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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTER ENDED MAY 31, 2002
[ ] 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 0-27046
TRAFFIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 22-3322277
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ONE BLUE HILL PLAZA 10965
PEARL RIVER, NEW YORK (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (845) 620-1212
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 [ ]
The number of shares outstanding of the Registrant's common stock is
14,516,146 (as of 07/12/02).
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TRAFFIX, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
QUARTER ENDED MAY 31, 2002
ITEMS IN FORM 10-Q
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements ........................................ 2
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................ 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk .. None
PART II OTHER INFORMATION
Item 1. Legal Proceedings ........................................... 39
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 ............................ 40
SIGNATURES .............................................................. 41
1
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MAY 31, NOVEMBER 30,
2002 2001
----------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ................................................... $18,812,755 $14,458,055
Marketable securities ....................................................... 23,072,139 23,677,999
Accounts receivable, trade, net of allowance for doubtful accounts
of $618,453 at May 31, 2002 and $383,676 at November 30, 2001 ............. 7,458,489 7,326,032
Deferred income taxes ....................................................... 1,733,282 3,242,815
Due from related parties .................................................... 324,392 106,654
Prepaid expenses and other current assets ................................... 794,437 1,415,836
----------- -----------
TOTAL CURRENT ASSETS ................................................. 52,195,494 50,227,391
Property and equipment, at cost, net of accumulated depreciation ............... 1,731,905 951,702
Goodwill and other intangibles, net ............................................ 2,785,895 1,362,407
Deferred income taxes .......................................................... 147,084 147,084
Other .......................................................................... 54,000 54,000
----------- -----------
TOTAL ASSETS ......................................................... $56,914,378 $52,742,584
=========== ===========
LIABILITIES
Current liabilities:
Accounts payable ............................................................ $ 2,507,822 $ 3,928,418
Accrued expenses ............................................................ 7,132,279 4,098,921
Due to related parties ...................................................... 450,207 469,935
Income taxes payable ........................................................ 278,112 1,672,953
----------- -----------
TOTAL CURRENT LIABILITIES ............................................ 10,368,420 10,170,227
----------- -----------
Minority interest .............................................................. 276,925 159,651
----------- -----------
SHAREHOLDERS' EQUITY
Preferred stock-- $.001 par value; 1,000,000 shares authorized; none issued
and outstanding ............................................................. -- --
Common stock-- $.001 par value; authorized 50,000,000 shares; issued
14,516,146 shares and 14,290,491 shares, respectively ....................... 14,516 14,289
Common stock issuable-- $.001 par value; 78,347 shares ......................... 485,758 --
Additional paid-in capital ..................................................... 42,640,718 41,395,784
Retained earnings .............................................................. 5,323,230 3,206,770
Accumulated other comprehensive income ......................................... 81,525 72,577
Common stock held in treasury, at cost, 961,403 shares ......................... (2,276,714) (2,276,714)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY ........................................... 46,269,033 42,412,706
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ........................... $56,914,378 $52,742,584
=========== ===========
The accompanying notes are an integral part of these financial statements.
2
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- -------------------------
MAY 31, MAY 31, MAY 31, MAY 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net revenue ....................................... $10,804,538 $ 5,828,543 $23,175,435 $10,754,097
Cost of sales ..................................... 3,383,204 1,647,737 6,761,815 2,625,602
----------- ----------- ----------- -----------
GROSS PROFIT ................................. 7,421,334 4,180,806 16,413,620 8,128,495
Selling expenses .................................. 2,370,775 652,980 5,517,314 1,168,864
General and administrative expenses ............... 3,949,851 2,404,377 7,550,471 4,943,784
Bad Debt expense .................................. 109,172 -- 438,506 --
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS ....................... 991,536 1,123,449 2,907,329 2,015,847
Other income (expense):
Interest expense ............................... (9,266) -- (19,768) --
Interest income and dividends .................. 183,386 494,309 393,599 1,144,261
Realized (losses) gains on marketable
securities ................................... 20,564 (1,776) 83,157 (1,776)
Permanent impairment charges ................... -- -- -- (4,690,258)
Other non-operating income (expense) ........... 100,666 79,883 235,102 88,350
Minority interest in (income) loss of
subsidiary ................................... (104,303) -- (130,949) --
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE PROVISION FOR
INCOME TAXES ............................... 1,182,583 1,695,865 3,468,470 (1,443,576)
Provision for income taxes ........................ 469,540 680,381 1,352,010 1,311,799
----------- ----------- ----------- -----------
NET INCOME (LOSS) ............................ $ 713,043 $ 1,015,484 $ 2,116,460 $(2,755,375)
=========== =========== =========== ===========
Basic income (loss) per share (Note 3):
Net income (loss) .............................. $ 0.05 $ 0.07 $ 0.16 $ (0.19)
----------- ----------- ----------- -----------
Weighted average shares outstanding ............ 13,508,056 14,768,211 13,512,487 14,763,992
=========== =========== =========== ===========
Diluted income (loss) per share (Note 3):
Net income (loss) .............................. $ 0.05 $ 0.07 $ 0.14 $ (0.19)
----------- ----------- ----------- -----------
Weighted average shares outstanding ............ 14,830,315 15,267,926 14,789,936 14,763,992
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
3
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
--------------------------
MAY 31, MAY 31,
2002 2001
----------- ------------
Cash flows from operating activities:
Net income (loss) .................................................. $ 2,116,460 $ (2,755,375)
Adjustments to reconcilenet income (loss) to net cash used
in operating activities:
Depreciation and amortization .................................... 482,436 140,897
Reserve for customer chargebacks ................................. -- (15,476)
Provision for uncollectible accounts ............................. 438,506 548,309
Exchange loss .................................................... (20,788) --
Deferred income taxes ............................................ 1,509,533 34,891
Net (gains) on sale of marketable securities ..................... (83,182) (1,776)
Permanent impairment charges ..................................... -- 4,690,258
Amortized discounts and premiumson marketable securities ......... (39,114) (208,603)
Minority interest ................................................ 117,274 --
Changes in assets and liabilities of business:
Accounts receivable ........................................... (570,961) (1,774,650)
Prepaid expenses and other current assets ..................... 621,399 (1,031,228)
Accountspayable ............................................... (1,420,596) (719,956)
Income taxes payable .......................................... (1,086,964) (3,426,601)
Due from/to related parties ................................... (237,466) (837,533)
Other, principally accrued expenses ........................... 2,814,444 158,588
----------- ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 4,640,981 (5,198,255)
----------- ------------
Cash flows from investing activities:
Purchases of securities ............................................ (96,468,324) (124,597,572)
Proceeds from sales of securities .................................. 97,226,217 132,866,774
Capital expenditures ............................................... (1,190,098) (467,372)
Payments for asset acquisitions, net of cash received .............. (548,482) --
Purchases of long-term investments ................................. -- (49,000)
----------- ------------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES ......... (980,687) 7,752,830
----------- ------------
Cash flows from financing activities:
Proceeds from stock options exercised .............................. 580,003 60,177
Proceeds--net on settled Section 16-b action ....................... 114,403 --
----------- ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES ................... 694,406 60,177
----------- ------------
Net increase incash andcash equivalents ............................ 4,354,700 2,614,752
Cash and cash equivalents, beginning of period ..................... 14,458,055 4,551,344
----------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................... $18,812,755 $ 7,166,096
----------- ------------
During the six months ended May 31, 2002, the Company has 117,521 shares of
common stock issued and issuable, valued at $728,636 in the purchase of the
assets of a closely held, private company (See note 9.)
The accompanying notes are an integral part of these financial statements.
4
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
The accompanying unaudited consolidated financial statements of the Company
have been prepared in accordance with generally accepted accounting principles
for interim financial information. Accordingly, the unaudited consolidated
financial statements do not include certain information and note disclosures
normally required by generally accepted accounting principles. The accompanying
unaudited consolidated financial statements reflect all adjustments (consisting
only of normal recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of the financial position and operating
results for the interim periods presented. In the preparation of these financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the interim periods reported. Actual results could differ from
those estimates. Principally, estimates are used in accounting for bad debts and
sales allowances, depreciation and amortization, income taxes and contingencies.
Managements' estimates and assumptions are continually reviewed against actual
results with the effects of any revisions being reflected in the results of
operations at that time. The accompanying unaudited consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto, together with management's discussion and analysis
of financial condition and results of operations, contained in the Company's
Annual Report on Form 10-K for the fiscal year ended November 30, 2001. The
results of operations for the three and six month periods ended May 31, 2002 are
not necessarily indicative of the results to be expected for the subsequent
quarters or the entire fiscal year ending November 30, 2002. Certain prior year
amounts in the unaudited consolidated financial statements have been
reclassified to conform with the current year presentation.
During the six months ended May 31, 2002 and 2001, options for 186,481
shares and 37,975 shares of the Company's common stock, respectively, were
exercised by certain employees and directors. Tax benefits of $307,876 and
$9,623 in six months ended May 31, 2002 and 2001, respectively, were recorded as
an increase to additional paid-in capital and a reduction of income taxes
currently payable.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141
requires that all business combinations be accounted for by the purchase method
of accounting and changes the criteria for recognition of intangible assets
acquired in a business combination. The provisions of SFAS 141 apply to all
business combinations initiated after June 30, 2001. We do not expect that the
adoption of SFAS 141 will have a material effect on our consolidated financial
position or results of operations. SFAS 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, once SFAS
142 is adopted, which will be in our fiscal year ending November 30, 2003;
however, these assets must be reviewed at least annually for impairment
subsequent to adoption. Intangible assets with finite useful lives will continue
to be amortized over their respective useful lives. The standard also
establishes specific guidance for testing for impairment of goodwill and
intangible assets with indefinite useful lives. The provisions of SFAS 142 will
be effective for our fiscal year ending November 30, 2003, earlier adoption was
not elected by the Company pursuant to the terms of SFAS 142. However, goodwill
and intangible assets acquired after June 30, 2001 are subject immediately to
the non-amortization provisions of SFAS 142. While we are currently in the
process of evaluating the potential impact that the adoption of SFAS 142 will
have on our consolidated financial position and results of operations, our
preliminary assessment is that the adoption of SFAS 142 will have an immaterial
impact on the Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS 144 amends existing
accounting guidance on asset impairment and provides a single accounting model
for long-lived assets to be disposed of. Among other provisions, the new rules
change the cri-
5
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
teria for classifying an asset as held-for-sale. The standard also broadens the
scope of businesses to be disposed of that qualify for reporting as discontinued
operations, and changes the timing of recognizing losses on such operations. The
provisions of SFAS 144 will be effective for our fiscal year ending November 30,
2003 and will be applied prospectively. We are currently in the process of
evaluating the potential impact that the adoption of SFAS 144 will have on our
consolidated financial position and results of operations. Based on the relative
components of our balance sheet at May 31, 2002 we believe that the adoption of
SFAS 144 will have an immaterial impact on the Company's consolidated financial
position and results of operations, if any effect at all.
2. SIGNIFICANT ACCOUNT POLICIES
REVENUE RECOGNITION
The Company currently earns the most significant portion of revenue from
its E-commerce segment pursuant to marketing agreements with marketing partners
and corporate customers (collectively, "Corporate Customers"). The provisions of
each agreement determine the type and timing of revenue to be recorded. The
Company generates its E-commerce revenue from the following eight basic
categories: (1) delivery of consumer traffic to the websites and inbound
telemarketing call centers of our Corporate Customers (e.g., click-thrus from
the game banners on the Company's websites), (2) delivery of consumer data to
our Corporate Customers with respect to the consumers who have registered for
our Corporate Customers' products or services (e.g., a consumer who registered
via the registration page of one of the Company's websites to receive on-line
promotions from our Corporate Customers), (3) delivery of pre-qualified consumer
data to our Corporate Customers as a result of consumers' responses to targeted
questions and surveys (e.g., receiving free gifts for your children), (4)
delivery of a sale or completed application for our Corporate Customers products
or services (e.g., a consumer who responds to a Traffix e-mail promotion on
behalf of a Corporate Customer by completing an on-line application for a credit
card or subscribes for a cellular phone service), (5) generating revenue from
any of the foregoing categories by placing our Corporate Customers' offers on
the media of third parties with whom we have a marketing relationship on a
revenue share basis, (6) sales of costume jewelry, gift items and other
proprietary products and services directly to consumers, (7) rentals and sales
of copies of specific segments of its databases to Corporate Customers for their
proprietary marketing and database enhancements, and (8) customer acquisition
services, both on-line and off-line, under a net branch agreement with qualified
mortgage banking establishments.
The Company invoices its customers in accordance with the terms of the
underlying agreement. Revenue is recognized at the time the marketing activity
is delivered, or service is provided, net of estimated contractually specified
data qualification allowances, when applicable. Such data qualification
allowances may include duplications, invalid addresses, age restrictions and
other allowances, and are recorded as contra revenue. Historically, the variance
between actual allowances and previously estimated allowances has been
immaterial. In accordance with revenue recognition pronouncements, specifically
Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements"
("SAB 101") issued in December 1999, and in accordance with the Company's
historical accounting policies and reporting practices, the Company records all
related obligations associated with the related net revenue at its point of
recognition. The Company adopted SAB 101 during the first three months of the
fiscal year ended November 30, 2001. Such adoption did not materially impact
financial position or results of operations at that time.
Revenues from the Company's off-line customer acquisition services segment
currently include the revenue earned by Montvale Management, LLC, the Company's
majority owned subsidiary. Such revenues are currently less than 10% of the
Company's consolidated net revenues for the six months ended May 31, 2002, and
result from Montvale's provision of net branch services to mortgage banking and
other related financial institutions. Approximately 15% of Montvale's revenues
are derived from on-line sources, with such portion being included in the
Company's E-commerce segment. Montvale recognizes income in accordance with
Statement of Financial
6
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Accounting Standards ("SFAS") No. 91, "Accounting for Non Refundable Fees
and Costs Associated with Originating or Acquiring Loans". Pursuant to SFAS No.
91, Montvale recognizes its commission upon the disbursement of loan proceeds.
Prior to September 1, 2001, revenues from the Company's off-line customer
acquisition services consisted of residential long distance customer acquisition
programs, and were recorded upon the achievement of certain events particular to
the corresponding program's fulfillment liability. Subsequent to the delivery of
the initial sales record to the respective long distance carrier, the Company
may have been required to provide to the customer certain products and services
(fulfillment liability), such as prepaid cellular telephones and/or other
suitable premiums. These costs were estimated and accrued, based upon historical
rates and costs, as a component of marketing expense and included in the cost of
sales, at the time the associated revenues were recognized. The Company's
current business, as conducted in its E-commerce segment, in certain cases also
requires the provision of a premium. These E-commerce segment premiums are
estimated and accrued, based upon historical and current experience. Such
E-commerce premium costs are classified as a component of marketing expense and
included in the cost of sales, at the time the associated revenues are
recognized. Any variance in the initial accrual as compared to the actual
experience is taken into operations in the period that the variance is
determinable.
Revenue from the Company's LEC Billed Product and Service segment (the
Company has not marketed such services since November 1998), consisted of
various enhanced telephone services, principally voice mail services, and were
recognized net of an estimated provision for refunds and credits subsequently
granted to customers ("customer chargebacks"). Since the provision for customer
chargebacks was established prior to the periods in which chargebacks are
actually expended, the Company's revenues are adjusted in later periods if the
Company's incurred chargebacks varied from the amounts previously estimated. The
Company's LEC Billed Product and Service segment was inactive during the six
months ended May 31, 2002.
With respect to capitalization and amortization of marketing costs, the
Company's policy is to expense, as a cost of sale, data acquisition costs and
all other related marketing costs, at the time an obligation or expense is
incurred.
TRANSACTIONS WITH MAJOR CUSTOMERS
During the three and six months ended May 31, 2002, the Company had five
major customers in its E-commerce segment, which in combination accounted for
approximately $5.5 million and $12.9 million of consolidated net revenue,
respectively, or 51% and 56% of consolidated net revenues, respectively.
Approximately $5.1 million, or 69% of consolidated net accounts receivable was
attributable to such major customers as of May 31, 2002. For the three and six
months ended May 31, 2002, two of the five customers referenced above had
related net revenues that equaled or exceeded 10% of the Company's consolidated
net revenue for such period. The five major customers referenced above accounted
for 22%, 9%, 8%, 8% and 4% of consolidated net revenue, respectively, for the
three months ended May 31, 2002, and 26%, 10%, 9%, 7% and 4% of consolidated net
revenue, respectively, for the six months ended May 31, 2002. Of the remaining
approximate 100 active customers in the three and six months ended May 31, 2002,
no other single customer had net revenue that equaled or exceeded 4% of
consolidated net revenue.
