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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27046
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
PEARL RIVER, NEW YORK 10965
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (845) 620-1212
TITLE OF CLASS EXCHANGE ON WHICH REGISTERED
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SECURITIES REGISTERED PURSUANT COMMON STOCK NASDAQ NATIONAL MARKET
TO SECTION 12(B) OF THE ACT: $.001 PAR VALUE
SECURITIES REGISTERED PURSUANT COMMON STOCK
TO SECTION 12(G) OF THE ACT: $.001 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
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The number of shares outstanding of the Registrant's common stock is
14,268,403 (as of 2/10/03). The aggregate market value of the voting stock held
by nonaffiliates of the Registrant was approximately $38,612,473 (as of 2/10/03,
based upon a closing price of the Company's Common Stock on the Nasdaq National
Market on such date of $3.41).
DOCUMENTS INCORPORATED BY REFERENCE
None.
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TRAFFIX, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2002
ITEMS IN FORM 10-K
PAGE
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PART I
Item 1. Business ...................................................... 2
Item 2. Properties .................................................... 6
Item 3. Legal Proceedings ............................................. 6
Item 4. Submission of Matters to a Vote of Security Holders ........... N/A
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters ........................................... 9
Item 6. Selected Financial Data ....................................... 9
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................... 10
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk ................................................... N/A
Item 8. Financial Statements and Supplementary Data ................... 42
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ........................ N/A
PART III
Item 10. Directors and Executive Officers of the Registrant ............ 42
Item 11. Executive Compensation ........................................ 46
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters ................ 49
Item 13. Certain Relationships and Related Transactions ................ 51
Item 14. Control and Procedures ........................................ 51
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K ........................................... 52
SIGNATURES ................................................................ 54
1
FORWARD LOOKING INFORMATION
MAY PROVE INACCURATE
THIS ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS
AND INFORMATION RELATING TO US THAT ARE BASED ON THE BELIEFS OF MANAGEMENT, AS
WELL AS ASSUMPTIONS MADE BY AND INFORMATION CURRENTLY AVAILABLE TO US. WHEN USED
IN THIS DOCUMENT, THE WORDS "ANTICIPATE," "BELIEVE," "ESTIMATE," AND "EXPECT"
AND SIMILAR EXPRESSIONS, AS THEY RELATE TO US, ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REFLECT OUR CURRENT VIEWS WITH
RESPECT TO FUTURE EVENTS AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND
ASSUMPTIONS, INCLUDING THOSE DESCRIBED IN THIS ANNUAL REPORT ON FORM 10-K.
SHOULD ONE OR MORE OF THESE RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD
UNDERLYING ASSUMPTIONS PROVE INCORRECT, ACTUAL RESULTS MAY VARY MATERIALLY FROM
THOSE DESCRIBED HEREIN AS ANTICIPATED, BELIEVED, ESTIMATED OR EXPECTED. WE DO
NOT INTEND TO UPDATE THESE FORWARD-LOOKING STATEMENTS.
ITEM 1. BUSINESS
OVERVIEW
We are a leading on-line database marketing company that uses our on-line
media network to generate leads, customers and sales for us and our corporate
clients. We provide complete end-to-end marketing solutions for companies
seeking to increase sales and customers through on-line marketing programs,
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 a 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 client's sales and
generating comprehensive reporting in order for the client to analyze the
effectiveness of a promotion. We use our websites, interactive games, email
marketing and database of permission-based, profiled records (and the on-line
media of third parties) to generate the customers, sales and 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, we generate revenue from our
own products and services, such as retail gift items, which accounted for
approximately 3.0% of our revenue in the fiscal year ended November 30, 2002
("Fiscal 2002"). Commencing in Fiscal 2003, these products and services have
been expanded, and will include an ISP service, a long-distance telecom service,
and on-line dating. We also generate revenues 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, we believe we are able to provide 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 and operate multiple on-line properties, such as GroupLotto.com, the
free on-line lottery, and AtlasCreditGroup.com, AtlasEducationGroup.com and
iMatchup.com (which commenced operations in December 2002), as well as a number
of interactive games (such as Direct Deposit Promotions and Scratch&Win), all
supplemented by other web sites and services provided on the Web. These
activities are designed to generate real-time response-based marketing results
for our corporate clients, as well as for our own offers. When visiting our
on-line properties, consumers are given the opportunity 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
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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.
