially, each Warrant issued in the initial public
offering of September 24, 1996 entitled the holders thereof
to purchase one share of the Company's common stock at an
exercise price of $6.50 per share, until September 9, 2001.
On August 31, 2001, the Company extended the term of its
warrants by 18 months, the Warrants will now expire on March
10, 2003. On June 23, 1997, the Board of Directors approved
a reduction in the exercise price of the Warrants from $6.50
to $3.00. On February 5, 1998, the Company affected a one
for three reverse split of the Company's common stock.
Accordingly, the Company adjusted the terms of the Warrants
to reflect the reverse split such that exercise of three
Warrants would entitle the holder to purchase one share of
common stock at an exercise price of $9.00. Giving effect to
the January 1999 100% common stock dividend, the January
2000 10% common stock dividend and the May 2000 20% common
stock dividend, the warrants have been cumulatively adjusted
such that the exercise of each warrant at an exercise price
of $3.41 purchases .88 of a share of common stock.
-16-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 10- STOCKHOLDERS' EQUITY (continued)
b) Warrants (continued)
ii) On April 15, 1998, the Company's Board of Directors
authorized the distribution of warrants to all shareholders
of the Company's common stock as of May 8, 1998. Pursuant to
the distribution, each shareholder of record will receive
one warrant to purchase one share of common stock at an
exercise price of $4.00 per share. The warrants, which are
exercisable for a period of three years, commencing one year
after issuance and receipt by shareholder, shall be issued
and distributed once the Company has file a registration
statement for same and same has been declared effective by
the Securities and Exchange Commission. The Company to date
has not filed the registration statement.
NOTE - 11 RELATED PARTIES TRANSACTIONS
a) For the nine months ended March 31, 2002 and 2001
financial consulting fees were paid to a corporation
and an individual who are related to the Company's
President and CEO amounting to $36,320 and $34,000,
respectively.
b) During October 1996, pursuant to two promissory
notes, the Company loaned two of its officers a total
of $87,000 bearing interest at six and one-half
percent (6 1/2) payable over three years. As of March
31, 2002, the unpaid portion amounted to $37,000,
which has been classified as current. As of March 31,
2002, the Company's President was also advanced
additional funds totaling $3,000 which are
non-interest bearing and due on demand and are
classified as current.
-17-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE - 12 SEGMENT INFORMATION
The Company's operations have been classified into two
segments: swimwear sales and film productions. These operating
segments were based on the nature of the projects and services
offered. Operating segments are defined as components of an
enterprise about which separate financial information is
available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and
assess performance. The Company's CEO has been identified as
the chief decision maker. The Company's chief operating
decision maker directs the allocation of resources to
operating segments based on the profitability and cash flow of
the respective segments. Information about the two segments is
as follows:
Nine Months Ended March 31st
----------------------------
2002 2001
--------------------------------------- --------------------------------
Segment Consolidated Segment Consolidated
----------------- ------------------ ----------------- ----------
Sales:
Swimwear sales $ 6,313,067 $ 5,692,623
Film production - -
----------------- -----------------
Total sales $ 6,313,067 $ 5,692,623
================== ==========
Operating income (loss):
Swimwear sales $ 649,892 $ 445,455
Film production (600) (208,564)
------------------ ----------
Total operating income (loss) $ 649,292 $ 236,891
------------------ ----------
Corporate:
General and administrative expense $ (271,008) $ (429,960)
------------------ ----------
(Loss) equity in earnings of affiliate (595) (4,837)
Amortization expense (53,214) (53,214)
Interest income 11,008
59,478
Interest and finance expense (357,941) (339,171)
Other 9,050 18,106
------------------ ----------
Loss from operating before (benefit) (13,408) (512,707)
Provision for income tax - (16,974)
------------------ ----------
Net (loss) income $ (13,408) $ (495,733)
================== ==========
Identifiable assets:
Swimwear sales $ 1,604,943 $ 2,148,190
Film productions 1,451,104 1,600,163
Corporate 1,143,940 1,909,898
------------------ ----------
Total assets $ 4,199,987 $ 5,658,251
================== ==========
-18-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE - 12 SEGMENT INFORMATION (continued)
Operating profit is total revenue less cost of sales and
operating expenses and excludes general corporate expenses,
interest expenses and income taxes. Identifiable assets are
those used by each segment of the Company's operations.
Corporate assets are primarily cash and investments.