During the three and six months ended May 31, 2001, the Company had four
customers in its E-commerce segment which, in combination, accounted for
approximately 48.3% and 47.5% of consolidated net revenues, respectively, and
approximately 36% of consolidated net accounts receivable as of May 31, 2001.
7
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
3. EARNINGS PER SHARE
The following table sets forth the reconciliation of the weighted average
shares used for basic and diluted earnings per share:
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------ -----------------------
MAY 31, MAY 31, MAY 31, MAY 31,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Denominator:
Denominator for basic earnings per
share-- weighted average shares .......... 13,508,056 14,768,211 13,512,487 14,763,992
Effect of dilutive securities:
Stock options .............................. 1,322,259 499,715 1,277,449 --
---------- ---------- ---------- ----------
Denominator for diluted earnings per
share-- adjusted weighted average
shares ................................... 14,830,315 15,267,926 14,789,936 14,763,992
========== ========== ========== ==========
Options to purchase 150,000 and 887,146 shares of common stock for the
three months ended May 31, 2002 and 2001, respectively, and 275,000 and
2,369,081 for the six months ended May 31, 2002 and 2001, respectively, were
outstanding but were not included in the computation of diluted earnings per
share because their effect would be anti-dilutive.
4. COMPREHENSIVE INCOME (LOSS)
Unrealized gains and losses on the Company's marketable securities are
reported in comprehensive income (loss) and accumulated other comprehensive
income (loss). Comprehensive income (loss) is defined as "the change in equity
of a business enterprise during a period from transactions and other events and
circumstances from non-owner sources." Excluding net income, the Company's
primary source of comprehensive income (loss) would ordinarily include the
after-tax net unrealized gains and (losses) on available-for-sale securities,
and the equity adjustment from foreign currency translation. Based on prior
fiscal year unrealized capital losses in excess of the current years three and
six month periods unrealized gains, a full credit has been taken against the
estimated deferred tax liability attributable to the unrealized gains arising in
the three and six month periods ended May 31, 2002. At November 30, 2001, full
valuation allowances were taken against the estimated deferred tax assets
attributable to the unrealized losses based on the absence of other appreciated
capital gain property. The components of comprehensive income (loss) are
presented below:
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- -----------------------
MAY 31, MAY 31, MAY 31, MAY 31,
2002 2001 2002 2001
-------- ---------- ---------- -----------
Net income (loss) ............................ $713,043 $1,015,484 $2,116,460 $(2,755,375)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments ........ (21,057) -- (20,788) --
Unrealized gain (loss) from available-for-sale
securities, arising during the period,
net of income taxes of $ -0- ................. 47,723 266,683 29,736 430,480
Less: reclassification adjustment for loss
realized in net income ....................... -- -- -- 4,190,207
-------- ---------- ---------- -----------
Comprehensive income ............................ $739,709 $1,282,167 $2,125,408 $1,865,312
======== ========== ========== ===========
8
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
5. ADVERTISING AND MARKETING COSTS
Currently, the material portion of the Company's advertising and marketing
costs are comprised of (1) costs associated with the transmission of e-mail
marketing messages, both from internal sources and external third party vendors
(2) costs associated with the purchase of on-line consumer data, and (3) email
program promotional and creative development costs. Such costs are charged to
operations (1) at the time of the email transmission, (2) upon receipt of the
qualified consumer data, and (3) at the time the promotional and creative
services are provided, respectively, and are included as a component of cost of
sales.
In certain cases where the Company makes payment for consumer data, on-line
media, or prepays for commercial email delivery, in advance of the receipt or
provision of such items, the Company expenses such prepayments ratably over the
shorter of the contract period or to the extent of actual fulfillment.
Total advertising and marketing costs, included in the cost of sales, for
the three months ended May 31, 2002 and 2001 were approximately $3,288,000 and
$1,494,000, respectively, and for the six months ended May 31, 2002 and 2001
were approximately $6,576,000 and $2,307,000, respectively.
Included in prepaid expenses and other current assets at May 31, 2002 and
November 30, 2001, were approximately $112,000 and $324,000, respectively,
relating to the unamortized portion of prepayments related to marketing
arrangements.
6. MARKETABLE SECURITIES AND LONG-TERM INVESTMENTS, AT COST
During the current quarter and six months ended May 31, 2002, the Company
did not have any material events regarding its marketable securities or
long-term, cost-based investments.
During the prior fiscal year's three-month period ended February 28, 2001,
the Company recognized losses (through a permanent impairment charge) of
$4,190,207 on certain of its available-for-sale marketable securities. The
underlying securities' historical carrying values were reduced to their related
closing prices at February 28, 2001, giving effect to the prior year's permanent
impairment charge. The Company had continually evaluated the carrying value of
such investments, and in terms of risk at the individual company level coupled
with risk at the market level, the Company's prior year evaluation indicated
that the decline in the related securities was "other-than-temporary". As a
result of this analysis, the Company adjusted the "cost basis" of these
securities, effective February 28, 2001, to the closing prices on that date and
realized the corresponding loss during the three-month period ended February 28,
2001. This loss is included in the Company's other income (expense), "Permanent
impairment charges" for the six months ended May 31, 2001.
During the fiscal year ended November 30, 2000, the Company had invested
approximately $500,000 in a private company, and carried the investment under
the cost method. After continued review of such investment, and the investment's
consistent failure to achieve significant goals set forth in its business and
financing plans, such investment fell within the Company's impairment evaluation
criteria. According to the above analysis, the Company's impairment loss for the
six months ended May 31, 2001 amounted to $500,051, and is included as a
component of other income (expense) "Permanent impairment charges" for the six
months ended May 31, 2001.
7. TALK AMERICA, INC. ARBITRATION AWARD
During the year ended November 30, 2001, the Company was successful in its
legal action against Talk America, Inc. ("Talk"), resulting in an approximate
$6.2 million arbitration award. The award represented restitution for long
distance customers delivered to Talk, and for lost profits suffered by the
Company due to Talk's
9
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
wrongful termination of an agreement between the parties. During the year ended
November 30, 2001, the Company collected the first installment of $3.7 million
resulting from the arbitration award. The first installment was included as
revenue in the Company's fourth quarter of the fiscal year ended November 30,
2001, as it was deemed to relate to the lost profit portion of the arbitration
settlement. During the six months ended May 31, 2002, the Company received the
final installment, with interest, from Talk in the sum of approximately $2.54
million. The final installment represented approximately $227,000 in lost
profits for long distance customers delivered to Talk and, as such was included
as revenue during the six months ended May 31, 2002. The balance of the second
and final installment, or approximately $2.3 million represented liquidated
damages. The liquidated damage portion of the final installment is included in
the Company's "Other income(expense)" income statement caption, and is grouped
within that caption's "Other non-operating income(expense)" sub-set. The balance
of the second installment, or $227,000, is included in the Company's revenues,
with approximately $158,000 included in the Company's E-commerce segment, and
the balance of approximately $70,000 included in the Company Off-line Marketing
Services segment.
8. SEGMENT INFORMATION
Historically, the Company's reportable operating segments are aligned into
three fundamental areas: (1) Internet Commerce billed directly to the Company's
marketing partners and corporate customers, as well as consumers (E-commerce),
(2) Off-line Marketing services billed directly to long distance carriers,
wireless carriers and other service providing businesses (Off-line Marketing
services) and (3) Products and Services billed to consumers by Local Exchange
Carriers (LEC Billed products and services-inactive during the three and six
month periods ended May 31, 2002). The balance of the Company's operations,
immaterial individually and in the aggregate, are included as part of Corporate
and other. This business segment delineation is consistent with the Company's
management and financial reporting structure based on products and services. The
Company evaluates performance based on many factors, with the primary criteria
being each segment's gross profit and EBITDA, which the Company has defined as
net income excluding (i) special charges, (ii) interest expense, (iii) interest
and dividend income, (iv) net gains (losses) on the sale of marketable
securities, (v) long-lived asset impairment charges, (vi) gains on non-monetary
cost basis exchanges, (vii) other non-operating income, (viii) minority interest
income (loss), (ix) depreciation, (x) amortization and (xi) income taxes. The
Company shares a common workforce and office headquarters, which precludes an
allocation of all overhead components. Overhead items that are specifically
identifiable to a particular segment are applied to such segment and all other
overhead costs are included in Corporate and other. The following tables set
forth the Company's financial results, by management performance criteria, by
operating segment. All revenues are from non-intersegment sources; therefore no
intersegment elimination applies.
SEGMENT DATA -- NET REVENUE
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- -------------------------
MAY 31, MAY 31, MAY 31, MAY 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
For the periods:
E-commerce .............................. $ 9,549,917 $5,510,106 $21,184,367 $ 9,630,672
Off-line Marketing Services ............. 1,254,621 -- 1,991,068 --
LEC Billed Products and Services ........ -- 318,437 -- 1,123,425
Corporate and other ..................... -- -- -- --
----------- ---------- ----------- -----------
CONSOLIDATED TOTALS ................... $10,804,538 $5,828,543 $23,175,435 $10,754,097
=========== ========== =========== ===========
10
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEGMENT DATA -- GROSS PROFIT
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- -------------------------
MAY 31, MAY 31, MAY 31, MAY 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
For the periods:
E-commerce ................................... $6,282,821 $3,933,121 $14,603,882 $7,146,028
Off-line Marketing Services .................. 1,138,513 (16,176) 1,809,738 (29,303)
LEC Billed Products and Services ............. -- 263,861 -- 1,011,770
Corporate and other .......................... -- -- -- --
---------- ---------- ----------- ----------
CONSOLIDATED TOTALS ........................ $7,421,334 $4,180,806 $16,413,620 $8,128,495
========== ========== =========== ==========
SEGMENT DATA -- EBITDA
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- -------------------------
MAY 31, MAY 31, MAY 31, MAY 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
For the periods:
E-commerce ................................... $1,945,829 $1,884,156 $ 5,145,354 $ 3,122,787
Off-line Customer Acquisition Services ....... 254,311 (102,881) 291,681 (237,949)
LEC Billed Products and Services ............. -- 167,195 -- 833,981
Corporate and other .......................... (959,863) (745,917) (2,047,270) (1,562,075)
---------- ---------- ----------- -----------
CONSOLIDATED TOTALS ........................ $1,240,277 $1,202,553 $ 3,389,765 $ 2,156,744
========== ========== =========== ===========
SEGMENT DATA -- DEPRECIATION AND AMORTIZATION
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- -------------------------
MAY 31, MAY 31, MAY 31, MAY 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
For the periods:
E-commerce ................................... $173,864 $19,503 $338,545 $25,937
Off-line Customer Acquisition Services ....... 6,484 -- 10,987 --
LEC Billed Products and Services ............. -- -- -- --
Corporate and other .......................... 68,393 59,601 132,904 114,960
-------- ------- -------- --------
CONSOLIDATED TOTALS ........................ $248,741 $79,104 $482,436 $140,897
======== ======= ======== ========
9. ASSET ACQUISITIONS
In December 2001, the Company acquired the assets of the following two
entities for a total cost of $1,676,682. The components of the asset purchase
prices are set forth following the descriptions of the assets acquired:
o InfiKnowledge, a software development and Internet services firm based
in New Brunswick, Canada, with the key assets purchased including an
email delivery system, a suite of over 50 on-line games, as well as a
team of highly skilled, interactive game developers who, the Company
believes, possesses the capabilities to enhance, develop and add support
to its on-line marketing business and provide the foundational assets to
allow the Company to internalize its email delivery platform through
capital expenditures, thereby reducing its reliance on third party email
delivery vendors.
o ThanksMuch, a Woodmere, New York based company that specializes in the
on-line sale of costume jewelry and other small gift items. The Company
anticipates that the assets acquired, coupled with the man-
11
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
agement team who will continue to run the business, will be utilized to
provide an opportunity for increased revenue, gross profits and cash
flows in future fiscal periods.
The total purchase price for these two acquisition was: (a) cash of
$897,500, of which $697,500 was paid simultaneous with the respective asset
acquisition closings in December 2001 and $200,000 of which is payable to the
sellers of Infiknowledge on December 6, 2002 and which is included as a
component of the Company's accrued expenses as at May 31, 2002; and (b) 117,521
shares of the Company's common stock, valued at $6.20 per share (the average
closing prices of the Company's stock for the period December fourth to December
tenth of 2001), which accounted for the additional consideration in the
InfiKnowledge asset acquisition. Of the total share consideration, 39,174 of
such shares were issued at the closing of the InfiKnowledge acquisition and
78,347 shares remain issuable, with 39,174 shares to be issued on December 6,
2002 and 39,173 shares to be issued on December 6, 2003. The issuable shares
were considered as outstanding common shares in the computation of both basic
and diluted weighted shares outstanding for the period December 6, 2001 to May
31, 2002. Goodwill and other intangible assets recognized in the transactions
amounted to $1,477,000, of which approximately 90%, or $1.3 million, is expected
to be deductible for income tax purposes. The goodwill and other intangibles
were assigned to the E-commerce segment. The purchase price allocation has yet
to be finalized pending the review of certain items regarding identifiable
intangibles and goodwill. It is estimated that this review will be completed in
the quarter ending August 31, 2002 and such final allocation is anticipated to
have an immaterial impact, if any, on amortization expense.
10. LITIGATION
1. NANCY GAREN-- On or about October 16, 2001, Nancy Garen, author of
"Tarot Made Easy", commenced an action against a series of defendants, including
the Company, in the United States District Court for the Central District of
California, entitled NANCY GAREN V. STEVEN L. FEDER, PETER L. STOLZ, THOMAS H.
LINDSEY, GALACTIC TELCOM, INC., ACCESS RESOURCE SERVICES, INC., PSYCHIC READERS
NETWORK, INC. D/B/A MISS CLEO, OSHUN 5 COMMUNICATIONS, INC., CIRCLE OF LIGHT,
INC., CENTRAL TALK MANAGEMENT, INC., TRAFFIX, INC., WEKARE READERS &
INTERPRETERS, INC., WEST CORPORATION, AND DOES 1 THROUGH 10 (EDCV 01-790
(VAP-SGLx)). Plaintiff alleges that defendants are liable for a copyright
infringement, contributory copyright infringement, vicarious copyright
infringement, unfair competition, contributory federal unfair competition and
state statutory and common law unfair competition, and further requests a
constructive trust, a temporary restraining order, and damages from alleged
infringement of a copyright or, alternatively, statutory damages for each act of
infringement in "an amount provided by law in excess of $250,000,000", all as
the same may have arisen from the defendants' marketing of tarot card reading
and other psychic services. The Company does not believe that there is any merit
to Ms. Garen's claims as they relate to the Company, has denied the claims in
its answer to the complaint, and intends vigorously to defend against the
claims.
2. MAVIES WINGLER -- On or about May 9, 2001, Mavies Wingler commenced an
action against Group Lotto, Inc. ("GLI"), a wholly-owned subsidiary of the
Company, in the Circuit Court of Logan County, West Virginia. Ms. Wingler claims
to have picked the winning numbers entitling her to $10 million. On June 8,
2001, the action was removed to the United States District Court, Southern
District of West Virginia, and is entitled WINGLER V. GROUPLOTTO, Inc., Docket
Number 2:01 -- CV -- 518. The action is in the discovery stage. The Company does
not believe that there is any merit to Ms. Wingler's claim, and intends
vigorously to defend against it. The Company and GLI have a contract of
indemnification with SCA Promotions, Inc. to be indemnified for prizes paid out
to qualified winners. GLI winners are required to produce the Group Lotto Entry
Notification form ("GLEN") within a specified period of time after matching a
drawing's winning numbers in order to qualify for receipt of the appropriate
prize winnings.
3. DANIEL RODGERS-- In March, 2002, Daniel Rodgers commenced an action
against the Company in Supreme Court of the State of New York, Rockland County.
The complaint alleges that the Company disseminated false
12
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
and misleading advertisements through email advertisements and through the
website of its subsidiary, GroupLotto.com. Mr. Rodgers purports to represent a
class consisting of those who, during the period January 1, 2001 to March 5,
2002, provided their name, address, email address and other biographical
information in response to the email advertisements or in response to the
GroupLotto web page. The Complaint purports to allege claims of common law
fraud, deceptive acts and practices, and false and misleading advertising under
New York law. The Complaint seeks injunctive relief, unspecified monetary
damages, and attorney's fees. The Company has not yet filed an answer to the
Complaint, but believes that there is no merit to the claims and intends
vigorously to defend against them.