WEBSITES. 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 the bulk of our consumer
traffic to this website through proprietary and third party email marketing
programs, emailed to lists of consumers who have indicated an interest in our
product and service offers by opting in to receive information on 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 win any
number of prizes, which range from $100 to $25,000. The consumer plays the game
by "scratching" with the mouse certain parts of the entry ticket to uncover the
results. These games are presented as "pop-ups" upon browser exit, and can also
be "pushed" to consumers by delivering them to the player's email inbox. We also
market credit card offers through our "Direct Deposit" sweepstakes game (patent
pending), whereby a consumer can win up to $5,000 instantly if a portion of his
or her credit card number matches a pre-selected winning number.
We own and operate several other websites such as AtlasCreditGroup.com,
AtlasEducationGroup.com, prizecade.com and jewelclaimcenter.com. Such websites
are deployed to generate revenue for our clients in a similar manner as the
GroupLotto model described above. Each of these sites is designed to appeal to a
specific consumer interest category that we matched with product promotions that
appeal to such interest category.
EMAIL MARKETING. Direct marketing via email is an important business
resource. Each program that we market for our clients can be implemented not
only through the websites, interactive games and "pop-ups" discussed above, but
also, and often, through email marketing. We currently market to approximately
150 million permission-based records, which are either owned or managed by us
under our revenue share arrangement.
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 (acquired in December 2001 through the acquisition of the assets
of Infiknowledge.com, a privately held Canadian technology company), which
reduces our dependence on third party vendors and further reduces the expenses
associated with delivering our monthly commercial email messages and reduces the
costs of our site maintenance and development costs. FOR A FURTHER DISCUSSION OF
RECENT BUSINESS AND LEGAL DEVELOPMENTS REGARDING THIS E-COMMERCE COMPONENT, AND
SPECIFICALLY THE LOSS OF A SIGNIFICANT CUSTOMER AND EVENTS IMPACTING EMAIL
MARKETING, SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
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, and have access to, extensive databases, manage our own
internal 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.
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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 coupled with our proprietary databases, the other
databases under our management and our delivery and reporting systems),
distinguish us from our competitors in the on-line marketing industry.
SYNDICATION. We expend a significant portion of our email resources to
generate sales for our own products and services and for traffic to our
websites. After we develop a campaign that works efficiently on our own 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 on-line 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 such media companies benefit from receiving an
immediately marketable, fully-packaged and tested marketing program. As a
result, we believe we are able to leverage campaigns we have developed
(including our own products and services) so that we can generate additional
revenue with virtually no costs or risks associated with such business
extension.
TRAFFIX'S 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, sells gift items (such as
DVDs, CDs and inexpensive jewelry) 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. These
products include credit card billed products in the "Voice Over Internet
Protocol" area ("TxNET-LD"), dial-up modem ISP back-up systems ("TxNET-ISP"),
dating/personal programs conducted over the Internet ("iMatchup.com"), jewelry,
voicemail, DVDs and books. One of the additional benefits of these programs is
our ability to accumulate consumer credit card data, which allows for the
subsequent use of our marketing concept of "just-one-click" credit card billing,
making on-line purchases easier for the consumer, and allowing us to more easily
process additional sales and services in the future. In addition, certain of
these services are designed as monthly recurring revenue sources, such as our
dating and long-distance service. Further, we anticipate that certain of these
services will derive monthly recurring revenue streams through the use of Local
Exchange Carrier (LEC) billing.
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 year ended November 30, 2002, the Thanksmuch.com
website generated approximately $1.3 million, or approximately 3.0% of
consolidated net revenue, with an approximate $27,000 contribution to
consolidated income from operations for such period.
Our expansion in, and dependence on, our on-line direct marketing efforts,
coupled with the potential for state and/or federal legislation limiting on-line
marketing's consumer contact capability, should all be considered when referring
to our current fiscal year's results, as well as prior year's historical
results, in evaluating the potential for our future operations, cash flows, and
financial position.
SEGMENT INFORMATION
During the fiscal year ended November 30, 2002, we generated revenue from
the following segments: E-Commerce and Off-line Marketing. The E-Commerce
segment realized significant growth during the fiscal year ended November 30,
2002, when compared to the prior fiscal 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 email promotions. The Off-Line Marketing services segment consists
of revenue generated by us through off-line direct marketing channels.