-19-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
CAUTIONARY STATEMENTS ON FORWARD-LOOKING STATEMENTS
Statements contained in this report which are not historical facts and may be
considered forward looking information with respect to plans, projections, or
future performance of the Company as defined under the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are subject
to risks and uncertainties which could cause actual results to differ
materially from those projected. The words "anticipate ", "believe",
"estimate", "expect", "objective", and "think" or similar expressions used
herein are intended to identify forward-looking statements. The
forward-looking statements are based on the Company's current views and
assumptions and involve risks and uncertainties that include, among other
things, the effects of the Company's business, actions of competitors,
changes in laws and regulations, including accounting standards, employee
relations, customer demand, prices of purchased raw material and parts,
domestic economic conditions, including housing starts and changes in
consumer disposable income, and foreign economic conditions, including
currency rate fluctuations. Some or all of the facts are beyond the Company's
control.
General
Shopnet.com, Inc. ("Shopnet" or the "Company") was incorporated in the State
of Delaware on December 1, 1995 as Hollywood Productions, Inc. On May 10,
1999, Shopnet filed an amendment to its Articles of Incorporation effecting a
change in its name to its current one. On May 12, 1999, it incorporated a new
wholly-owned subsidiary, Hollywood, to which it assigned its motion picture
business thereby rendering Shopnet a holding company for Hollywood and
another wholly-owned subsidiary, Breaking Waves. Shopnet was formed initially
for the purpose of acquiring screenplays and producing motion pictures. In
September 1996, in connection with the completion of its IPO, it acquired all
of the capital stock of Breaking Waves which designs, manufactures, and
distributes private and brand name label children's swimwear. As of June 30,
2001, the company changed its year end from December 31 to June 30.
The consolidated financial statements at March 31, 2002 and 2001 included the
accounts of Shopnet and its wholly owned subsidiaries, Breaking Waves and
Hollywood (collectively referred to as the "Company") except where otherwise
indicated after elimination of all significant intercompany transactions and
accounts.
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and related footnotes which provide
additional information concerning the Company's financial activities and
condition. Since Shopnet and its subsidiaries operate in different
industries, the discussion and analysis is presented by entity in order to be
more meaningful.
Critical Accounting Policies
a) Principles of consolidation
The accompanying consolidated financial statements include the
accounts of Shopnet and its wholly owned subsidiaries, Breaking
Waves and Hollywood (the "Company"), after elimination of all
significant intercompany transactions and accounts. Affiliated
companies which are 20 to 50 percent owned are accounted for under
the equity method.
b) Inventory
Inventory consists of finished goods and is valued at the lower of
cost (using the first-in, first-out method) or market. All
inventory is pledged as collateral for factored receivables
pursuant to a factoring agreement with a financial institution
-20-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Critical Accounting Policies (continued)
c) Film production and distribution costs
The Company follows industry standards in capitalizing film
production and distribution costs. Film production and
distribution costs include all costs associated with the writing,
producing, and distribution of the film. Film costs include the
costs of production, prints, pre-release, and other advertising
expected to benefit future periods. These costs, as well as
participation and talent residuals, are charged against earnings
on an individual film basis in the ratio that the current year's
gross film revenues bear to management's estimate of total
remaining ultimate gross film revenues from all sources.
Film costs are stated at the lower of cost or estimated net
realizable value on an individual film basis. Revenue and cost
forecasts are continually reviewed by management and revised when
warranted by changing conditions. Estimates of total gross revenue
can change significantly due to the level of amortization, as
adjusted. Such adjustments could have a material effect on the
results of operations in future periods. When estimates of total
revenue and costs indicate that a feature film will result in an
ultimate loss, additional amortization is recognized to the extent
required to produce a zero gross margin over the remaining life of
the film.
d) Equity Method of Accounting
Investments in significantly (20 to 50 percent) owned affiliates
are accounted for by the equity method of accounting, whereby the
investment is carried at cost of acquisition, plus the Company's
equity percentage in undistributed earnings or losses since
acquisition. Reserves are provided where management determines
that the investment or equity in earnings is not realizable.
e) Income taxes
The Company accounts for income taxes in accordance with the
"liability method" of accounting for income taxes. Accordingly,
deferred tax liabilities and assets are determined based on the
difference between the financial statement and tax basis of assets
and liabilities, using enacted tax rates in effect for the year in
which the differences are expected to reverse. Current income
taxes are based on the respective periods' taxable income for
federal, state and city income tax reporting purposes.
f) Revenue and cost recognition
The terms of Breaking Waves' sales are FOB shipping point thereby
revenue is recognized upon shipment from the warehouse. Sales
returns are recorded upon acceptance of the goods by the
warehouse. Duty costs, which are a component of cost of sales, are
recorded upon the clearance of such goods through customs.