4. PHILIP MICHAEL THOMAS-- On June 3, 2002, the American Arbitration
Association rendered an award in the sum of approximately $2.3 million
(inclusive of interest) in favor of the Claimants, in the arbitration entitled
PHILIP MICHAEL THOMAS, PMT PRODUCTIONS INC., KAYE PORTER MANAGEMENT, RMI
ENTERTAINMENT, INC., MILLENNIUM TELEMEDIA, INC., CLAIMANTS V. NEW LAUDERDALE,
LLC D/B/A CALLING CARD CO., PSYCHIC READERS NETWORK, INC. D/B/A PRN
TELECOMMUNICATIONS, AND QUINTEL ENTERTAINMENT, INC., RESPONDENTS (NO.
131400004900). The award consists of approximately $1.48 million in damages,
plus interest at nine percent (9%) from January 1, 1996 and January 1, 1997, or
approximately $785,000. The award also denied Claimants' punitive damages and
all other claims asserted in the arbitration.
The Claimants in the arbitration have filed a motion in an action pending
in the Circuit Court, Broward County, Florida (Thomas et al v. New Lauderdale,
LLC et al, Case No. 98-12259-07) (the "Action"), to confirm the award. The
Respondents in the arbitration have also filed a motion to vacate and\or modify
the award. In addition, the plaintiffs in the Action have filed a motion to be
relieved from a stay of those proceedings in order to pursue claims against the
defendants in the Action which they contend have not been resolved by the
arbitration, including claims for punitive damages against the Company as well
as the individual defendants. The Company has indemnified the individual
defendants in the Action; believes that the arbitration award finally resolves
all claims; and intends vigorously to defend against the plaintiffs' further
pursuit of claims in the Action.
11. SUBSEQUENT EVENTS
On June 3, 2002, the American Arbitration Association rendered an award in
the sum of approximately $2.3 million (inclusive of interest) in favor of the
Claimants, in the arbitration entitled PHILIP MICHAEL THOMAS, PMT PRODUCTIONS
INC., KAYE PORTER MANAGEMENT, RMI ENTERTAINMENT, INC., MILLENNIUM TELEMEDIA,
INC., CLAIMANTS V. NEW LAUDERDALE, LLC D/B/A CALLING CARD CO., PSYCHIC READERS
NETWORK, INC. D/B/A PRN TELECOMMUNICATIONS, AND QUINTEL ENTERTAINMENT, INC.,
RESPONDENTS (NO. 131400004900). The award consists of approximately $1.48
million in damages, plus interest at nine percent (9%) from January 1, 1996 and
January 1, 1997, or approximately $785,000. The award also denied Claimants'
punitive damages and all other claims asserted in the arbitration.
The Company has accrued and recorded this award as a non-operating expense
at May 31, 2002, and for the three months ended May 31, 2002, respectively, as
it results from a segment of the Company's business in which it is no longer
active.
The Claimants in the arbitration have filed a motion in an action pending
in the Circuit Court, Broward County, Florida (Thomas et al v. New Lauderdale,
LLC et al, Case No. 98-12259-07) (the "Action"), to confirm the award. The
Respondents in the arbitration have also filed a motion to vacate and\or modify
the award. In addition, the plaintiffs in the Action have filed a motion to be
relieved from a stay of those proceedings in order to pursue claims against the
defendants in the Action which they contend have not been resolved by the
arbitration, including claims for punitive damages against the Company as well
as the individual defendants. The Company has indemnified
13
the individual defendants in the Action; believes that the arbitration award
finally resolves all claims; and intends vigorously to defend against the
plaintiffs' further pursuit of claims in the Action.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The matters discussed in the following Management's Discussion and Analysis
of Financial Condition and Results of Operations may contain forward-looking
statements and information relating to the Company that are based on the current
beliefs and expectations of Management, as well as assumptions made by and
information currently available to the Company. When used in this Management's
Discussion and Analysis, and elsewhere in this Form 10-Q, the words
"anticipate", "believe", "estimate", and "expect" and similar expressions, as
they relate to the Company are intended to identify forward-looking statements.
Such statements reflect the current views of the Company's management, with
respect to future events and are subject to certain risks, uncertainties and
assumptions, which could cause the actual results to differ materially from
those reflected in the forward-looking statements.
OVERVIEW
We are a leading on-line database marketing company that acquires customers
for, drives consumer traffic to, and generates sales for our corporate clients.
We provide complete end-to-end marketing solutions for companies seeking to
increase sales and customers through on-line marketing programs, and database
development and enhancement programs. The services we offer range from the
development of a complete creative promotion to be used to market the client's
product to consumers, broadcasting the promotion on-line in order to generate
new customers for the client, delivery of data files from the results of
campaigns, creating and hosting the customized websites or web pages necessary
to effect the consumer transaction that drives the clients' sales and generating
comprehensive reporting in order for the client to analyze the effectiveness of
the promotion. We use the proprietary on-line media of our websites,
newsletters, interactive games, email marketing and database of
permission-based, profiled records to generate the customers, sales and/or leads
for our clients. We are paid by our clients primarily on a success- based model;
in that we receive a fee for every lead, customer or sale generated for the
client. In addition to our third party client-based revenue, during fiscal 2002
we began generating revenue from our proprietary products and services (e.g.,
costume jewelry and inexpensive gift items) and from the sales and rentals (for
use both on-line and off-line) of our proprietary, profiled databases.
BACKGROUND
From our inception in 1993 (under the name "Quintel Communications, Inc.")
through 1999, we generated the bulk of our revenue from database marketing using
the traditional media of television, postal mail and telemarketing. In 2000, we
repositioned our database marketing business to the on-line media of the Web.
Applying the direct marketing disciplines honed from our years of operating in
the "off-line" media, our management believes it is able to provide
significantly enhanced response-based results in a more cost-efficient and
scaleable manner via on-line marketing. In addition, as a result of our direct
marketing background, we believe we are able to design on-line marketing
programs to cost-effectively generate traffic and leads for traditional direct
marketing media channels, such as inbound and outbound telemarketing and direct
mail.
ON-LINE MARKETING
We own the free on-line lottery, www.grouplotto.com, as well as a number of
other interactive games, vertical web sites and services on the Web. These
properties are designed to generate real-time response-based marketing.
Consumers are given the opportunity, while on-line, to purchase, sign-up for,
ask to be contacted regarding, or simply indicate an interest in, hundreds of
offers for various products and services provided by our corporate clients and
marketing partners. Specifically through these interactive Web properties we
generate a variety of transactional results for our corporate clients ranging
from (a) Web traffic, (b) inbound telemarketing calls, (c) outbound
telemarketing leads, (d) demographically/psychographically profiled lists of
consumers, (e) highly-targeted customized response-based leads, (f) completed
applications for products, and (g) actual sales of products and services.
14
GROUPLOTTO.COM. The GroupLotto website offers consumers the opportunity to
win up to $10 million daily in a free, on-line lottery. The lottery prizes are
indemnified by an independent, third-party agency. In order to play, each
consumer must provide complete and accurate registration information and agree
to receive ("opt-in") marketing messages from GroupLotto and our marketing
partners. The interactive media on this website includes registration pages,
game banners, and "pop-ups", the purpose of which is to generate web traffic,
leads and sales. Revenue is generated at this website from our corporate clients
who pay for such traffic, leads and sales. We generate our bulk consumer traffic
to this website through email marketing to lists of consumers who have indicated
an interest in our marketing programs by opting in to receive such offers.
Similar to the GroupLotto website, we generate results for our clients
through several other interactive games and products. For example, we market
through a "scratch and win" game that offers consumers the chance to instantly
find out if they have won any number of prizes. The consumer plays the game by
"scratching" with the mouse certain parts of the entry ticket to uncover the
results. These games can also be "pushed" to consumers by delivering them to the
player's email inbox.
We own and operate several other websites such as prizecade.com,
atlas-credit.com, altas-education.com, jewel-claim-center.com and
games-to-win.com. We use these sites to generate revenue from our clients in a
similar manner as the GroupLotto model. We believe these sites could also offer
other new revenue opportunities, such as brand marketing. For the three months
ended May 31, 2002, these sites contributed immaterially to the net revenue and
operating income of the Company.
EMAIL MARKETING. One of our most important revenue sources is direct
marketing via email. Each program that we market for our clients can be
implemented not only through the website, interactive games and "pop-ups"
discussed above, but also, and often primarily, through email marketing. We
currently have approximately 50 million profiled, permission-based records,
which have been acquired under a number of affinity group based brands.
Compared to postal marketing and telemarketing, email marketing is
significantly less expensive, offers much faster response times, and, we
believe, provides for a more rich consumer media experience. We now own an email
delivery system, which reduces our dependence on third party vendors and further
reduces the expenses associated with delivering our monthly commercial email
messages. FOR A FURTHER DISCUSSION OF RECENT BUSINESS AND LEGAL DEVELOPMENTS
REGARDING THIS SUB-SEGMENT, AND SPECIFICALLY EMAIL MARKETING, SEE "--RESULTS OF
OPERATIONS."
One of the attractive features for clients, and, we believe, a significant
competitive advantage, is our ability to create and test a variety of marketing
campaigns for prospective and existing corporate clients at no risk to the
client. Since we own extensive databases, manage a creative department, and can
deliver email at a low cost, we are able to offer prospective and existing
clients the opportunity to test market new products, services, price points and
creative concepts in order to determine if an on-line campaign works for the
client and which campaigns work most effectively.
Even after campaigns are fully implemented, we further analyze the
marketing results to gauge whether the campaigns are continuing to generate
adequate results for the client, whether the media is being utilized
cost-efficiently, and to determine whether new and different copy is yielding
better overall results. These are the traditional direct-marketing disciplines,
which we believe, when applied together with our proprietary databases, delivery
systems and reporting systems, distinguish us from our competitors in the
on-line marketing industry.
SYNDICATION. After we develop a campaign that works efficiently on our
proprietary media, we often "syndicate" the program to third-party media.
Typically, we have expended time, media and other costs in developing certain
campaigns. In exchange for this invested effort, we obtain the right to market
those campaigns to a list of other online media companies. We enter into
agreements with these other on-line media companies to run the campaigns
generally on a fee-share arrangement. We believe these media companies benefit
by receiving an immediately marketable, fully-packaged and tested marketing
program. As a result, we believe we are able to
15
leverage campaigns we have developed (including our proprietary products and
services) so that we can generate additional revenue with virtually no costs or
risks associated with such business extension.
PROPRIETARY PRODUCTS AND SERVICES
A new business unit, which we introduced during the three months ended
February 28, 2002, is the on-line marketing of our own products and services.
For example, one of our websites, Thanksmuch.com, now sells inexpensive costume
jewelry and other gift items directly to consumers. When a consumer selects a
gift item and tenders his credit card, he is given the opportunity to purchase
other, more valuable products and services at special discounts. In addition to
the Thanksmuch line of jewelry and gifts, we are developing and testing other
products and services for direct marketing to consumers. No assurances can be
given, however, that these anticipated sources of revenue will generate any
significant income to our operations in future fiscal periods, if at all. During
the three months ended May 31, 2002, the Thanksmuch.com website generated
approximately $622,000, or approximately 6% of net revenue, with an approximate
$120,000 contribution to income from operations from such revenue.
Our expansion in, and dependence on, our on-line direct marketing efforts,
coupled with the continued unproven reliability and profitability of such
efforts, the potential for state and/or federal legislation limiting online
marketing's consumer contact capability, and the potential for seasonality
within the E-commerce marketplace, should all be considered when referring to
our current three and six month results, as well as prior historical results, in
evaluating the potential for our future operations, cash flows, and financial
position.
BASIS OF PRESENTATION
Certain amounts for the prior period that are presented in the accompanying
unaudited consolidated financial statements, and referred to in the discussions
below, have been reclassified to conform with the current period presentation.
SEGMENT INFORMATION
Segments are defined as components of an enterprise for which separate
financial information is available that is evaluated regularly by the chief
operating decision maker(s) in deciding how to allocate resources and in
assessing performance. Disclosure is also required about products and services,
geographic areas and major customers.
During the three and six month periods ended May 31, 2002 and 2001, we
generated revenue from the following segments: E-Commerce, Off-line Marketing
and, for fiscal 2001 only, LEC Billed Products. The E-Commerce segment realized
significant growth during the six months ended May 31, 2002 and the fiscal year
ended November 30, 2001, when compared to the prior comparable periods, and
currently represents the core of our business operations. Revenue in the
E-commerce segment is generated primarily from marketing of third party products
and services on our websites and through e-mail promotions. The Off-Line
Marketing services segment consists of revenue generated by us through off-line
direct marketing channels. Historically, this segment's activities were
primarily telemarketing for the acquisition of long distance and wireless phone
customers for the respective carriers. Currently, this segment also includes
Montvale Management, LLC and its provision of net branch services to qualified
mortgage banking and lending institutions. The LEC Billed Products segment
represented telecommunications-related products and services marketed by us
directly to consumers who were billed by local exchange carriers on the
consumer's telephone bill. This segment was inactive during the six months ended
May 31, 2002.
The Company evaluates performance based on many factors, with the primary
criteria being each segment's gross profit and EBITDA, which is net income
excluding (i) special charges, (ii) interest expense, (iii) interest and
dividend income, (iv) realized net (losses) gains on marketable securities, (v)
permanent impairment charges, (vi) gains on nonmonetary cost basis exchanges,
(vii) other nonoperating income (loss), (viii) minority interest income (loss),
(ix) depreciation, (x) amortization and (xi) income taxes. The Company shares a
common workforce and office headquarters, which precludes an allocation of all
overhead components. Overhead items that are specifically identifiable to a
particular segment are applied to such segment and all other overhead costs are
included in Corporate and other.
16
RESULTS OF OPERATIONS
The following is a discussion of the financial condition and results of
operations of the Company for the three and six-month periods ended May 31, 2002
and May 31, 2001, respectively. It should be read in conjunction with the
Company's Form 10-K as filed for the year ended November 30, 2001, the Notes
thereto and other financial information included elsewhere in this report.
THREE MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001
The Company's net revenues, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the three month periods
ended May 31, 2002 and May 31, 2001, are detailed in the following tables:
SEGMENT DATA -- NET REVENUES, BY SEGMENT COMPONENT
THREE MONTHS ENDED MAY 31, CHANGE CHANGE
--------------------------- INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE COMPONENTS
GroupLotto and other web sites ...................... $ 1,802,829 $1,404,383 $ 398,446 28%
Net branch commission fees .......................... 202,248 -- 202,248 100%
Email marketing programs ............................ 5,548,049 2,897,310 2,650,739 91%
Data sales and rentals .............................. 1,329,542 1,208,413 121,129 10%
Sales of jewelry and gifts .......................... 622,459 -- 622,459 100%
Internet game development and other ................. 44,790 -- 44,790 100%
----------- ---------- ---------- -----
TOTAL E-COMMERCE .................................... 9,549,917 5,510,106 4,039,811 73%
----------- ---------- ---------- -----
OFF-LINE MARKETING SERVICE COMPONENTS
Net branch commission fees .......................... 1,185,682 -- 1,185,682 100%
Other off-line marketing ............................ 68,939 -- 68,939
----------- ---------- ---------- -----
TOTAL OFF-LINE MARKETING SERVICE .................... 1,254,621 -- 1,254,621 100%
----------- ---------- ---------- -----
LEC BILLED PRODUCTS AND SERVICES COMPONENTS
Enhanced Services, principally voice mail ........... -- 318,437 (318,437) -100%
----------- ---------- ---------- -----
TOTAL LEC BILLED PRODUCTS AND SERVICES .............. -- 318,437 (318,437) -100%
----------- ---------- ---------- -----
CORPORATE AND OTHER COMPONENTS
Miscellaneous products, list revenue and other ...... -- -- -- 0%
----------- ---------- ---------- -----
TOTAL CONSOLIDATED NET REVENUE ...................... $10,804,538 $5,828,543 $4,975,995 85%
=========== ========== ========== =====
Net Revenue increased $4,975,995, or 85%, to $10,804,538 for the three
months ended May 31, 2002 from $5,828,543 in the comparable prior year period.