Historically, this segment's activities
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consisted of telemarketing services used for the acquisition of long distance
and wireless phone customers for various phone service providers. In Fiscal
2002, this segment consisted exclusively of our majority owned subsidiary,
Montvale Management, LLC, and the revenues and expenses of Montvale's net branch
services provided 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
Fiscal 2002. Segment information is set forth in Note 13 to the Consolidated
Financial Statements referred to in the Financial Statements and Supplementary
Data section hereof and incorporated herein by reference. For a more detailed
discussion of our segment information, also see "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
COMPETITION
We face intense competition in the marketing of products and services,
particularly on the Internet. Many of our competitors are well established, have
reputations for success in the development and marketing of services and have
significant financial, marketing, distribution, personnel and other resources.
These financial and other capabilities permit such companies to implement
extensive advertising and promotional campaigns, both generally and in response
to efforts by additional competitors to enter into new markets and introduce new
services.
INSURANCE
As an operating entity, we may be subject to substantial liability as a
result of our day-to-day operations. Accordingly, we maintain a general
liability insurance policy that is subject to a per occurrence limit of
$1,000,000 with a $2,000,000 aggregate limit and an umbrella policy covering an
additional $10,000,000 of liability. In addition, we have errors and omissions
insurance with a limit of $5,000,000. We also maintain Directors and Officers
liability insurance policies for legal costs and claims. Such insurance may not
be sufficient to cover all potential claims and additional insurance may not be
available in the future at reasonable costs.
GOVERNMENT REGULATION
Various state laws exist, and federal legislation is currently pending,
that limit our ability to deliver commercial e-mail messages to consumers. The
Federal Trade Commission is convening a three-day workshop to review commercial
e-mail practices. There are presently no federal laws that explicitly regulate
sending unsolicited e-mail. The pending federal bills and existing state laws
require that certain "opt-out" procedures be included in e-mails 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 e-mail 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. Over half the states have enacted legislation
affecting the sending of unsolicited commercial e-mail. If strict federal
legislation is subsequently written into law, with its terms specifically
limiting our ability to market our offers, we could potentially realize a
material adverse impact in future fiscal period net revenue growth, and
therefore, profitability and cash flows could be adversely affected.
In November 2002, we received an inquiry from the Federal Trade Commission
questioning whether we needed to comply with the Graham Leach Bliley Act
(privacy of consumer information for financial institutions) arising from Atlas
Credit Group, one of our Internet subsidiaries. We responded by stating that we
need not comply with the Graham Leach Bliley Act because Atlas Credit Group
utilizes advertising from other financial institutions, but is not itself a
financial institution as defined under the statute. We have not received any
further comments from the Federal Trade Commission. ThanksMuch.com, LLC, another
of our Internet subsidiaries, was served with a class action lawsuit in State
Court in the County of Los Angeles, California, for damages associated with
allegedly violating the State's Shipping and Handling laws. This suit was
recently settled. The settlement offers a $5.00 certificate to California
consumers on future purchases of ThanksMuch products and provides a small
payment for attorneys' fees.
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The Pennsylvania Attorney General's Office had requested us to enter into
an Assurance of Voluntary Compliance Agreement to resolve allegations concerning
certain of our sales practices. The Attorney General alleged that our Fly Free
telemarketing program, as well as certain pay-per-call services, did not
adequately disclose to the consumer the terms of the offer being made. The
Agreement also provides for a payment to the State in an amount yet to be
determined. Discussions with the Pennsylvania Attorney General's Office are
on-going.
Any changes in the Internet operating landscape that materially hinders our
current ability and/or cost to deliver commercial e-mail messages to the
consumer records in our databases, and the consumer records in the databases of
our affiliates, could potentially cause a material impact on net revenue and
gross margin and, therefore, our profitability and cash flows could be adversely
affected.
EMPLOYEES
We currently employ 104 full-time employees, including six executive
officers, and two part-time employees. We believe that our relations with our
employees are satisfactory. None of our employees are represented by a union.
TRANSACTIONS WITH MAJOR CUSTOMERS
Transactions with major customers and related economic dependence
information is set forth under the heading Transactions with Major Customers in
Note 1 to the Consolidated Financial Statements referred to in the Financial
Statements and Supplementary Data section hereof and incorporated herein by
reference.
OUR COMPANY
We were organized in 1993 under the laws of the State of Delaware as
Quintel Entertainment, Inc. We changed our name to Quintel Communications, Inc.
in 1998 and to Traffix, Inc. in 2000. Our executive offices are located at One
Blue Hill Plaza, Pearl River, New York 10965, our Internet address is
www.traffixinc.com, and our telephone number is (845) 620-1212.