Revenues from the theatrical distribution of motion pictures are
recognized when motion pictures are exhibited. Revenues from video
sales are recognized, together with related costs, on the date
that video units are made widely available for sale by retailers.
Revenues from the licensing of feature films, together with
related costs, are recorded when the material is available for
telecasting by the licensee and when certain other conditions are
met. Film production and distribution costs are stated at the
lower of unamortized cost or estimated net realizable value. In
accordance with Financial Accounting Standards Board's Statement
of Financial Accounting Standards ("SFAS") No. 53, "Financial
Reporting by Producers and Distributors of Motion Pictures Films,"
the individual film forecast method is used to amortize film
costs.
-21-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Critical Accounting Policies (continued)
g) Earnings per share
Earnings per common share is computed pursuant to SFAS No. 128
"Earnings Per Share." Basic earnings per share is computed as net
income (loss) available to common share holders divided by the
weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution
that could occur from common shares issuable through stock
options, warrants and convertible preferred stock.
h) Use of estimates
In preparing financial statements in conformity with generally
accepted accounting principles generally accepted in the United
States of America, management is required to make estimates and
assumption which affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and revenues
and expenses during the reporting period. The most significant
estimate with regard to these financial statements is the estimate
of projected income of motion pictures which is the basis used in
amortizing film production and distribution costs. Actual results
could differ from those estimates.
i) Fair value disclosure at March 31, 2002 and June 30, 2001:
The carrying value of cash, accounts receivable, inventory,
accounts payable, accrued expenses, and capital lease obligations
are a reasonable estimate of their fair value.
Three months ended March 31, 2002 as compared to the three months ended
March 31, 2001
For the three months ended March 31, 2002, the Company reported a
consolidated net income of $535,131 as compared to a consolidated net income
of $207,797 for the three months ended March 31, 2001. Comprehensive income
for the three months ended March 31, 2002 was $535,131 as compared to
comprehensive income of $112,547 for the three months ended March 31, 2001.
Breaking Waves
For the three months ended March 31, 2002 and 2001, Breaking Waves generated
net sales of $4,612,362 and $3,653,260, respectively, with related cost of
sales amounting to $2,828,915 and $2,437,428 respectively. The increase in
sales amounting to $959,102, or approximately 26%, from 2002 to 2001 was
primarily attributable to the greater acceptance of the Company's product
line and increased marketing efforts.
The gross profit for the three months ended March 31, 2002 amounted to
$1,783,447, or 39% of sales as compared to the three months ended March 31,
2001 during which it amounted to $1,215,832 or 33% of sales.
Selling, general, and administrative expenses during the three months ended
March 31, 2002 and 2001 amounted to $ 946,295 and $ 711,879, respectively.
The increase amounting to $234,416 or approximately 33%, is primarily
attributable to an increase in selling and warehousing expenses which reflect
the increase in sales volume.
-22-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Breaking Waves (continued)
The major components of the Breaking Waves selling, general, and
administrative expenses are as follows for the three months ended March 31:
2002 2001
--------- --------
Officers, office staff, designer and sales , salaries and related benefits $157,810 $134,459
Commission expense ........................................................ 195,912 128,325
Warehousing costs ......................................................... 270,087 190,462
Royalty fees .............................................................. 45,819 89,887
Rent expense .............................................................. 26,381 24,522
Factor commissions ........................................................ 49,222 36,276
Miscellaneous general corporate overhead expenses ......................... 201,064 107,948
Interest expense in connection with its factoring agreement amounted to
$88,075 and $156,022 for the three months ended March 31, 2002 and 2001,
respectively. The decrease is due to a reduction in the stated prime interest
rate.
Breaking Waves generated net income of $635,014 and $351,767 for the three
months ended March 31, 2002 and 2001 respectively.
Hollywood
On May 12, 1999, Shopnet incorporated a wholly-owned subsidiary, Hollywood,
to which it assigned its film production business. All film related
operations prior to May 12, 1999 were conducted by Shopnet under its former
name.