The primary component of the increase was attributable to an approximate $4
million increase in the Company's E-commerce segment net revenues, combined with
an increase of approximately $1.3 million in net revenue from the Company's
Off-line Marketing services segment. Such increases were partially offset by a
decrease of $318,437 in the Company's LEC Billed Product and Services legacy
segment. The E-commerce segment revenue increase resulted from the Company's
increasing focus on generating revenue from its current core business, on-line
direct marketing. The Company expects this segment to continue to represent the
substantial part of the Company's revenue in future fiscal periods. The Company
is assessing the potential of an increased emphasis of revenue generation from
off-line, conventional direct marketing activities and will implement the
strategy if deemed beneficial for the Company. Currently, the Company is using
its on-line databases to enhance third party off-line databases through the
application of overlay technology, whereby databases are appended to one
another, effectively increasing the depth of consumer related information within
the appended database.
17
The growth in the Company's E-commerce segment was primarily attributable
to approximately $5.5 million in revenue generated from the segment's E-mail
marketing program sub-set. This represented an approximate $2.6 million increase
over the prior year's $2.9 million in revenue generated from such segment's
sub-set. This substantial increase of approximately 91% over the prior year's
comparable period was primarily the result of the Company's acquisition of
significant volumes of permission-based email records, extension of the quantity
and quality of third party (client) offers being emailed to the databases and
greater effectiveness in the Company's email delivery programs. In the prior
year's comparable period, the Company had been in the early stages of developing
and carrying out its online strategy, and as such had not benefited from these
efficiencies. The sub-set of E-mail marketing program revenue represented
approximately 51% of the Company's consolidated net revenue for the three months
ended May 31, 2002.
During the three months ended May 31, 2002, the Company experienced
problems with the delivery of its email promotional offers. Such problems
reduced revenue and income from the E-Commerce sub-segment. The Company believes
that the significant component of the email delivery problem is attributable to
Internet Service Providers that unilaterally block commercial emails from
reaching their consumer subscribers. The Company has addressed the issue by
deploying new reinforced delivery platforms with increased redundancy and
expanded diversification using both internal and external emailing resources.
Although the Company has conceived of a number of programs to address this
specific problem, there can be no assurance that any of these programs will work
effectively, or can be timely implemented.
Any further changes in the Internet operating landscape that materially
hinders the Company's current ability and/or cost to deliver commercial email
messages to the consumer records in its databases, and the consumer records in
the databases of its affiliates, could potentially cause a material impact on
net revenue and gross margin and, therefore, its profitability and cash flows
could be adversely affected. Various state laws exist, and federal legislation
is currently pending, that limit the Company's ability to deliver commercial
e-mail messages to consumers. There are presently no federal laws that regulate
sending unsolicited email. The pending federal bills and existing state laws
require that certain "opt-out" procedures be included in emails and prohibit
"false routing" or "fictitious address" information. Existing state, and pending
federal, laws require functioning return e-mail addresses and that valid postal
addresses be included by the senders of commercial email messages. Some states
require an "ADV" label in the subject line, and proscribe false header or
misleading subject lines. Attorneys General and/or consumers are given authority
to enforce the state laws. States with legislation affecting the sending of
unsolicited commercial email include: California, Colorado, Connecticut,
Delaware, Idaho, Illinois, Iowa, Louisiana, Maryland, Missouri, Nevada, North
Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, Tennessee, Utah, Virginia,
Washington and West Virginia. If strict federal legislation is subsequently
written into law, with its terms specifically limiting the Company's ability to
market its offers, the Company could potentially realize a material adverse
impact in future fiscal period net revenue growth, and therefore, profitability
and cash flows could be adversely affected.
The Company's E-commerce segment's web site sub-set realized an increase in
revenues of approximately $398,000, or 28%, when comparing the current three
months ended May 31, 2002 ($1.8 million in revenue) with the three months ended
May 31, 2001 ($1.4 million in revenue). This increase is the result of the
Company's shift from low priced "click through" revenue to higher generating
registration, lead generation and on-line customer acquisition based revenue.
The Company generates a significant portion of its site traffic from email
marketing. SEE THE PRECEDING PARAGRAPH FOR A FURTHER DISCUSSION OF RECENT
BUSINESS AND LEGAL DEVELOPMENTS ATTRIBUTABLE TO EMAIL MARKETING.
Additional increases in the Company's consolidated revenues were
attributable to new sub-sets added to the E-commerce segment during the three
months ended May 31, 2002 when compared to the three months ended May 31, 2001.
The combined revenue resulting from the new sub-sets amounted to $869,497 and is
detailed as follows: (a) $202,248 of such increase relates to the Company's
majority-owned subsidiary (Montvale Management LLC) that provides services under
a net branch agreement with licensed mortgage banking and brokerage companies in
the acquisition of candidates for new mortgages and the refinancing of existing
debt, which subsidiary also conducts the same services off-line and is the sole
component of the Company's Off-line Marketing Services segment revenue of
$1,185,682; (b) $622,459 of such increase relates to the on-line sales of
jewelry and gifts by the Company's new subsidiary, ThanksMuch, Inc., which was
formed with the assets acquired from a closely held private company on December
14, 2001, all as more fully described in Note 8 to the financial statements; and
(c) $44,790 of such increase relates to the Internet game development revenues
generated by the Company's new subsidiary, InfiKnowledge ULC, which was formed
with the assets acquired from a private Canadian company on December 6, 2001,
all as more fully described in Note 8 to the financial statements.
The increases in revenues from the Company's E-commerce segment and
Off-line Marketing Services segment were partially offset by a decrease of
$318,437 in revenues from the Company's LEC Billed Products and Services
18
segment. Such decrease resulted from the Company's elimination of billing voice
mail services under its contract with the service bureau known as Federal
Transtel, Inc. ("FTT") in October 2001. FTT has since filed for protection under
the United States Bankruptcy Code.
See "Transactions with Major Customers" and the Securities and Exchange
Commission's ("SEC") mandated FR-60 disclosures following the "Liquidity and
Capital Resources" section for a further discussion of the significant customer
concentrations, critical accounting policies and estimates, and other factors
that could affect future results.
The Company's cost of revenues during the three months ended May 31, 2002
and May 31, 2001 are comprised of direct and indirect marketing costs associated
with the (1) acquisition of consumer data, (2) costs of email delivery, (3)
premium fulfillment costs and (4) contingent-based prize indemnification
expense, billing and collection fees, and customer service costs.
The Company's cost of sales, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the three month periods
ended May 31, 2002 and May 31, 2001 are set forth below:
CONSOLIDATED COST OF SALES, BY SEGMENT, BY COMPONENT
FOR THE THREE MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Email marketing and related delivery costs ........... $1,141,215 $ 699,695 $ 441,520 63%
Data purchases and premium costs ..................... 1,960,386 747,755 1,212,631 162%
Promotional, creative and other costs ................ 69,959 30,404 39,555 130%
---------- ---------- ---------- -----
TOTAL E-COMMERCE ADVERTISING .................... $3,171,560 $1,477,854 $1,693,706 115%
---------- ---------- ---------- -----
SERVICE BUREAU FEES
Contingent based prize indemnification costs ......... $ 95,536 $ 99,131 (3,595) -4%
---------- ---------- ---------- -----
TOTAL E-COMMERCE COST OF SALES .................. $3,267,096 $1,576,985 $1,690,111 107%
---------- ---------- ---------- -----
OFF-LINE MARKETING SERVICES
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Telemarketing, direct mail and related costs ......... $ 116,108 $ 16,176 $ 99,932 618%
TOTAL OFF-LINE MARKETING COST OF SALES .......... $ 116,108 $ 16,176 $ 99,932 618%
---------- ---------- ---------- -----
LEC BILLED PRODUCTS AND SERVICES
SERVICE BUREAU FEES
Billing and collection fees .......................... $ -- $ 54,576 (54,576) -100%
---------- ---------- ---------- -----
TOTAL LEC BILLED COST OF SALES .................. $ -- $ 54,576 (54,576) -100%
---------- ---------- ---------- -----
TOTAL COST OF SALES ........................... $3,383,204 $1,647,737 $1,735,467 105%
---------- ---------- ---------- -----
Cost of sales on a consolidated basis increased $1,735,467, or 105%, to
$3,383,204 for the three months ended May 31, 2002 from $1,647,737 in the
comparable prior year period.
On a segmental level, the Company's E-commerce segment cost of sales
increased, on a net basis, approximately $1.7 million, or 107%, to $3.3 million
during the three months ended May 31, 2002, when compared to $1.6 million
incurred in the prior year's comparable period. The Company's continuing
strategy of generating revenues primarily from direct marketing campaigns
delivered on-line was the significant factor contributing to this increase. The
Company realized marketing costs for email delivery of approximately $1.1
million in the current fiscal quarter ended May 31, 2002, representing an
increase of $441,520, or 63%, when compared to approximately $700,000 in email
delivery costs incurred in the prior year's comparable period. In December 2001,
the
19
Company acquired the assets of a Canadian-based technology company
(InfiKnowledge). The Company continues to expect that the integration of the
acquired assets, technology and human resources into its operations and email
delivery platform will continue to reduce the unitary costs of its email
promotions and serve to preserve and/or improve operating margins. SEE THE
PRECEDING "NET REVENUE" SECTION FOR A FURTHER DISCUSSION OF RECENT BUSINESS AND
LEGAL DEVELOPMENTS ATTRIBUTABLE TO EMAIL MARKETING.
The Company realized costs of approximately $1,200,000 for data purchases
necessary to build and maintain its marketing databases. In addition, the
Company realized cost of approximately $746,000 for premium costs related to
redemption obligations for certain of its marketing program offers. These costs
represent an increase of approximately $1.2 million, or 162%, over data purchase
costs of $747,755 during the three months ended May 31, 2001. In the prior
fiscal year's comparable period, the Company had immaterial costs relative to
redemption obligations.
The Company uses the services of an agency for the provision of
indemnification coverage in the event the GroupLotto site produces a winner in
one of its free on-line lottery games. The costs attributable to the provision
of such indemnification coverage decreased approximately $3,600, or 4%, when
compared with the fiscal period ended May 31, 2001. The reason for this decrease
was due to an approximate 7% decrease in the games played at the GroupLotto.com
website.
The Company's Off-line Marketing Services segment's cost of sales increased
$99,932, or 618%, to $116,108, when compared to $16,176 during the three months
ended May 31, 2001. The increase was attributable to the Company's
majority-owned subsidiary (Montvale Management LLC), which was inactive during
the three months ended May 31, 2001.
The balance of the decrease in cost of goods sold relates to the LEC Billed
Product and Service segment and amounted to a reduction of $54,576. This
reduction resulted from the Company's elimination of billing voice mail services
under its contract with the service bureau Federal Transtel, Inc. ("FTT") in
October 2001. FTT has since filed for protection under the United States
Bankruptcy Code.
The Company's gross profit in terms of dollars, on a segmental basis, and
the Company's gross profit percentage, on a segmental basis, for each of the
three month periods ended May 31, 2002 and 2001 are set forth below:
CONSOLIDATED GROSS PROFIT, BY SEGMENT
FOR THE PERIODS:
THREE MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-commerce ..................................... $6,282,821 $3,933,121 $2,349,700 60%
Customer Acquisition services .................. 1,138,513 (16,176) 1,154,689 100%
LEC Billed products and services ............... -- 263,861 (263,861) -100%
---------- ---------- ---------- -----
CONSOLIDATED TOTALS ............................ $7,421,334 $4,180,806 $3,240,548 78%
========== ========== ========== =====
CONSOLIDATED GROSS PROFIT PERCENTAGES, BY SEGMENT
FOR THE PERIODS:
THREE MONTHS ENDED ABSOLUTE RELATIVE
--------------------------- PERCENTAGE PERCENTAGE
MAY 31, MAY 31, CHANGE CHANGE
2002 2001 INC (DEC) INC (DEC)
----------- ----------- ----------- -------
E-commerce ..................................... 65.8% 71.4% -5.6% -7.8%
Customer Acquisition services .................. 90.7% 0.0% 90.7% 100.0%
LEC Billed products and services ............... 0.0% 82.9% -82.9% -100.0%
---- ---- ----- ------
CONSOLIDATED GROSS PROFIT PERCENTAGE ........... 68.7% 71.7% -3.0% -4.2%
==== ==== ===== ======
20
Consolidated Gross Profit Percentage ("Gross Margin") as a percentage of
net revenue was 68.7% during the three months ended May 31, 2002, compared to
71.7% in the prior year's comparable fiscal period, representing an absolute
percentage point decrease of 3%, or a 4.2% decline on a relative basis. On a
segmental basis, the Company's E-commerce segment accounted for the majority of
the decrease in margin when compared to the prior year's comparable fiscal
period. The 5.6% absolute percentage point decrease resulted from the Company's
increased costs associated with data purchases, which are fully expensed at the
time of the data's receipt. The Company anticipates that this expensing policy
could provide a margin improvement benefit in future fiscal periods through the
continued marketing to such acquired data. An additional factor contributing to
the slight decline in the gross margin percentage is attributable to the costs
of fulfillment obligations related to the Company's marketing program conducted
for a long distance service provider. Such costs approximated $746,000 in the
quarter ended May 31, 2002. During the prior year's comparable period, the
Company did not have an email program that generated significant fulfillment
costs. Changes in the gross margins generated from the Company's Off-line
Marketing Services segment and LEC Product and Services segment primarily offset
each other in terms of percentage changes.
The Company's Selling Expenses and General and Administrative Expenses for
each of the three months ended May 31, 2002 and May 31, 2001 are presented, on a
segmental basis, and with the components of the individual segments, in the
tables set forth below:
FOR THE PERIODS:
THREE MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE
Fee share commissions .......................... $ 900,173 $251,986 $ 648,187 257%
Other commissions .............................. 473,223 -- 473,223 100%
Selling salaries and related expenses .......... 417,868 318,288 99,580 31%
Occupancy and equipment costs .................. 4,515 4,305 210 5%
Travel and entertainment ....................... 59,648 78,401 (18,753) -24%
---------- -------- ---------- -----
TOTAL SELLING-- E-COMMERCE SEGMENT ........ $1,855,427 $652,980 $1,202,447 184%
---------- -------- ---------- -----
OFF-LINE MARKETING SERVICES
Fee share commissions .......................... $ -- $ -- $ -- 0%
Other commissions .............................. -- -- -- 0%
Selling salaries and related expenses .......... 458,335 -- 458,335 100%
Occupancy and equipment costs .................. 45,889 -- 45,889 100%
Travel and entertainment ....................... 11,124 -- 11,124 100%
---------- -------- ---------- -----
TOTAL SELLING-- OFF-LINE SEGMENT .......... $ 515,348 $ -- $ 515,348 100%
---------- -------- ---------- -----
Consolidated Totals ..................... $2,370,775 $652,980 $1,717,795 263%
========== ======== ========== =====
Selling expenses on a consolidated basis increased approximately $1.7
million, or 263%, from $652,980 during the three months ended May 31, 2001 to
$2,370,775 during the three months ended May 31, 2002. The increase was
primarily attributable to the Company's E-commerce segment, with an increase of
approximately $1.2 million, and increases of $515,348 in selling expenses in the
Company's Off-line Marketing Services segment.
The significant factors contributing to the increase in selling expenses
were (a) increased fee share commissions ($648,187) and other sales related
commissions ($473,223) incurred in the Company's E-commerce segment (see below
for a detailed description of this expense category); and (b) increased selling
based compensation of $99,580, arising from the expansion of the E-commerce
segment's sales force and selling activities.
21
Regarding the increase in fee share commissions, during the fiscal year
ended November 30, 2001, the Company significantly expanded the practice of
marketing promotional offers on behalf of its marketing clients ("Clients") to
third party databases on a fee share commission basis. The fee share commission
relationship generally arises after the Company concludes a contractual
arrangement with a Client pursuant to which the Company modifies or develops
the:(i) copy, (ii) offer form and (iii) promotional materials for the Client's
product or service. The Company then tests the promotion, and agrees to deliver
a minimum level of new customers, and/or targeted leads to the Client.
Simultaneously with the execution of these contractual arrangements, the Company
often obtains the rights from the Client to market their promotions to a list of
third parties with whom the Company has marketing relationships (the "Third
Parties"). The Company enters into contracts with each Third Party with whom it
intends to market Client promotions. The terms of these agreements generally
provide that the Third Party has the right to (i) approve the creative materials
for each promotion, (ii) approve the timing of each promotion's mailing, (iii)
terminate the contract on short notice, and (iv) reject any promotion for any
reason. Each agreement also restricts the third party from doing business with
the client other than through the Company for the period of time covered by the
agreement, and sets forth the terms of the Third Party's compensation. Payments
are performance based only and are either fixed fees paid for each customer or
lead generated for the Client, or a revenue share that is a percentage of the
revenue generated (after deduction for certain direct costs) by the Company for
marketing that offer to the Third Party database. The Company utilizes unique
Universal Resource Locater identifier links ("URLs") when promotions are mailed
to the Third Party database. It is the unique URL's that form the tracking
mechanism by which the Client reports results to the Company, and the Company is
able to account for revenue generated under the fee share arrangement with Third
Parties. In addition, the Company manages third party databases on a revenue
share basis. Amounts payable to the third parties under these programs are
captured in the "fee share commission" category of selling expense.
Selling expenses within the Company's Off-line Marketing Services segment
increased $515,348, or 100%, when compared to the prior year's comparable
period. The Company expects that in the balance of the fiscal year ended
November 30, 2002 it will continue to realize quarterly increases in this
segment's selling expenses based on the anticipated expansion of the operations
of its majority owned subsidiary, Montvale Management LLC, which conducts
business off-line, as well as on-line, as a net branch for licensed mortgage
banking and brokerage companies.
The Company's general and administrative expenses ("G&A") are principally
comprised of (i) compensation costs and related expenses for executive, finance,
information systems and general administration personnel, (ii) professional fees
(which include legal; audit, accounting and tax; public relations; database
management and consulting; and public company related printing costs), (iii)
insurance costs, (iv) occupancy and other equipment rental costs, (v) site
development, maintenance and modification costs related to the Company's
E-commerce segment, and (vi) all other general and miscellaneous corporate
expense items.
CONSOLIDATED GENERAL AND ADMINISTRATIVE EXPENSES, BY SEGMENT, BY COMPONENT
FOR THE PERIODS:
THREE MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE
Compensation costs and related expenses ............. $1,133,945 $ 592,719 $ 541,226 91%
Professional fees ................................... 474,195 197,471 276,724 140%
Insurance costs ..................................... 119,718 141,544 (21,826) -15%
Occupancy and equipment costs ....................... 77,179 57,214 19,965 35%
Site development, maintenance and modifications ..... 287,133 406,145 (119,012) -29%
All other G&A expenses .............................. 454,084 20,395 433,689 2126%
---------- ---------- ---------- -----
TOTAL G&A-- E-COMMERCE SEGMENT ...................... $2,546,254 $1,415,488 $1,130,766 80%
---------- ---------- ---------- -----
22
FOR THE PERIODS:
THREE MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
OFF-LINE MARKETING SERVICES
Compensation costs and related expenses ......... $ -- $ 49,404 $ (49,404) -100%
Professional fees ............................... 20,284 -- 20,284 100%
Insurance costs ................................. 1,260 3,672 (2,412) -66%
Occupancy and equipment costs ................... -- 7,702 (7,702) -100%
All other G&A expenses .......................... 353,794 25,927 327,867 1265%
---------- ---------- ---------- -----
TOTAL G&A-- OFF-LINE SEGMENT .................... $ 375,338 $ 86,705 $ 288,633 333%
---------- ---------- ---------- -----
LEC BILLED PRODUCTS AND SERVICES
Compensation costs and related expenses ......... $ -- $ 49,272 $ (49,272) -100%
Insurance costs ................................. -- 34,604 (34,604) -100%
Occupancy and equipment costs ................... -- 7,702 (7,702) -100%
All other G&A expenses .......................... -- 5,088 (5,088) -100%
---------- ---------- ---------- -----
TOTAL G&A-- LEC SEGMENT ......................... $ -- $ 96,666 $ (96,666) -100%
---------- ---------- ---------- -----
CORPORATE AND OTHER
Compensation costs and related expenses ......... $ 515,909 $ 370,619 $ 145,290 39%
Professional fees ............................... 226,306 349,171 (122,865) -35%
Insurance costs ................................. 121,025 453 120,572 100%
All other G&A expenses .......................... 165,019 85,275 79,744 94%
---------- ---------- ---------- -----
TOTAL G&A-- CORPORATE AND OTHER ................. $1,028,259 $ 805,518 $ 222,741 28%
---------- ---------- ---------- -----
CONSOLIDATED TOTALS ............................. $3,949,851 $2,404,377 $1,545,474 64%
========== ========== ========== =====
General and Administrative expenses ("G&A") on a consolidated basis
increased approximately $1.5 million, or 64%, when comparing G&A of
approximately $2.4 million from the three months ended May 31, 2001 to G&A of
approximately $3.9 million incurred during the three months ended May 31, 2002.
The net increase was attributable to (a) the Company's E-commerce segment
(approximately $1.1 million, or 73% of the total increase), with such increase
related to increased compensation costs, professional fees and other G&A
expenses, offset by a decline in maintenance costs associated with the Company's
web sites, all required to support the 73% increase in revenues generated by
such segment during the three months ended May 31, 2002; (b) increases
attributable to the Company's Off-line Marketing Services segment (approximately
$289,000, or 19% of total increase), with such increase related to G&A necessary
to support the segment's growth in revenues from $ -0- in fiscal 2001's second
quarter to approximately $1.2 million during the three months ended May 31,
2002; and (c) other corporate overhead (approximately $222,000, or 14% of the
total increase) not specifically identifiable to the Company's operating
segments, with such cost increase including (i) directors and officers liability
insurance, (ii) professional fees incurred in the defense of actions arising
from legacy operations, and (iii) other non-allocable G&A aggregating
approximately $1 million. These overhead increases were slightly offset by an
approximate $97,000 decrease in overhead attributable to the Company's currently
inactive LEC Billed Product and Services segment.
23
OTHER INCOME (EXPENSE)
The Company's components of "Other income (expense)" for the three months
ended May 31, 2002 and 2001 are set forth below:
CONSOLIDATED OTHER INCOME (EXPENSE)
FOR THE PERIODS:
THREE MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
Other income (expense):
Interest expense .................................... $ (9,266) $ -- $ (9,266) 100%
Interest income and dividends ....................... 183,386 494,309 (310,923) -63%
Net gains(losses) on sale of marketable securities .. 20,564 (1,776) 22,340 100%
Other non-operating income:
Talk.com Arbitration Settlement ................. 2,314,121 2,314,121 100%
P.M.Thomas Arbitration Settlement ................ (2,275,582) (2,275,582) 100%
Residual revenues from terminated programs ....... -- 79,883 (79,883) -100%
Other miscellaneous (expense) .................... 62,126 -- 62,126 100%
Minority interest (income) loss ..................... (104,303) -- (104,303) 100%
---------- ---------- ---------- -----
TOTAL CONSOLIDATED OTHER INCOME (EXPENSE) ........... $ 191,046 $ 572,416 $ (381,370) -67%
========== ========== ========== =====
Consolidated Other Income (Expense) decreased approximately $381,000, from
approximately $572,000 for the three months ended May 31, 2001 to approximately
$191,000 for the three months ended May 31, 2002.
The primary factors contributing to the net decrease, in the order of the
table set forth above, are as follows:
(a) a decrease in interest and dividend income of approximately $311,000
resulting from significant decreases in the interest rates available on
short-term commercial paper during the three months ended May 31, 2002;
(b) an increase in gains realized through sales of marketable securities
approximating $22,000 in the quarter ended May 31, 2002, when compared to the
quarter ended May 31, 2001, which included a loss of approximately $2,000; and
(c) the three months ended May 31, 2002 included the final installment
related to the Talk.com arbitration victory ($2.3 million) awarded to the
Company in November 2001, offset by the $2.3 million award granted to the
claimants in the Phillip Michael Thomas arbitration. See "Part II -- Legal
Proceedings."
PROVISION FOR INCOME TAXES
The Company's effective income tax rate is a result of the combination of
federal income taxes at statutory rates, and state taxes, subject to the effects
of valuation allowances taken against the "realizability" of deferred tax
assets. The Company recorded income tax expense of $469,540 for the three months
ended May 31, 2002 on pre-tax income of approximately $1,182,583. This equates
to an effective tax rate of approximately 39.7%. This effective tax rate is less
than the Company's historically recognized tax rate due to the realization in
the three months ended May 31, 2002 of previously devalued deferred tax assets
related to capital losses, coupled with the effect of interim period tax
allocation. In the prior comparable period, the Company had recorded income tax
expense of $680,381 on a pre-tax profit of approximately $1,695,865. This
represented an effective tax rate of 40.1%.
24
SIX MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001
The Company's net revenues, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the six month periods
ended May 31, 2002 and May 31, 2001, are detailed in the following tables:
SEGMENT DATA -- NET REVENUES, BY SEGMENT COMPONENT
SIX MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE COMPONENTS
GroupLotto and other web sites ................... $ 4,239,862 $ 2,491,927 $ 1,747,935 70%
Net branch commission fees ....................... 332,209 -- 332,209 100%
Email marketing programs ......................... 13,462,033 5,556,433 7,905,600 142%
Data sales and rentals ........................... 2,064,018 1,582,312 481,706 30%
Sales of jewelry and gifts ....................... 821,137 -- 821,137 100%
Internet game development and other .............. 265,108 -- 265,108 100%
----------- ----------- ----------- -----
TOTAL E-COMMERCE ................................. 21,184,367 9,630,672 11,553,695 120%
----------- ----------- ----------- -----
OFF-LINE MARKETING SERVICE COMPONENTS
Net branch commission fees ....................... 1,922,129 -- 1,922,129 100%
Other off-line marketing ......................... 68,939 -- 68,939 100%
----------- ----------- ----------- -----
TOTAL OFF-LINE MARKETING SERVICE ................. 1,991,068 -- 1,991,068 100%
----------- ----------- ----------- -----
LEC BILLED PRODUCTS AND SERVICES COMPONENTS
"900" Entertainment Service royalties ............ -- 486,406 (486,406) -100%
Enhanced Services, principally voice mail ........ -- 637,019 (637,019) -100%
----------- ----------- ----------- -----
TOTAL LEC BILLED PRODUCTS AND SERVICES -- 1,123,425 (1,123,425) -100%
----------- ----------- ----------- -----
CORPORATE AND OTHER COMPONENTS
Miscellaneous products, list revenue and other ... -- -- -- 0%
----------- ----------- ----------- -----
TOTAL CONSOLIDATED NET REVENUE ................... $23,175,435 $10,754,097 $12,421,338 116%
=========== =========== =========== =====
Net Revenue increased $12,421,338, or 116%, to $23,175,435 for the six
months ended May 31, 2002 from $10,754,097 in the comparable prior year period.
The primary component of the increase was attributable to an approximate $11.6
million increase in the Company's E-commerce segment net revenues, combined with
an increase of approximately $2 million in net revenue from the Company's
Off-line Marketing services segment. Such increases were partially offset by a
decrease of $1.1 million in the Company's LEC Billed Product and Services legacy
segment. The E-commerce segment revenue increase resulted from the Company's
increasing focus on generating revenue from its current core business, on-line
direct marketing. The Company expects this segment to continue to represent the
substantial part of the Company's revenue in future fiscal periods. The Company
is assessing the potential of an increased emphasis of revenue generation from
off-line, conventional direct marketing activities and will implement the
strategy if deemed beneficial for the Company. Currently, the Company is using
its on-line databases to enhance third party off-line databases through the
application of overlay technology, whereby databases are appended to one
another, effectively increasing the depth of consumer related information within
the appended database.
The growth in the Company's E-commerce segment was primarily attributable
to approximately $13.5 million in revenue generated from the segment's E-mail
marketing program sub-set. This represented a $7.9 million increase over the
prior year's $5.5 million in revenue generated from such segment's sub-set. This
substantial increase of approximately 142% over the prior year's comparable
period was primarily the result of the Company's acquisition of significant
volumes of permission-based email records, extension of the quantity and quality
of third party (client) offers being emailed to the databases and greater
efficiencies in the Company's email delivery programs. In the prior year's
comparable period, specifically the first three months of the fiscal year ended
November
25
30, 2001, the Company had been in the early stages of developing and carrying
out its online strategy. The sub-set of E-mail marketing program revenue
represented approximately 58% of the Company's consolidated net revenue for the
six months ended May 31, 2002.
During the three months ended May 31, 2002, the Company experienced
problems with the delivery of its email promotional offers. Such problems
reduced revenue and income from the E-Commerce sub-segment. The Company believes
that the significant component of the email delivery problem is attributable to
Internet Service Providers that unilaterally block commercial emails from
reaching their consumer subscribers. The Company has addressed the issue by
deploying new reinforced delivery platforms with increased redundancy and
expanded diversification using both internal and external emailing resources.
Although the Company has conceived of a number of programs to address this
specific problem, there can be no assurance that any of these programs will work
effectively, or can be timely implemented.
Any further changes in the Internet operating landscape that materially
hinders the Company's current ability and/or cost to deliver commercial email
messages to the consumer records in its databases, and the consumer records in
the databases of its affiliates, could potentially cause a material impact in
future net revenue and gross margin, and, therefore, its profitability and cash
flows could be adversely affected. Various state laws exist, and federal
legislation is currently pending, that limit the Company's ability to deliver
commercial e-mail messages to consumers. There are presently no federal laws
that regulate sending unsolicited email. The pending federal bills and existing
state laws require that certain "opt-out" procedures be included in emails and
prohibit "false routing" or "fictitious address" information. Existing state,
and pending federal, laws require functioning return e-mail addresses and that
valid postal addresses be included by the senders of commercial email messages.
Some states require an "ADV" label in the subject line, and proscribe false
header or misleading subject lines. Attorneys General and/or consumers are given
authority to enforce the state laws. States with legislation affecting the
sending of unsolicited commercial email include: California, Colorado,
Connecticut, Delaware, Idaho, Illinois, Iowa, Louisiana, Maryland, Missouri,
Nevada, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, Tennessee,
Utah, Virginia, Washington and West Virginia. If strict federal legislation is
subsequently written into law, with its terms specifically limiting the
Company's ability to market its offers, the Company could potentially realize a
material adverse impact in future fiscal period net revenue growth, and
therefore, profitability and cash flows could be adversely affected.
The Company's E-commerce segment's web site sub-set realized an increase in
revenues of $1.7 million, or 70%, when comparing the current six months ended
May 31, 2002 ($4.2 million in revenue) with the six months ended May 31, 2001
($2.5 million in revenue). This increase is the result of the Company's shift
from low priced "click through" revenue to higher generating registration, lead
generation and on-line customer acquisition based revenue. The Company generates
a significant portion of its site traffic from email marketing. SEE THE
PRECEDING PARAGRAPH FOR A FURTHER DISCUSSION OF RECENT BUSINESS AND LEGAL
DEVELOPMENTS ATTRIBUTABLE TO EMAIL MARKETING.
Additional increases in the Company's consolidated revenues were
attributable to new sub-sets added to the E-commerce segment during the six
months ended May 31, 2002 when compared to the six months ended May 31, 2001.
The combined revenue resulting from the new sub-sets amounted to approximately
$1.4 million and is detailed as follows: (a) $332,209 of such increase relates
to the Company's majority-owned subsidiary (Montvale Management LLC) that
provides services under a net branch agreement with licensed mortgage banking
and brokerage companies in the acquisition of candidates for new mortgages and
the refinancing of existing debt, which subsidiary also conducts the same
services off-line and recorded approximately $1.9 million within its Off-line
Marketing Services segment; (b) $821,137 of such increase relates to the on-line
sales of jewelry and gifts by the Company's new subsidiary, ThanksMuch, Inc.,
which was formed with the assets acquired from a closely held private company on
December 14, 2001, all as more fully described in Note 8 to the financial
statements; (c) $165,108 of such increase relates to the Internet game
development revenues generated by the Company's new subsidiary, InfiKnowledge
ULC, which was formed with the assets acquired from a private Canadian company
on December 6, 2001, all as more fully described in Note 8 to the financial
statements; and (d) the balance of such increase, or $100,000, was attributable
to a web marketing, design and development contract executed and completed by
the Company during the three months ended February 28, 2002.
The increases in revenues from the Company's E-commerce segment and
Off-line Marketing Services segment were partially offset by a decrease of
$1,123,425 in revenues from the Company's LEC Billed Products and Services
segment. A portion of the decrease, or $486,406, resulted from the expiration in
the prior year's three months ended February 28, 2001, of certain agreements
pursuant to which the Company had been paid a royalty fee (with virtually no
corresponding costs) to refrain from conducting, marketing, advertising or
promoting certain LEC Billed Products and Services. The six months ended May 31,
2002, did not include any revenue related to these services and the Company does
not anticipate re-entering that market. The balance of the decrease in
26
LEC Billed Product and Service segment revenue, or $637,019, resulted from the
Company's elimination of billing voice mail services under its contract with the
service bureau Federal Transtel, Inc. ("FTT") in October 2001. FTT has since
filed for protection under the United States Bankruptcy Code.