For the three months ended March 31, 2002 and 2001, Hollywood generated no
sales from its motion picture "Dirty Laundry". Although sales prior to and
including the nine months ended June 30, 2001 were minimal, the Company is
expending efforts to effect increased sales during the fiscal year ending
June 30, 2002 and thereafter as a result of the implementation of a new
marketing strategy which among other things, emphasizes the development of
new marketing and distribution arrangements for "Dirty Laundry". Hollywood
generated a loss of $600 and $947 for the three months ended March 31, 2002
and 2001, respectively.
Subsequent to "Dirty Laundry", Hollywood also has invested in other movie
ventures, some of which have generated revenue to date. See "Investment in
Joint Ventures."
Shopnet.com
For the three months ended March 31, 2002, Shopnet generated no income. For
the corresponding three months ended March 31, 2001, Shopnet generated income
amounting to $21,615 comprised of interest from its money market and sublet
income from its corporate office.
Shopnet's selling, general, and administrative expense amounted to $99,283
and $143,023 for the three months ended March 31, 2002 and 2001. This
represents a decrease of $43,740, or approximately 31%.
-23-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Shopnet.com (continued)
The major components of the Company's expenses are as follows for the three
months ended December 31:
2002 2001
-------- --------
Salaries (officer and office staff) and stock
compensation and related benefits $ 28,741 $44,684
Rent .................................................................. 0 19,156
Legal and professional fees ........................................... 17,234 18,650
Consulting fees ....................................................... 10,400 6,000
Other general corporate and administrative expense .................... 42,908 54,533
Shopnet generated a net loss of $99,283 and $143,023 for the three months
ended March 31, 2002 and 2001, respectively. These net losses include, on a
consolidated basis, amortization of goodwill of $17,738 in each period.
Nine months ended March 31, 2002 as compared to the nine months ended March
31, 2001
For the nine months ended March 31, 2002 and 2001, the Company reported a
consolidated net loss of $13,408 and $495,733. Comprehensive loss for the
nine months ended March 31, 2002 was $19,758 as compared to a comprehensive
loss of $749,733 for the nine months ended March 31, 2001.
Breaking Waves
For the nine months ended March 31, 2002 and 2001, Breaking Waves generated
net sales of $6,313,067 and $5,692,623, respectively, with related cost of
sales amounting to $3,927,537 and $3,709,898, respectively. The increase in
sales amounting to $620,444, or approximately 11%, from 2002 to 2001 was
primarily attributable to the greater acceptance of the Company's product
line and increased marketing efforts.
The gross profit for the nine months ended March 31, 2002 amounted to
$2,385,530, or 38% of sales as compared to the nine months ended March 31,
2001 during which it amounted to $1,982,725 or 35% of sales.
Selling, general, and administrative expenses during the nine months ended
March 31, 2002 and 2001 amounted to $1,735,638 and $1,537,272, respectively.
The increase amounting to $198,366 or approximately 13%, is primarily
attributable to an increase in selling and warehousing expenses which reflect
the increase in sales volume.
The major components of the Breaking Waves selling, general, and
administrative expenses are as follows for the nine months ended March 31:
2002 2001
--------- --------
Officers, office staff, designer and sales , salaries and related benefits $433,239 $416,535
Commission expense ........................................................ 189,093 168,607
Warehousing costs ......................................................... 355,751 268,175
Royalty fees .............................................................. 98,430 162,643
Rent expense .............................................................. 74,998 71,303
Factor commissions ........................................................ 62,687 52,965
Miscellaneous general corporate overhead expenses ......................... 521,440 397,044
-24-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Breaking Waves (continued)
Interest expense in connection with its factoring agreement amounted to
$190,908 and $293,216 for the nine months ended March 31, 2002 and 2001,
respectively. The decrease is due to a reduction in the stated prime interest
rate.
Breaking Waves owns 1,270,000 unregistered common shares ("Play Co. Shares")
of Play Co. Toys & Entertainment Corp. ("Play Co, " a toy retailer and a
publicly traded company whose Chairman of the Board is also the President of
Shopnet and Breaking Waves).
Breaking Waves' ownership percentage is approximately 1.5% of Play Co.'s
outstanding Common Stock. The investment in Play Co. is accounted for under
the requirements of SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities. " Under SFAS 115, the securities are considered
available for sale and therefore the carrying value is based on the fair
market value of the securities at March 31, 2002 and 2001 which amounted to
$0 and $12,700, respectively. The change in the fair market value of the
securities during the periods is recorded as an unrealized gain or loss as a
component of comprehensive income. The company has pledged such shares as
collateral for a standby letter of credit in connection with Breaking Waves'
factoring agreement with Century Business Credit Corporation ("Century") and
the are therefore considered non-current.