See "Transactions with Major Customers" and the Securities and Exchange
Commission's ("SEC") mandated FR-60 disclosures following the "Liquidity and
Capital Resources" section for a further discussion of the significant customer
concentrations, critical accounting policies and estimates, and other factors
that could affect future results.
The Company's cost of revenues during the six months ended May 31, 2002 and
May 31, 2001 are comprised of (1) direct and indirect marketing costs associated
with the (a) contact and identification strategies, (b) procurement and (c)
retention of consumers for its databases, including direct response email
marketing costs, data purchases, promotional costs and premium fulfillment
costs, and (2) the related contingent-based prize indemnification expense, and
LEC segment related billing and collection fees, and customer service costs.
The Company's cost of sales, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the six month periods
ended May 31, 2002 and May 31, 2001 are set forth below:
CONSOLIDATED COST OF SALES, BY SEGMENT, BY COMPONENT
FOR THE
SIX MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Email marketing and related delivery costs ........... $2,587,026 $1,126,857 $1,460,169 130%
Data purchases and premium costs ..................... 3,723,449 1,101,007 2,622,442 238%
Promotional, creative and other costs ................ 84,619 50,154 34,465 69%
---------- ---------- ---------- -----
TOTAL E-COMMERCE ADVERTISING ......................... $6,395,094 $2,278,018 $4,117,076 181%
---------- ---------- ---------- -----
SERVICE BUREAU FEES
Contingent based prize indemnification costs ......... $ 185,391 $ 206,626 $ (21,235) -10%
---------- ---------- ---------- -----
TOTAL E-COMMERCE COST OF SALES ....................... $6,580,485 $2,484,644 $4,095,841 165%
---------- ---------- ---------- -----
OFF-LINE MARKETING SERVICES
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Telemarketing, direct mail and related costs ......... $ 181,330 $ 21,739 $ 159,591 734%
Premium fulfillment costs ............................ $ -- $ 7,564 $ (7,564) -100%
---------- ---------- ---------- -----
TOTAL OFF-LINE MARKETING COST OF SALES ............... $ 181,330 $ 29,303 $ 152,027 519%
---------- ---------- ---------- -----
LEC BILLED PRODUCTS AND SERVICES
SERVICE BUREAU FEES
Billing and collection fees .......................... $ -- $ 111,655 $ (111,655) -100%
---------- ---------- ---------- -----
TOTAL LEC BILLED COST OF SALES ....................... $ -- $ 111,655 $ (111,655) -100%
---------- ---------- ---------- -----
TOTAL COST OF SALES .................................. $6,761,815 $2,625,602 $4,136,213 158%
========== ========== ========== =====
Cost of sales on a consolidated basis increased $4,136,213, or 158%, to
$6,671,815 for the six months ended May 31, 2002 from $2,625,602 in the
comparable prior year period.
On a segmental level, the Company's E-commerce segment cost of sales
increased, on a net basis, approximately $4.1 million, or 165%, to $6.6 million
during the six months ended May 31, 2002, when compared to $2.5 million incurred
in the prior year's comparable period. The Company's continuing strategy of
generating revenues primarily from direct marketing campaigns delivered on-line
was the significant factor contributing to
27
this increase. The Company realized marketing costs for email delivery of
approximately $2.6 million in the six months ended May 31, 2002, representing an
increase of $1.5 million, or 130%, when compared to approximately $1.1 million
in email delivery costs incurred in the prior year's comparable period. In
December 2001, the Company acquired the assets of a Canadian-based technology
company (InfiKnowledge). The Company continues to expect that the integration of
the acquired assets, technology and human resources into its operations and
email delivery platform will continue to reduce the unitary costs of its email
promotions and serve to preserve and/or improve operating margins. SEE THE
PRECEDING "NET REVENUE" SECTION FOR A FURTHER DISCUSSION OF RECENT BUSINESS AND
LEGAL DEVELOPMENTS ATTRIBUTABLE TO EMAIL MARKETING.
The Company realized costs of approximately $2.6 million for data purchases
necessary to build and maintain its marketing databases and approximately $1.1
million for premium costs related to redemption obligations for certain of its
marketing program offers. These costs represent an increase of approximately
$2.6 million, or 238%, over data purchase costs of $1.1 million during the six
months ended May 31, 2001. In the prior fiscal year's comparable period, the
Company had immaterial costs relative to redemption obligations.
The Company uses the services of an agency for the provision of
indemnification coverage in the event the GroupLotto site produces a winner in
one of its free on-line lottery games. The costs attributable to the provision
of such indemnification coverage decreased approximately $21,000, or 10%, when
compared with the prior fiscal period ended May 31, 2001. The reason for this
decrease was due to an approximate 12% decrease in the games played at the
Company's GroupLotto.com website.
The Company's Off-line Marketing Services segment's cost of sales increased
$152,027, or 519%, to $181,330, when compared to $29,303 during the six months
ended May 31, 2001. The increase was attributable to the Company's
majority-owned-subsidiary (Montvale Management LLC), which was inactive during
the six months ended May 31, 2001.
The balance of the decrease in cost of goods sold relates to the LEC Billed
Product and Service segment and amounted to a reduction of $111,655. This
reduction resulted from the Company's elimination of billing voice mail services
under its contract with the service bureau Federal Transtel, Inc. ("FTT") in
October 2001. FTT has since filed for protection under the United States
Bankruptcy Code.
The Company's gross profit in terms of dollars, on a segmental basis, and
the Company's gross profit percentage, on a segmental basis, for each of the six
month periods ended May 31, 2002 and 2001 are set forth below:
CONSOLIDATED GROSS PROFIT, BY SEGMENT
FOR THE PERIODS:
SIX MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-commerce $14,603,882 $7,146,028 $7,457,854 104%
Customer Acquisition services 1,809,738 (29,303) 1,839,041 100%
LEC Billed products and services -- 1,011,770 (1,011,770) -100%
----------- ---------- ---------- -----
CONSOLIDATED TOTALS $16,413,620 $8,128,495 $8,285,125 102%
=========== ========== ========== =====
28
CONSOLIDATED GROSS PROFIT PERCENTAGES, BY SEGMENT
FOR THE PERIODS:
SIX MONTHS ENDED ABSOLUTE RELATIVE
--------------------------- PERCENTAGE PERCENTAGE
MAY 31, MAY 31, CHANGE CHANGE
2002 2001 INC (DEC) INC (DEC)
----------- ----------- ----------- -------
E-commerce .................................. 68.9% 74.2% -5.3% -7.1%
Customer Acquisition services ............... 90.9% 0.0% 90.9% 100.0%
LEC Billed products and services ............ 0.0% 90.1% -90.1% -100.0%
---- ---- ----- ------
CONSOLIDATED GROSS PROFIT PERCENTAGE ........ 70.8% 75.6% -4.8% -6.3%
==== ==== ===== ======
Consolidated Gross Profit Percentage ("Gross Margin") as a percentage of
net revenue was 70.8% during the six months ended May 31, 2002, compared to
75.6% in the prior year's comparable fiscal period, representing an absolute
percentage point decrease of 4.8%, or a 6.3% decline on a relative basis. On a
segmental basis, the Company's E-commerce segment accounted for the majority of
the decrease in margin when compared to the comparable prior fiscal period. The
7.1% absolute percentage point decrease resulted from the Company's increased
costs associated with data purchases, which are fully expensed at the time of
receipt. The Company anticipates that this expensing policy could provide a
margin improvement benefit in future fiscal periods through the continued
marketing to such acquired data. An additional factor contributing to the slight
decline in the gross margin percentage is attributable to the costs of
fulfillment obligations related to the Company's marketing program offers
conducted for a long distance service provider. Such costs approximated $1.1
million in the six months ended May 31, 2002. During the prior year's comparable
period, the Company did not have a marketing program that generated significant
fulfillment costs. Changes in the gross margins generated from the Company's
Off-line Marketing Services segment and LEC Product and Services segment
primarily offset each other in terms of percentage changes.
The Company's Selling Expenses and General and Administrative Expenses for
each of the six months ended May 31, 2002 and May 31, 2001 are presented, on a
segmental basis, and with the components of the individual segments, in the
tables set forth below:
FOR THE PERIODS:
SIX MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE
Fee share commissions ....................... $2,649,369 $ 409,635 $2,239,734 547%
Other commissions ........................... 954,105 -- 954,105 100%
Selling salaries and related expenses ....... 824,367 640,274 184,093 29%
Occupancy and equipment costs ............... 11,715 11,105 610 5%
Travel and entertainment .................... 166,890 107,850 59,040 55%
----------- ---------- ---------- -----
TOTAL SELLING-- E-COMMERCE SEGMENT .......... $4,606,446 $1,168,864 $3,437,582 294%
----------- ---------- ---------- -----
OFF-LINE MARKETING SERVICES
Fee share commissions ....................... $ -- $ -- $ -- 0%
Other commissions ........................... -- -- -- 0%
Selling salaries and related expenses ....... 847,120 -- 847,120 100%
Occupancy and equipment costs ............... 45,889 -- 45,889 100%
Travel and entertainment .................... 17,859 -- 17,859 100%
----------- ---------- ---------- -----
TOTAL SELLING-- OFF-LINE SEGMENT ............ $ 910,868 $ -- $ 910,868 100%
----------- ---------- ---------- -----
CONSOLIDATED TOTALS ......................... $5,517,314 $1,168,864 $4,348,450 372%
=========== ========== ========== =====
29
Selling expenses on a consolidated basis increased approximately $4.3
million, or 372%, from $1.2 million during the six months ended May 31, 2001 to
$5.5 million during the six months ended May 31, 2002. The increase was
primarily attributable to the Company's E-commerce segment, with an increase of
approximately $3.4 million, and increases of approximately $911,000 in selling
expenses in the Company's Off-line Marketing Services segment.
The significant factors contributing to the increase in selling expenses
were (a) increased fee share commissions incurred in the Company's E-commerce
segment of approximately $2.2 million (see below for a detailed description of
this expense category); and (b) increased selling based compensation and other
related selling costs combined ($184,093 and $59,650, respectively) arising from
the expansion of the E-commerce segment's sales force and selling activities.
Regarding the increase in fee share commissions, during the fiscal year
ended November 30, 2001, the Company significantly expanded the practice of
marketing promotional offers on behalf of its marketing clients ("Clients") to
third party databases on a fee share commission basis. The fee share commission
relationship generally arises after the Company concludes a contractual
arrangement with a Client pursuant to which the Company modifies or develops
the:(i) copy, (ii) offer form and (iii) promotional materials for the Client's
product or service. The Company then tests the promotion, and agrees to deliver
a minimum level of new customers, and/or targeted leads to the Client.
Simultaneously with the execution of these contractual arrangements, the Company
often obtains the rights from the Client to market their promotions to a list of
third parties with whom the Company has marketing relationships (the "Third
Parties"). The Company enters into contracts with each Third Party with whom it
intends to market Client promotions. The terms of these agreements generally
provide that the Third Party has the right to (i) approve the creative materials
for each promotion, (ii) approve the timing of each promotion's mailing, (iii)
terminate the contract on short notice, and (iv) reject any promotion for any
reason. Each agreement also restricts the third party from doing business with
the client other than through the Company for the period of time covered by the
agreement, and sets forth the terms of the Third Party's compensation. Payments
are performance based only and are either fixed fees paid for each customer or
lead, generated for the Client, or a revenue share that is a percentage of the
revenue generated (after deduction for certain direct costs) by the Company for
marketing that offer to the Third Party database. The Company utilizes unique
Universal Resource Locater identifier links ("URLs") when promotions are mailed
to the Third Party database. It is the unique URL's that form the tracking
mechanism by which the Client reports results to the Company, and the Company is
able to account for revenue generated under the fee share arrangement with Third
Parties.
Selling expenses within the Company's Off-line Marketing Services segment
increased $910,868, or 100%, when compared to the prior year's comparable
period. The Company expects that in the remaining quarters of the fiscal year
ended November 30, 2002, it will realize an increase in this segment's selling
expenses based on the anticipated expansion of the operations of its majority
owned subsidiary, Montvale Management LLC, which conducts business off-line, as
well as on-line, as a net branch for licensed mortgage banking and brokerage
companies.
30
CONSOLIDATED GENERAL AND ADMINISTRATIVE EXPENSES, BY SEGMENT, BY COMPONENT
FOR THE PERIODS:
SIX MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
E-COMMERCE
Compensation costs and related expenses ....... $2,249,340 $1,001,434 $1,247,906 125%
Professional fees ............................. 832,257 319,590 512,667 160%
Insurance costs ............................... 231,861 196,608 35,253 18%
Occupancy and equipment costs ................. 150,099 114,672 35,427 31%
Site development, maintenance and
modifications .............................. 507,179 1,022,303 (515,124) -50%
All other G&A expenses ........................ 781,385 225,707 555,678 246%
---------- ---------- ---------- -----
TOTAL G&A-- E-COMMERCE SEGMENT ................ $4,752,121 $2,880,314 $1,871,807 65%
---------- ---------- ---------- -----
OFF-LINE MARKETING SERVICES
Compensation costs and related expenses ....... $ -- $ 89,171 $ (89,171) -100%
Professional fees ............................. 23,404 -- 23,404 100%
Insurance costs ............................... 2,355 65,536 (63,181) -96%
Occupancy and equipment costs ................. -- 14,334 (14,334) -100%
All other G&A expenses ........................ 592,417 39,605 552,812 1396%
---------- ---------- ---------- -----
TOTAL G&A-- OFF-LINE SEGMENT .................. $ 618,176 $ 208,646 $ 409,530 196%
---------- ---------- ---------- -----
FOR THE PERIODS:
SIX MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
LEC BILLED PRODUCTS AND SERVICES
Compensation costs and related expenses ....... $ -- $ 88,896 $ (88,896) -100%
Insurance costs ............................... -- 65,536 (65,536) -100%
Occupancy and equipment costs ................. -- 14,334 (14,334) -100%
All other G&A expenses ........................ -- 9,023 (9,023) -100%
---------- ---------- ---------- -----
TOTAL G&A-- LEC SEGMENT ....................... $ -- $ 177,789 $ (177,789) -100%
---------- ---------- ---------- -----
CORPORATE AND OTHER
Compensation costs and related expenses ....... $1,095,754 $930,554 $ 165,200 18%
Professional fees ............................. 498,973 545,597 (46,624) -9%
Insurance costs ............................... 235,384 1,298 234,086 100%
All other G&A expenses ........................ 350,063 199,586 150,477 75%
---------- ---------- ---------- -----
TOTAL G&A-- CORPORATE AND OTHER ............... $2,180,174 $1,677,035 $ 503,139 30%
---------- ---------- ---------- -----
CONSOLIDATED TOTALS ........................... $7,550,471 $4,943,784 $2,606,687 53%
========== ========== ========== =====
General and Administrative expenses ("G&A") on a consolidated basis
increased approximately $2.6 million, or 53%, when comparing G&A of $4.9 million
from the six months ended May 31, 2001 to G&A of $7.6 million incurred during
the six months ended May 31, 2002. The net increase was attributable to (a) the
Company's E-commerce segment (approximately $1.9 million, or 72% of total
increase), with such increase related to increased compensation costs,
professional fees and other G&A, offset by a decline in maintenance costs
associated with the Company's web sites, all required to support the 120%
increase in revenues generated by such segment during the six months ended May
31, 2002, (b) the Company's Off-line Marketing Services segment (approximately
$409,530, or 16% of total increase), with such increase related to G&A necessary
to support the segments growth in revenues from $ -0- in fiscal 2001's first
quarter to approximately $1,991,068 during the six months ended May 31, 2002,
and (c) other corporate overhead (approximately $503,139, or 19% of total
31
increase) not specifically identifiable to the Company's operating segments,
with such cost increase including (i) directors and officers liability
insurance, (ii) professional fees incurred in the defense of actions arising
from legacy operations, and (iii) other non-allocable G&A aggregating
approximately $337,939. These overhead increases were slightly offset by an
approximate $177,789 decrease in overhead attributable to the Company's
currently inactive LEC Billed Product and Services segment.
OTHER INCOME (EXPENSE)
The Company's components of "Other income(expense)" for the six months
ended May 31, 2002 and 2001 are set forth below:
CONSOLIDATED OTHER INCOME (EXPENSE)
FOR THE PERIODS:
SIX MONTHS ENDED
--------------------------- CHANGE CHANGE
MAY 31, MAY 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ----------- -------
OTHER INCOME (EXPENSE):
Interest expense .................................... $ (19,768) $ -- $ (19,768) 100%
Interest income and dividends ....................... 393,599 1,144,261 (750,662) -66%
Net gains(losses) on sale of marketable securities .. 83,157 (1,776) 84,933 100%
Permanent impairment charges -- (4,690,258) 4,690,258 -100%
Other non-operating income:
Talk.com Arbitration Settlement .................. 2,314,121 -- 2,314,121 100%
P.M.Thomas Arbitration Settlement ................ (2,275,582) -- (2,275,582) 100%
Residual revenues from terminated
Programs ......................................... -- 88,350 (88,350) -100%
Other miscellaneous (expense) .................... 71,563 -- 71,563 100%
Liquidation proceeds on prior year
impairment loss ................................ 125,000 -- 125,000 100%
Minority interest (income) loss ..................... (130,949) -- (130,949) -100%
----------- ----------- ----------- -----
TOTAL CONSOLIDATED OTHER INCOME (EXPENSE) ........... $ 561,141 $(3,459,423) $ 4,020,564 -116%
=========== =========== =========== =====
Consolidated Other Income increased approximately $4 million, from
approximately ($3,459,423) in expense for the six months ended May 31, 2001 to
approximately $561,000 of income for the six months ended May 31, 2002.
The primary factors contributing to the net increase, in the order of the
table set forth above, are as follows:
(a) a decrease in interest and dividend income of approximately $751,000
resulting from significant decreases in the interest rates available on
short-term commercial paper during the six months ended May 31, 2002;
(b) an increase in gains realized through sales of marketable securities
approximating $85,000 in the six months ended May 31, 2002;
(c) during the six months ended May 31, 2002 the Company did not incur
losses from asset impairments, yet during the six months ended May 31, 2001 the
Company realized losses, through a permanent impairment, of approximately $4.1
million on marketable securities resulting from significant declines in the
values of such marketable equity securities held in the Company's investment
portfolio, and these losses were deemed to be other than temporary.
Additionally, during the six months ended May 31, 2001, the Company realized a
permanent impairment of $500,051 on a long-term investment that subsequently
discontinued its operations in the third quar-
32
ter of fiscal 2001. As of the May 31, 2002 balance sheet date, the Company has
significantly reduced its exposure to market fluctuations in its investment
portfolio by limiting the contents of such portfolio to approximately $21.9
million in high grade, short term, commercial paper and auction rate securities
(with yields ranging from 1.98% to 2.32%, with maturities of 30 to 180 days),
with approximately $1 million in high risk investments, consisting of common
stock equities and real estate investment trust equities;
(d) an increase of $125,000 attributable to liquidation proceeds received
from a prior year long-term investment that was entirely written off through an
impairment charge in the fiscal year ended November 30, 2000; and
(e) the six months ended May 31, 2002 included the final installment
related to the Talk.com arbitration victory ($2.3 million) awarded to the
Company in November 2001, offset by $2.3 million award granted to the claimants
in the Phillip Michael Thomas arbitration. See "Part II -- Legal Proceedings."
PROVISION FOR INCOME TAXES
The Company's effective income tax rate is a result of the combination of
federal income taxes at statutory rates, and state taxes, subject to the effects
of valuation allowances taken against the "realizability" of deferred tax
assets. The Company recorded income tax expense of $1,352,010 for the six months
ended May 31, 2002 on pre-tax income of $3,468,470. This equates to an effective
tax rate of approximately 39%. This effective tax rate is less than the
Company's historically recognized tax rate due to the realization in the six
months ended May 31, 2002, of previously devalued deferred tax assets related to
capital losses, coupled with the effect of interim period tax allocation. In the
prior comparable period the Company had recorded income tax expense of
$1,311,799 for the six months ended May 31, 2001 on a pre-tax loss of
approximately $1,443,576. This effective tax rate relationship is the result of
the Company taking a full valuation allowance during the six months ended May
31, 2001, against the future tax benefits attributable to the loss carryovers
arising from permanent impairment charges of $4,690,258 incurred during such
period. This deferred tax asset valuation allowance has been recorded during the
six months of the fiscal year ended November 30, 2001, due to the absence of
appreciated capital gain property (available for the potential generation of
capital gain income) to offset the net capital losses generated by the
impairment charges.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial and liquidity position remained strong as exhibited
by the Company's cash, cash equivalents, short-term marketable securities and
marketable equity securities of approximately $41.9 million at May 31, 2002.
Cash, cash equivalents, short-term marketable securities and equity securities
were approximately $38.1 million at November 30, 2001. This increase of
approximately $3.8 million was the result of the Company's collection of
approximately $2.5 million from the final installment on the Talk.com
arbitration award and cash flows generated from the Company's operating and
financing activities, offset by approximately $1 million used in investing
activities (principally capital expenditures of $1,190,098).
Trade accounts receivable, as a percentage of net revenues was 69% at May
31, 2002. The Company's days-sales-outstanding ("DSO") in accounts receivable at
May 31, 2002 were 63 and 59 days for the three and six month periods ended May
31, 2002, respectively, compared to 88 and 94 days during the prior year's
comparable periods, respectively. The decrease in the DSO for the three months
ended May 31, 2002 when compared to the prior year's comparable periods and the
first quarter of Fiscal 2002 (70 days), relates to shortened collection periods
on the outstanding accounts receivables from the Company's significant
customers, as well as the balance of its customer base.
The majority of the Company's customers are extended 30-day credit terms.
The Company continually monitors customer adherence to such terms and constantly
strives to improve the effectiveness of its collection efforts with the goal of
achieving a DSO in the 40-day range. Future fiscal periods might not reflect
this goal of a 40-day DSO, and might exceed the 63 and 59-day DSO's recognized
during the three and six-month periods ended May 31, 2002.
33
Cash provided by financing activities during the six months ended May 31,
2002 amounted to $694,406, and included approximately $580,000 in proceeds
generated by the exercise of the Company's stock options and approximately
$114,000 in proceeds (net of related costs and income taxes) related to an
insider trading action brought against a former non-management insider, pursuant
to which such insider was required to return his deemed insider trading gains to
the Company.
The Company announced on June 19, 2002, that its Board of Directors
authorized a stock repurchase plan. Under such plan, the Company is authorized
to buy back up to two million shares of its outstanding common stock. As of the
date of this report, the Company has acquired approximately 380,000 shares at an
average price of approximately $3.97 per share, for a total outlay of
approximately $1.5 million.
Historically, the Company's primary cash requirements have been used to
fund the cost of advertising and promotion, with additional funds having been
used in the purchasing of equipment and services in connection with the
commencement of new business lines and further development of businesses being
test marketed. During the fiscal year ended November 30, 2000, the Company
executed its on-line direct marketing strategy. The Company's future plans and
business strategy continue to call for its Internet based E-commerce segment to
be its primary operating focus, with such segment generating a material portion
of future revenues. If the Company's online activities fail to generate
sufficient revenue, then the continuation of the Company's on-line growth could
have a material adverse impact on the Company's capital and liquidity resources
relating to possible expenditures for (a) marketing campaigns, (b) product
development costs, (c) site development and maintenance and related technology
based costs, (d) potential on-line, and/or off-line, business acquisitions, (e)
costs associated with developing alternative means of email promotion delivery,
or (f) other unexpected and/or currently unidentifiable costs. During the six
months ended May 31, 2002, the Company expended approximately $1.2 million in
capital expenditures to support its E-commerce activities.
In December 2001, the Company acquired the assets of a private Canadian
based Internet technology company. The Company believes that this acquisition
will decrease certain costs relative to its reliance on third parties in the
provision of emailing services and other Internet hosting services. The
realization of those proposed cost savings require capital expenditures by the
newly formed entity, with the funding of such expenditures being provided by the
Company. To date, such capital expenditures approximated $1 million.
During the three months ended May 31, 2002, the Company experienced
problems with the delivery of its email promotional offers. Such problems
reduced revenue and income from the E-Commerce sub-segment. The Company
currently believes that the significant component of the email delivery problem
is attributable to Internet Service Providers that unilaterally block commercial
emails from reaching their consumer subscribers. The Company has addressed the
issue by deploying new reinforced delivery platforms with increased redundancy
and expanded diversification using both internal and external emailing
resources. Although the Company has conceived of a number of programs to address
this specific problem, there can be no assurance that any of these programs will
work effectively, or can be timely implemented.
Any further changes in the Internet operating landscape that materially
hinders the Company's current ability and/or cost to deliver commercial email
messages to the consumer records in its databases, and the consumer records in
the databases of its affiliates, could potentially cause a material impact in
future fiscal period net revenue growth and gross margin, and, therefore, its
profitability and cash flows could be adversely affected. Various state laws
exist, and federal legislation is currently pending, that limit the Company's
ability to deliver commercial e-mail messages to consumers. There are presently
no federal laws that regulate sending unsolicited email. The pending federal
bills and existing state laws require that certain "opt-out" procedures be
included in emails and prohibit "false routing" or "fictitious address"
information. Existing state, and pending federal, laws require functioning
return e-mail addresses and that valid postal addresses be included by the
senders of commercial email messages. Some states require an "ADV" label in the
subject line, and proscribe false header or misleading subject lines. Attorneys
General and/or consumers are given authority to enforce the state laws. States
with legislation affecting the sending of unsolicited commercial email include:
California, Colorado, Connecticut, Delaware, Idaho, Illinois, Iowa, Louisiana,
Maryland, Missouri, Nevada, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode
Island, Tennessee, Utah, Virginia, Washington and West Virginia. If strict
federal legislation is subsequently written into law, with its terms
specifically limiting the Company's ability to market its offers, the Company
could potentially realize a material adverse impact in future fiscal period net
revenue growth, and therefore, profitability and cash flows could be adversely
affected.
Should the business climate, Internet operating environment or technology
environment change significantly, the Company could be faced with circumstances
that would limit or prevent its utilization of these capital expenditures.
34
The Company expended approximately $200,000 in cash for the Infiknowledge
asset acquisition (net of cash received of approximately $63,000). The Company
is also required to expend an additional $200,000 on December 6, 2002, regarding
the final cash installment related to the InfiKnowledge asset acquisition.
In December 2001, the Company also acquired the assets of a closely held
private company for approximately $361,000 (net of cash received of
approximately $74,000). The Company does not anticipate that this asset
acquisition will require significant capital expenditures to maintain, or
improve its operations.
During the fiscal year ended November 30, 1999, the Company's Internet
business plan and strategy prompted the Company to terminate the active
marketing of its legacy products and services. Accordingly, this legacy activity
may contribute, but in a significantly decreasing degree, to the Company's cash
flows and net income in subsequent fiscal periods, as was the case during the
year ended November 30, 2001 when compared to the years ended November 30, 2000
and 1999. This should be considered when using the Company's historical results
in evaluating future operations, cash flows and financial position.
Nevertheless, the Company will continue to explore opportunities to offer other
Off-line Marketing Services and LEC Billed Products and Services in the future.
On June 3, 2002, the American Arbitration Association rendered an award
approximating $2.3 million for the benefit of the Claimants, in the arbitration
entitled PHILIP MICHAEL THOMAS, PMT PRODUCTIONS INC., KAYE PORTER MANAGEMENT,
RMI ENTERTAINMENT, INC., MILLENNIUM TELEMEDIA, INC., CLAIMANTS V. NEW
LAUDERDALE, LLC D/B/A CALLING CARD CO., PSYCHIC READERS NETWORK, INC. D/B/A PRN
TELECOMMUNICATIONS, AND QUINTEL ENTERTAINMENT, INC. (NO. 131400004900). The
arbitrator awarded claimants approximately $1.48 million in damages, plus
interest at nine percent (9%) from January 1, 1996 and January 1, 1997, or
approximately $785,000. Other miscellaneous costs of the award approximated
$8,800.
The Company has accrued and recorded this award as a non-operating expense
at May 31, 2002, and for the three months ended May 31, 2002, respectively, as
it results from a segment of the Company's business in which it is no longer
active.
The claimants in the arbitration have filed a motion in an action pending
in the Circuit Court, Broward County, Florida (Thomas et al v. New Lauderdale,
LLC et al, Case No. 98-12259-07) (the "Action"), to confirm the award. The
respondents in the arbitration have also filed a motion to vacate and\or adjust
the award. In addition, the plaintiffs in the Action have filed a motion to be
relieved from a stay of those proceedings in order to pursue claims against the
defendants in the Action which they contend have not been resolved by the
arbitration, including claims for punitive damages against the Company, as well
as the individual defendants. The Company has indemnified the individual
defendants in the Action; believes that the arbitration award finally resolves
all claims; and intends vigorously to defend against the plaintiffs' claims.
Depending upon the results of the foregoing, the Company expects to disburse the
amount accrued for the award rendered in the arbitration sometime in its quarter
ending August 31, 2002.
Under current operating plans and assumptions, management believes that
projected cash flows from operations and available cash resources will be
sufficient to satisfy the Company's anticipated cash requirements for at least
the next twelve months. Currently, the Company does not have any material
long-term obligations other than those described in the note "Commitments and
Contingent Liabilities" included in the Company's financial statements included
in this document, nor has the Company identified any long-term obligations that
it contemplates incurring in the near future. As the Company seeks to further
extend its reach into the E-commerce arena, as well as identify new and other
consumer oriented products and services in the off-line arena, the Company may
use existing cash reserves, long-term financing, or other means to finance such
diversification.
TRANSACTIONS WITH MAJOR CUSTOMERS
During the three and six months ended May 31, 2002, the Company had five
major customers in its E-commerce segment, which in combination accounted for
approximately $5.5 million and $12.9 million of consoli-
35
dated net revenue, respectively, or 51% and 56% of consolidated net revenues,
respectively. Approximately $5.1 million, or 69%, of consolidated net accounts
receivable was attributable to such major customers as of May 31, 2002. For the
three and six months ended May 31, 2002, two of the five customers referenced
above had related net revenues that equaled or exceeded 10% of the Company's
consolidated net revenue for such period. The five major customers referenced
above accounted for 22%, 9%, 8%, 8% and 4% of consolidated net revenue,
respectively, for the three months ended May 31, 2002, and 26%, 10%, 9%, 7% and
4% of consolidated net revenue, respectively, for the six months ended May 31,
2002. Of the remaining approximate 100 active customers in the three and six
months ended May 31, 2002, no other single customer had net revenue that equaled
or exceeded 4% of consolidated net revenue.
During the three and six months ended May 31, 2001, the Company had four
customers in its E-commerce segment which, in combination, accounted for
approximately 48.3% and 47.5% of consolidated net revenues, respectively, and
approximately 36% of consolidated net accounts receivable as of May 31, 2001.
CRITICAL ACCOUNTING POLICY AND ACCOUNTING ESTIMATE DISCUSSION
In accordance with the Securities and Exchange Commission's (the
"Commission") Release Nos. 33-8040; 34-45149; and FR-60 issued in December 2001,
referencing the Commission's statement "regarding the selection and disclosure
by public companies of critical accounting policies and practices", the Company
has set forth below what it believes to be the most pervasive accounting
policies and estimates that could have a material effect on the Company's
results of operations and cash flows if general business conditions or
individual customer financial circumstances change in an adverse way relative to
the policies and estimates used in the attached financial statements or in any
"forward looking" statements contained herein.
FACTORS THAT COULD EFFECT FUTURE RESULTS
REVENUE RECOGNITION, VARIABLE COSTS AND BAD DEBTS
The Company currently earns the most significant portion of its revenue
from the E-commerce segment pursuant to marketing agreements with marketing
partners and corporate customers (collectively, "Corporate Customers"). The
provisions of each agreement determine the type and timing of revenue to be
recorded. The Company invoices its customers in accordance with the terms of the
underlying agreement. Revenue is recognized at the time the marketing activity
is delivered, or service is provided, net of estimated contractually specified
data qualification allowances, when applicable. Such data qualification
allowances may include duplications, invalid addresses, age restrictions and
allowances, and are recorded as contra revenue. The Company's revenues are
adjusted in later fiscal periods if the Company's actual allowances vary from
amounts previously estimated. Historically, the variance between actual
allowances and previously estimated allowances has been immaterial. If events
were to occur that would cause the Company's actual allowances (which are
recorded as offsets against gross revenue, as contra-revenues, in arriving at
reported net revenue) to vary significantly from those originally estimated and
reflected in the financial statements, the Company could suffer material
deterioration in future fiscal period gross margins, and, therefore, our
profitability and cash flows could be adversely affected.