On March 28, 2001, Play Co. filed for protection under Chapter Eleven of the
United States Code with the United States Bankruptcy Court for the Southern
District of New York. The filing was converted into a Chapter Seven filing on
August 28, 2001.
Breaking Waves recorded an unrealized (loss) gain of $(6,350) and $(254,000)
for the nine months ended March 31, 2002, and 2001 respectively, which has
been recorded as a component of comprehensive income (loss) in the statement
of operations.
Breaking Waves generated net income of $296,607 for the nine months ended
March 31, 2002 and net income of $172,184 for the nine months ended March 31,
2001.
Hollywood
For the nine months ended March 31, 2002 and 2001, Hollywood generated no
sales form its motion picture "Dirty Laundry". Although sales prior to and
including the nine months ended June 30, 2001 were minimal, the Company is
expending efforts to effect increased sales during the fiscal year ending
June 30, 2002 and thereafter as a result of the implementation of a new
marketing strategy which among other things, emphasizes the development of
new marketing and distribution arrangements for "Dirty Laundry". Upon a
review of the net realizable value of the movie cost, management has
determined that a $0 and $208,564 write down was necessary as of March 31,
2002 and 2001, respectively, Accordingly, Hollywood generated a loss of $663
and $214,064 for the nine months ended March 31, 2002 and 2001, respectively.
Subsequent to "Dirty Laundry", Hollywood also has invested in other movie
ventures, some of which have generated revenue to date. See "Investment in
Joint Ventures."
-25-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Shopnet.com
For the nine months ended March 31, 2002 and 2001, Shopnet generated minimal
income comprised of interest from its money market and sublet income from its
corporate office.
Shopnet's selling, general, and administrative expense amounted to $309,352
and $453,853 for the nine months ended March 31, 2002 and 2001. This
represents a decrease of $144,501 or approximately 32%.
The major components of the Company's expenses are as follows for the nine
months ended December 31:
2002 2001
------------- -------------
Salaries (officer and office staff) and stock compensation and related
benefits $99,385 $ 131,782
Rent 19,510 57,219
Legal and professional fees 72,314 77,296
Consulting fees 22,345 16,000
Other general corporate and administrative expense 95,798 171,556
Shopnet generated a net loss of $309,352 and $453,853 for the nine months
ended March 31, 2002 and 2001, respectively. These net losses include, on a
consolidated basis, amortization of goodwill of $17,738 in each period.
Liquidity and Capital Resources
At March 31, 2002, the Company's consolidated working capital amounted to
$189,503.
At March 31, 2002, current assets consisted primarily of inventory of
$1,374,066.
In September 2000, Breaking Waves entered into a factoring and revolving
inventory loan and security agreement with Century to sell its interest in
all present and future receivables without recourse. Breaking Waves submits
all sales offers to Century for credit approval prior to shipment, and pays a
factoring commission of .75% of receivables sold. Century retains from the
amount payable to Breaking Waves a reserve for possible obligations such as
customer disputes and possible credit losses on unapproved receivables.
Breaking Waves may take advances of up to 85% of the receivables, with
interest at the rate of 1 3/4% over prime. In connection with the factoring
agreement, the Company agreed to maintain $1,150,000 of cash in segregated
account in order to collateralize standby letters of credit for Breaking
Waves. Additionally, Breaking Waves was required to pledge as additional
collateral, $200,000 of its own cash and the Play Co. shares. Additional
collateral of $400,000 came from a third party which is a trust ("Trust"),
the beneficiary of which is the granddaughter of the Company's President and
Chief Executive Officer and the daughter of a principal stockholder of the
Company.
In September 2001, Century increased the required collateral in the amount
of $300,000, from $1,150,000. Subsequent to March 31, 2002, the Company
effected financing arrangements with two parties (one of which is the Trust,
the other relatives of as principal stockholder of the Company) providing
for assets in the aggregate amount of $1,050,000 ("Financing"), representing
a portion of the $1,450,000 required collateral. The provision of the assets
in connection with the financing arrangements provided for the $300,000
increase in required collateral and replacement of the Company's
certificates of deposit in the amount of $350,000.
-26-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources (continued)
The assets provided by such parties are available to Breaking Waves for a
ten year term, subject to earlier termination in the event of default.