Certain obligations are recorded at the time revenue is recognized. They
include costs payable to other on-line, as well as off-line, advertisers for
registered user acquisitions and consumer data, fee sharing costs under third
party database use agreements, email message delivery costs, contingent based
prize indemnification coverage (for potential free on-line lottery winners),
premium fulfillment costs related to the promotion and all other variable costs
directly associated with completing the Company's obligations relative to the
revenue recognized.
Should the Internet operating landscape affecting the Company adversely
change resulting in (a) higher costs of acquiring consumer data and registered
users for the Company's websites; (b) higher costs of acquiring data for our
marketing partners, compromising such marketing partners' ability to maintain
adequate databases to allow for continued third party database use agreements;
(c) the Company's fiscal 2002 InfiKnowledge asset acquisition failing to reduce
the cost of the Company's email delivery activities, or the Company being
required to depend
36
on third party emailing service bureaus to provide an increased portion of its
commercial email delivery at a cost in excess of anticipated internally
generated costs, or other third party influence on the Company's ability to
deliver email message to the records in its databases, or the records in its
marketing affiliates' databases; (d) the Company's contingent based prize
indemnification premiums for indemnification coverage increasing due to an
increase in the number of prize winners at the site, or other currently unknown
factors; (e) the Company's accruals for fulfillment obligations arising out of
its promotions proving to be less than the actual redemptions processed in
subsequent fiscal periods; or (f) unpredictable technology changes or commercial
technology applications; then, if any one, or a combination, of the above
factors were to materialize in subsequent fiscal periods, the Company could
suffer material deterioration in future fiscal period revenue growth and gross
margins, and, therefore, our profitability and cash flows could be adversely
affected to a material extent.
Revenue recognition is also subject to provisions based on the probability
of collection of the related trade accounts receivable. We continuously evaluate
the potential of the collectibility of trade receivables by reviewing such
factors as deterioration in the operating results, financial condition, or
bankruptcy filings, of our customers. As a result of this review process, we
record bad debt provisions to adjust the related receivables' carrying amount to
an estimated realizable value. Provisions for bad debts are also recorded due to
the review of other factors, including (a) the length of time the receivables
are past due, (b) historical experience, and (c) other factors obtained during
the conduct of collection efforts. If circumstances change regarding our
specific customers on an individual basis, or if demand for Internet direct
marketing softens, or if a continuation of the current global economic downturn
prevails, our estimates for bad debt provisions could be further increased,
which could adversely affect our operating margins, our profitability and our
cash flows.
CONTINUATION OF MAJOR CUSTOMERS AND PROSPECTS OF MAJORITY-OWNED SUBSIDIARY
During the three and six months ended May 31, 2002, the Company had five
major customers in its E-commerce segment, which in combination accounted for
approximately $5.5 million and $12.9 million of consolidated net revenue,
respectively, or 51% and 56% of consolidated net revenues, respectively.
Approximately $5.1 million, or 69%, of consolidated net accounts receivable was
attributable to such major customers as of May 31, 2002. For the three and six
months ended May 31, 2002, two of the five customers referenced above had
related net revenues that equaled or exceeded 10% of the Company's consolidated
net revenue for such period. The five major customers referenced above accounted
for 22%, 9%, 8%, 8% and 4% of consolidated net revenue, respectively, for the
three months ended May 31, 2002, and 26%, 10%, 9%, 7% and 4% of consolidated net
revenue, respectively, for the six months ended May 31, 2002. Of the remaining
approximate 100 active customers in the three and six months ended May 31, 2002,
no other single customer had net revenue that equaled or exceeded 4% of
consolidated net revenue.
All five of the major customers discussed above continued to conduct
business with the Company at the date of this report. Should the Company not be
able to continue its relationships with these companies on equivalent, or
similarly favorable terms, or replace any of these companies with other third
parties on similar revenue and gross margin generating terms, the Company could
suffer material deterioration in future fiscal period revenue growth and gross
margins and, therefore, our profitability and cash flows would be adversely
affected. Our potential decreased profitability relative to such possible
failure to continue current relationships, or our inability to replace them with
new relationships, could be partially mitigated by the execution of reductions
in our workforce and other downsizing cost reducing measures. It is not known
how rapidly the Company could respond with such reductions, if at all.
During the three and six-month periods ended May 31, 2002, the Company's
51% majority-owned subsidiary, Montvale Management LLC, contributed
approximately $1.4 and $2.2 million, or 12.8% and 9.7%, respectively, of
consolidated net revenues. The subsidiary became active in Fiscal 2001 (in the
Company's fourth quarter). The subsidiary generates revenue by operating under
net branch agreements, whereby it originates residential mortgages and
refinancings for licensed mortgage banking and brokerage companies under such
net branch agreement. The subsidiary business activity increased in Fiscal 2001
as a result of reduced mortgage and refinance loan interest rates, and increased
government funds for low-income homebuyers. The Company's future busi-
37
ness plans and operating assumptions anticipate that the subsidiary will
contribute an increasing amount of revenue to the Company in terms of absolute
dollars, and in terms of percentage of total revenues and operating income,
during the balance of the fiscal year ending November 30, 2002. Such assumptions
are subject to the continuation of the current interest rate market, the
continued acceptance by the general public of off-line and online marketing
promotions for mortgage and mortgage related products and the continued ability
of the independently operated majority-owned subsidiary to hire and maintain
competent staff and management personnel, trained in the specific field of net
branch operations. The Company can make no assurance that it will realize an
increased contribution of revenue and related profits from the majority-owned
subsidiary in future fiscal periods.
The Company's revenues and profitability from operations have historically
varied. Our revenues, cost of providing revenues, profit margins and overhead
expenses have varied historically among segments, as well as on a consolidated
basis. The revenue allocation among our segments in future periods will most
probably be different than our current revenue allocation due to several
factors, including consumer tastes and potential regulatory issues that may
exist in future periods and other currently unknown factors that could restrict
the Company's revenue generating cycle or cost structure. Therefore, it is
difficult to predict revenue and gross margin trends. Actual trends may cause
the Company to adjust its operating emphasis, which could result in continued
period-to-period fluctuations in the Company's results of operations.
Historically, the Company has had to react to rapid changes in the business
environment within which it operates. Management responded to these rapid
changes as deemed appropriate at the time of change, and as dictated by the
nature of such changes. Management's reaction to such changes covered a broad
range of business related adjustments, ranging from product mix repositioning
and staff reductions, to entire business model overhauls. Based on the Company's
current operations and marketing methods, as well as the still emerging status
of the Internet marketing environment, it is possible that management could
institute significant changes to the Company's business model in response to
unforeseen rapid changes in future fiscal periods.
IMPAIRMENT OF GOODWILL, OTHER INTANGIBLES AND INVESTMENT PORTFOLIOS COULD
IMPACT NET INCOME
The Company carries Goodwill and other Intangibles on its balance sheet
arising from current and prior year acquisitions. The Company must review, at
least annually, such Goodwill and other Intangibles for any asset impairment. If
the review of the Company's Goodwill and Intangibles related to the subsidiaries
organized to acquire such assets determine that such assets are impaired, then
the Company will be required to recognize an impairment charge on such Goodwill
necessary to reduce the carrying value of the Goodwill to its net realizable
value. Should events occur that would give rise to such impairment charge, the
Company would recognize decreased profitability to the extent of such
adjustment. Cash flows would not be directly affected by the impairment charge,
but cash flows would, most likely, be adversely affected as a result of the
facts and circumstances that created the impairment charge.
The Company maintains an investment portfolio that is managed by a
prominent financial institution. The portfolio includes high-grade corporate
commercial paper and auction rate securities, equity securities of real estate
investment trusts ("REITs") and common stock equities, all of which are held for
varying periods of time, pursuant to maturity dates, market conditions and other
factors. The values of our investments in the common stock of publicly-traded
companies, which as of May 31, 2002 amounted to approximately $1 million, are
subject to significant market price volatility, in addition to the potential for
business failure at the company level. Moreover, due to the economic downturn
and difficulties that may be faced by some of the companies in which we have
investments, our investment portfolio could be further impaired by the failure
of such companies in fulfilling their responsibility of adhering to the
repayment of principal upon maturity.
POTENTIAL OF FEDERAL, AND/OR STATE ENACTED LEGISLATION
Various state laws exist, and federal legislation is currently pending,
that limit the Company's ability to deliver commercial e-mail messages to
consumers. There are presently no federal laws that regulate sending unsolicited
email. The pending federal bills and existing state laws require that certain
"opt-out" procedures be included in emails and prohibit "false routing" or
"fictitious address" information. Existing state, and pending federal, laws
require functioning return e-mail addresses and that valid postal addresses be
included by the senders of commercial email messages. Some states require an
"ADV" label in the subject line, and proscribe false header or misleading
subject lines. Attorneys General and/or consumers are given authority to enforce
the state laws. States with legislation affecting the sending of unsolicited
commercial email include: California, Colorado, Connecticut, Delaware, Idaho,
Illinois, Iowa, Louisiana, Maryland, Missouri, Nevada, North Carolina, Ohio,
Oklahoma, Pennsylvania, Rhode Island, Tennessee, Utah, Virginia, Washington and
West Virginia. If strict federal legislation is subsequently written into law,
with its terms specifically limiting the Company's ability to market its offers,
the Company could potentially realize a material adverse impact in future fiscal
period net revenue growth, and therefore, profitability and cash flows could be
adversely affected.
38
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
1. NANCY GAREN-- On or about October 16, 2001, Nancy Garen, author of
"Tarot Made Easy", commenced an action against a series of defendants, including
the Company, in the United States District Court for the Central District of
California, entitled NANCY GAREN V. STEVEN L. FEDER, PETER L. STOLZ, THOMAS H.
LINDSEY, GALACTIC TELCOM, INC., ACCESS RESOURCE SERVICES, INC., PSYCHIC READERS
NETWORK, INC. D/B/A MISS CLEO, OSHUN 5 COMMUNICATIONS, INC., CIRCLE OF LIGHT,
INC., CENTRAL TALK MANAGEMENT, INC., TRAFFIX, INC., WEKARE READERS &
INTERPRETERS, INC., WEST CORPORATION, AND DOES 1 THROUGH 10 (EDCV 01-790
(VAP-SGLx)). Plaintiff alleges that defendants are liable for a copyright
infringement, contributory copyright infringement, vicarious copyright
infringement, unfair competition, contributory federal unfair competition and
state statutory and common law unfair competition, and further requests a
constructive trust, a temporary restraining order, and damages from alleged
infringement of a copyright or, alternatively, statutory damages for each act of
infringement in "an amount provided by law in excess of $250,000,000", all as
the same may have arisen from the defendants' marketing of tarot card reading
and other psychic services. The Company does not believe that there is any merit
to Ms. Garen's claims as they relate to the Company, has denied the claims in
its answer to the complaint, and intends vigorously to defend against the
claims.
2. MAVIES WINGLER -- On or about May 9, 2001, Mavies Wingler commenced an
action against Group Lotto, Inc. ("GLI"), a wholly-owned subsidiary of the
Company, in the Circuit Court of Logan County, West Virginia. Ms. Wingler claims
to have picked the winning numbers entitling her to $10 million. On June 8,
2001, the action was removed to the United States District Court, Southern
District of West Virginia, and is entitled WINGLER V. GROUPLOTTO, INC., Docket
Number 2:01 -- CV -- 518. The action is in the discovery stage. The Company does
not believe that there is any merit to Ms. Wingler's claim, and intends
vigorously to defend against it. The Company and GLI have a contract of
indemnification with SCA Promotions, Inc. to be indemnified for prizes paid out
to qualified winners. GLI winners are required to produce the Group Lotto Entry
Notification form ("GLEN") within a specified period of time after matching a
drawing's winning numbers in order to qualify for receipt of the appropriate
prize winnings.
3. DANIEL RODGERS -- In March, 2002, Daniel Rodgers commenced an action
against the Company in Supreme Court of the State of New York, Rockland County.
The complaint alleges that the Company disseminated false and misleading
advertisements through email advertisements and through the website of its
subsidiary, GroupLotto.com. Mr. Rodgers purports to represent a class consisting
of those who, during the period January 1, 2001 to March 5, 2002, provided their
name, address, email address and other biographical information in response to
the email advertisements or in response to the GroupLotto web page. The
Complaint purports to allege claims of common law fraud, deceptive acts and
practices, and false and misleading advertising under New York law. The
Complaint seeks injunctive relief, unspecified monetary damages, and attorney's
fees. The Company has not yet filed an answer to the Complaint, but believes
that there is no merit to the claims and intends vigorously to defend against
them.
4. PHILIP MICHAEL THOMAS-- On June 3, 2002, the American Arbitration
Association rendered an award in the sum of approximately $2.3 million
(inclusive of interest) in favor of the Claimants, in the arbitration entitled
PHILIP MICHAEL THOMAS, PMT PRODUCTIONS INC., KAYE PORTER MANAGEMENT, RMI
ENTERTAINMENT, INC., MILLENNIUM TELEMEDIA, INC., CLAIMANTS V. NEW LAUDERDALE,
LLC D/B/A CALLING CARD CO., PSYCHIC READERS NETWORK, INC. D/B/A PRN
TELECOMMUNICATIONS, AND QUINTEL ENTERTAINMENT, INC., RESPONDENTS (NO.
131400004900). The award consists of approximately $1.48 million in damages,
plus interest at nine percent (9%) from January 1, 1996 and January 1, 1997, or
approximately $785,000. The award also denied Claimants' punitive damages and
all other claims asserted in the arbitration.
The Claimants in the arbitration have filed a motion in an action pending
in the Circuit Court, Broward County, Florida (Thomas et al v. New Lauderdale,
LLC et al, Case No. 98-12259-07) (the "Action"), to confirm the award.
39
The Respondents in the arbitration have also filed a motion to vacate and\or
modify the award. In addition, the plaintiffs in the Action have filed a motion
to be relieved from a stay of those proceedings in order to pursue claims
against the defendants in the Action which they contend have not been resolved
by the arbitration, including claims for punitive damages against the Company as
well as the individual defendants. The Company has indemnified the individual
defendants in the Action; believes that the arbitration award finally resolves
all claims; and intends vigorously to defend against the plaintiffs' further
pursuit of claims in the Action.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS.
EXHIBIT
NUMBER
- -------
3.1.1 Articles of Incorporation of the Company, as amended(1)
3.1.2 Amendment to the Articles of Incorporation of the Company(2)
3.2 By-Laws of the Company(3)
- ----------
(1) Filed as an Exhibit to the Company's Registration Statement on Form 8-A,
dated October 23, 1995, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended August 31, 1998, and incorporated herein by reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(the "S-1 Registration Statement"), dated September 6, 1995 (File No.
33-96632), and incorporated herein by reference.
(B) REPORTS ON FORM 8-K.
The Company did not file any reports on Form 8-K during the second quarter
of the fiscal year ending November 30, 2002.
FORWARD LOOKING INFORMATION
This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. When used herein, words like "intend", "
anticipate", " believe", "estimate", "plan" or "expect", as they relate to the
Company, are intended to identify forward-looking statements. The Company
believes that the assumptions and expectations reflected in such forward-looking
statements are reasonable, based on information available to it on the date of
this Quarterly Report, but no assurances can be given that these assumptions and
expectations will prove to have been correct or that the Company will take any
action that it may presently be planning. The Company is not undertaking to
publicly update or revise any forward-looking statement if it obtains new
information or upon the occurrence of future events or otherwise.
40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TRAFFIX, INC.
By: /s/ JEFFREY L. SCHWARTZ
--------------------------------
Jeffrey L. Schwartz
Chairman, President and CEO
Date: July 15, 2002
By: /s/ DANIEL HARVEY
--------------------------------
Daniel Harvey
Chief Financial Officer
(Principal Financial Officer)
Date: July 15, 2002
41
EXHIBIT INDEX
EXHIBIT
NUMBER
- -------
3.1.1 Articles of Incorporation of the Company, as amended(1)
3.1.2 Amendment to the Articles of Incorporation of the Company(2)
3.2 By-Laws of the Company (3)
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(1) Filed as an Exhibit to the Company's Registration Statement on Form 8-A,
dated October 23, 1995, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended August 31, 1998, and incorporated herein by reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
dated September 6, 1995 (File No. 33-96632), and incorporated herein by
reference.
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