Breaking Waves is obligated to make an annual payment to each of the two
entities which provided such assets, equal to an aggregate of 1-1/4% of net
sales of Breaking Waves through June 30, 2002, and an aggregate of 1-3/4% of
net sales of Breaking Waves for each year the letter of credit is available
thereafter, payable 45 days after the end of each fiscal quarter. In October
2001, such entities received funds in the aggregate amount of $36,750
reflecting advance payment of such amounts.
At March 31, 2002, the Company was indebted to Century in the aggregate
amount of approximately $865,000.
Interest expense related to the Century factoring agreement totaled $190,908
and $256,510 for the nine months ended March 31, 2002 and 2001,
respectively. Century has a continuing interest in Breaking Waves' inventory
as collateral for the advances.
In September 2001, the Company and Breaking Waves retained Arc Financial
Corp. ("ARC"), a British Virgin Island company, for a ten year term to
provide financial consulting services. Pursuant to the terms of a consulting
agreement ("ARC Consulting Agreement"), ARC was retained to assist the
Company in the acquisition of financing to acquire inventory and for other
corporate purposes, as well as consult with the Company with regard to its
ongoing operations, including systems to control expenses, method to enhance
and promote sales of Breaking Waves' products and improving production. ARC
assisted the Company in the Financing. Pursuant to the terms of the ARC
Consulting Agreement, the Company and Breaking Waves agreed to compensate
ARC (i) an annual fee of $20,000 (`Base Fee") and (ii) a percentage of
annual net sales in the amount of 1-1/4% through June 30, 2002 and 1-3/4% of
net sales for each year of the term thereafter ("ARC Percentage Fee"),
payable 45 days after the closing of each fiscal quarter. In October 2001,
ARC received (i) a lump sum payment of $209,000 reflecting full advance
payment of the Base Fee and (ii) $36,750 reflecting advance payment of the
ARC Percentage Fee. The Company and Breaking Waves are entitled to terminate
the ARC Consulting Agreement any time after September 30, 2006, in which
event all prepaid fees are forfeited.
The Company anticipates that its current available cash will be sufficient
for the next twelve months and does not anticipate any cash shortfalls. In
the March 31, 2002 quarter, the Company implemented a number of initiatives
which it believes will reduce its cost of operations and overhead. In
particular, the Company believes that the repayment of its indebtedness to
Century in the amount of approximately $1,982,879 will translate into
decreased interest expense projected to be approximately $50,000 for the
next fiscal quarter.
In December 2001, the Company consolidated all of its operations in the New
York metropolitan region into new facilities where Breaking Waves currently
operates, resulting in annualized rental savings estimated at approximately
$60,000 over the next 12 months, plus additional savings in utilities and
other office and personnel expenses resulting from the economies generated
by the consolidated operations. The Company expects that these savings as
well as salary reductions that the Company implemented during the March 31,
2002 quarter, will amount to approximately $130,000 during the current
fiscal year ending June 30, 2002.
-27-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources (continued)
The Company has recently refocused its sales efforts, to the extent possible,
to eliminate unprofitable or low margin sales. This is compounded with
improved sales and orders during the quarter ended March 31, 2002. Breaking
Waves did ship sales orders during the month of April 2002 of approximately
$1,100,000. There can be no assurance that such figures will be indicative of
future results, that the Company will be successful in collecting all
receivables, or that any orders booked as of April 2002 will not ultimately
be cancelled.
Investments in Joint Ventures
Battle Studies Productions, LLC
In April 1998, the Company entered into a co-production agreement with North
Fork Bank for "Machiavelli Rises." The Company and North Fork formed Battle
Studies to finance, produce and distribute the film. Battle Studies will be
treated as a joint venture in order to co-produce motion pictures and to
finance the cost of production and distribution of such motion pictures. The
joint venture retains all rights to the motion pictures, the screenplays, and
all ancillary rights attached thereto. Total production costs to date have
aggregated approximately $425,000 of which the Company has funded
approximately $218,500. In accordance with the terms of the co-production
agreement, the proceeds of the film will be distributed as follows: first,
both parties shall be entitled to recoup their initial investment in the
film, at 135% thereof; then, after repayment to the respective parties of
additional cost incurred by same, any remaining proceeds shall be distributed
50% to North Fork and 50% to the Company. The film was shown in January 1999
in both New York and the Brussels Film Festival.
The Company accounts for the investment in Battle Studies on the equity
method. For the nine months ended March 31, 2002 and 2001, the Company,
recorded $595and $0, respectively, of equity losses for its proportionate
share of Battle Studies. No revenues have been derived from this film as of
March 31, 2002.
On October 12, 2000, Battle Studies entered into a distribution agreement
with Raven Pictures International ("Raven Pictures") to distribute Battle
Studies' motion picture ("Macheavelli Rises") to foreign countries. Battle
Studies has granted rights under the agreement for the theatrical, video,
non-theatrical and television markets. The term of the agreement is for
twenty-four months for all portions of territory outside of the United States
and English speaking Canada. Battle Studies expects to realize 75% (which is
net of a 25% fee to Raven Pictures) of the expected estimated gross revenues
derived from foreign countries less $20,000 for marketing and advertising
expense.
On January 17, 2001, Battle Studies entered into a distribution agreement
with KOAN to distribute and promote Battle Studies' motion picture
("Machiavelli Rises") in the United States and Canada. Battle Studies has
granted rights under the agreement for free TV, pay TV, cable, satellite,
video and DVD markets. The terms of the agreement is for twenty-four months
and it will be automatically renewed unless KOAN receives a letter of
cancellation at least thirty days prior to the date of termination or if
sales have not exceeded $250,000 over the twenty-four month period. Battle
studies expects to realize 70% (which is net of a 30% fee to KOAN) of the
expected estimated gross revenues derived from the United States and Canada
less $5,000 per year for promotional costs.
-28-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Investments in Joint Ventures (continued)
The Girl, LLC
Pursuant to an agreement dated July 1, 1999 with ALF for the production of a
film entitled "The Girl", Hollywood invested through March 31, 2002, $35,000
for a 22.533% interest in a new entity, The Girl, LLC a limited liability
company ("Girl LLC"). In return for its participation in Girl LLC, Hollywood
shall be entitled to receive a non-contested, non-dilutable 22.533% ownership
interest in Girl LLC, a recoupment of its investment on no less favorable
terms than any other investor and 22.533% of 100% of any contingent
compensation which shall be actually received by Girl LLC. Girl LLC retains
all rights to the motion pictures, the screenplays, and all ancillary rights
attached thereto. "The Girl" is completed and has been exhibited at several
film festivals. Girl LLC is in the process of attempting to secure video and
foreign distribution arrangements for the film.
Hollywood accounts for the investment in Girl LLC under the equity method.
Accordingly, as of March 31, 2002, the Company has recorded its investment at
$33,702. This represents its initial investment of $35,000 less $1,298 of
equity loss for its proportionate share of Girl LLC.
Factoring Arrangements
CIT Group
On August 20, 1997, Breaking Waves entered into a factoring and revolving
inventory loan and security agreement (as amended December 9, 1998) with CIT
Group (formerly, Heller Financial, Inc. "CIT") to sell their interest in all
present and future receivables without recourse. Breaking Waves paid CIT a
factoring commission of .85% of the receivable, with interest at the rate of
1 3/4% over prime. In connection with the factoring agreement, the Company
agreed to maintain $1,150,000 of cash in a segregated account in order to
collateralize standby letters of credit. In addition, during 1999, the
Company was required to transfer an additional $200,000 of cash as collateral
for the standby letter of credit. On or about September 12, 2000 the
agreement with CIT was cancelled and a new factoring agreement was entered
into with Century. Interest expense related to this agreement totaled $0 and
$36,706 for the nine months ended March 31, 2002 and 2001, respectively.
Lease Commitments
Shopnet leased its administrative office pursuant to a 5-year lease that
expired on November 30, 2001 at annual rent amounting to approximately
$70,000, before annual escalations. Upon the lease expiration, Shopnet
relocated to Breaking Waves's facilities. Breaking Waves terminated its lease
effective November 30, 2001. A new 6-year lease expiring September 30, 2007
was signed by Breaking Waves in July 2001 and is effective beginning December
1, 2001. Annual rent under the new lease is $84,915 through December 31, 2004
and $95,760 for the remainder of the lease. Breaking Waves also maintains a
Florida office, comprising approximately 780 square feet, with annual
payments of approximately $11,000.
-29-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
License Agreements
On October 16, 1995, Breaking Waves entered into a license agreement with
Beach Patrol, Inc. Pursuant to the licensing agreement, Breaking Waves was
given the right to use certain designs for its children's line under the
"Daffy Waterwear" label from January 1, 1996 to June 30, 1998. Thereafter,
the agreement provided for a three year extension, at the option of Breaking
Waves, through and until June 30, 2001. Breaking Waves has exercised this
option, thereby extending the agreement. The agreement calls for minimum
annual royalties of $75,000 to $200,000 over the life of the agreement with
options based on sales levels from $1,000,000 for the first year to
$4,000,000 in the sixth year. Breaking Waves has negotiated an additional two
year extension thereby extending the agreement through June 30, 2003, and it
contains a provision for an additional two year extension, at the option of
Breaking Waves, through and until June 30, 2005. The new agreement signed
February 28, 2001 and effective July 1, 2001 calls for minimum annual
royalties of $50,000 to $87,500 over the life of the extension with option
based on sales levels from $1,000,000 for the seventh year to $1,750,000 in
the tenth year. Breaking Waves recorded royalties and advertising under this
agreement totaling $30,000 and $138,897 during the nine months ended March
31, 2002, and 2001, respectively.
During June 2000, Breaking Waves entered into a license agreement with an
effective date of November 1, 2000 with Gottex Models Ltd., and Israeli
Corporation and Gottex Models (USA) Corp., a New York corporation for the use
of the trademark "Gottex" in the United States of America for children's
swimwear. The agreement calls for a royalty fee of 7% of net sales with
guaranteed minimum annual royalties of $70,000 to $140,000 over the life of
the agreement, subject to certain exceptions. The license agreement also
requires the Company to expend certain minimum amounts on advertising each
year. The license agreement is for a term of three years, subject to earlier
termination in accordance with its terms. In the nine months ending March 31,
2002, Breaking Waves recorded $68,430 in royalty expenses related to the
minimum guaranteed royalties contained in its agreement with Gottex. In the
corresponding nine months ended March 31, 2001, Breaking Waves recorded
royalties of $23,746.
-30-
PART II
Item 1. Legal Proceedings
On or about June of 2000, an action was brought in the Queens County Supreme
Court against the Company and several others claiming, among other things, that
the Company allegedly breached a contract and engaged in fraudulent statements
(including supposedly promising the plaintiff options and then not allowing the
plaintiff to exercise these options). The plaintiff seeks, among other things,
compensatory damages in the amount of $497,500, punitive damages in the amount
of $995,000, together with costs and attorney's fees. The complaint was recently
amended. The defendants including the Company have made a motion to dismiss the
complaint. There can be no assurance that this motion will be granted. The
Company intends to contest the action vigorously and believes that such claims
against it are baseless and without merit.
In or about December 2001, a group of over 275 foreign plaintiffs commenced an
action entitled Abeln v. Arbel, et. al in the United States District Court for
the Southern District of New York naming the Company, along with over 30 other
entities and individuals as defendants. The Company has not yet been served with
the summons and complaint, and cannot discern if such service will be
effectuated. Thus, the Company is not yet a party to the suit.
Among other things, the plaintiffs claim that a large amount of EACC's funds
have been invested in the Company. The plaintiffs allege that they incurred
losses and damages in excess of $25,000,000. The action seeks an unstated amount
of monetary damages together with punitive damages.
This matter has been delayed by the court because of an apparent dispute
regarding who will represent the plaintiffs.
Should the Company be served, it anticipates seeking Court approval to make a
motion to dismiss the complaint for among other reasons, failure to state a
claim.
In light of the early stage of this action, the Company's counsel is unable to
form an opinion as to the likelihood of an unfavorable outcome.
The Complaint purports to state claims, among others, for securities fraud,
RICO, breach of contract, common law fraud and breach of fiduciary duty
allegedly arising out of the defendants' supposed involvement with the preferred
stock of Europe American Capital Corporation ("EACC"). The complaint is unclear
but it appears that only the RICO and common law fraud claim are alleged as
against the Company.
The Company is not a party to any other material litigation and is not aware of
any threatened litigation that would have a material adverse effect on its
business. Neither the Company's officers, directors, affiliates, nor owners of
record or beneficially of more than five percent of any class of the Company's
Common Stock is a party to any material proceeding adverse to the Company or has
a material interest in any such proceeding adverse to the Company.
-31-
PART II
Item 2. Changes in Securities and Use of Proceeds: None
Item 3. Defaults Upon Senior Securities: None
Item 4. Submission of Matters to a Vote of Security Holders: None
Item 5. Other Information: None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None
-32-
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized, this 20th day of May 2002.
SHOPNET.COM, INC.
By: /s/ Harold Rashbaum
Harold Rashbaum
President and Chief Executive Officer
-33-