ITEM 2. PROPERTIES
We lease approximately 15,000 square feet of space at One Blue Hill Plaza,
Pearl River, New York, all of which is currently used for our principal
executive offices. The lease for such premises expires on July 31, 2006. The
base rent is $26,875 per month for the remainder of the term of the lease. We
also lease, under two separate lease agreements, approximately 8,480 square feet
of space in Moncton, New Brunswick, Canada, which is occupied by a wholly owned
subsidiary, and is currently used for development and maintenance of our
websites, and to house other data operations and the computer equipment used in
our email delivery processes. The combined base rent is approximately $5,000 per
month, and the expiration dates for the two leases are April 30, 2003 and April
30, 2005. We also lease 7,138 square feet of space, through our majority owned
subsidiary, Montvale Management, LLC, in Montvale, New Jersey. Such lease
expires October 31, 2003. We also lease approximately 1,000 square feet of space
in Woodmere, Long Island, New York, which is occupied by a wholly-owned
subsidiary, and is currently used to house the sales and fulfillment operations
of such wholly-owned subsidiary. The base rent is $1,300 per month and the lease
expires June 30, 2003. We intend to negotiate for the extension of those leases
scheduled to expire in 2003, or, if we are unable to do so, to lease or acquire
other similar space in close proximity to our existing space.
ITEM 3. LEGAL PROCEEDINGS
NANCY GAREN
On or about October 16, 2001, Nancy Garen, author of "Tarot Made Easy",
commenced an action against a series of defendants, including our Company, in
the United States District Court for the Central District of California,
entitled NANCY GAREN V. STEVEN L. FEDER ET AL. (EDCV 01-790 (VAP-SGLx).
Plaintiff alleged that defendants were liable for a copyright infringement,
contributory copyright infringement, vicarious copyright infringe-
6
ment, unfair competition, contributory federal unfair competition and state
statutory and common law unfair competition and damages from alleged
infringement of a copyright. Pursuant to a settlement with the defendants other
than our Company, the action was dismissed as against us, with prejudice and
without any cost to us.
MAVIES WINGLER
On or about May 9, 2001, Mavies Wingler commenced an action against Group
Lotto, Inc. ("GLI"), one of our wholly-owned subsidiaries, 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. At the end of 2002, Ms. Wingler's attorney
withdrew, and she is now representing herself. We 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. We do not believe that there is any merit to Ms. Wingler's claim
and intend to vigorously continue our defense thereof.
DANIEL RODGERS
In March 2002, Daniel Rodgers commenced an action against our Company in
Supreme Court of the State of New York, Rockland County. The complaint alleges
that we disseminated false and misleading advertisements through email
advertisements and through the website of GLI. In August 2002, we filed a motion
to dismiss the complaint. In January 2003, the court issued an order dismissing
the action. The plaintiff may file an appeal from the decision within a
specified 30-day period, which has not yet expired.
PLASMANET
On November 21, 2002, Plasmanet, Inc., one of our competitors, commenced an
action alleging patent infringement and misappropriation of trade secrets.
PLASMANET, INC. V. APAX PARTNERS, INC., ET AL., Case No. 02 CIV 9290 (S.D.N.Y.).
Plasmanet operates a website, FreeLotto.com, which is similar to one operated by
GLI. Plasmanet alleges that on September 24, 2002 it obtained a patent for a
"Free Remote Lottery System" and that we infringed said patent. In addition,
Plasmanet asserts that we misappropriated Plasmanet's trade secrets after we
were shown a private placement memorandum by an agent of Plasmanet's investment
banker. The complaint seeks injunctive relief and unspecified money damages. We
believe there is no merit to the claims and intend to vigorously defend against
them.
QWEST COMMUNICATIONS
Qwest Communications, Inc. has notified us of an indemnification claim
relating to a class action filed against Qwest in Minnesota. BINDNER V. LCI
INTERNATIONAL TELECOM CORP. ET AL., District Court of Minnesota, County of
Sibley, Case No. C0-00-242. Plaintiffs in that action claim that in late 1999
into mid-2000, they were misled when they were solicited to change their long
distance carrier to Qwest. They assert that they were not told that they would
have to stay at certain hotels and pay their regular rates as part of a
promotion, which offered them free airline tickets. We introduced the promotion
("Fly Free America") to Qwest, and had been retained by Qwest to operate the
telemarketing campaign. Fraud claims in the class action have been dismissed,
leaving breach of contract and false advertising claims. An application for
class certification is now pending. The class could be as large as 12,000
claimants.
In or about May 2000, we and Qwest entered into an agreement terminating
our contract and settling the amount due us (the "May 2000 Agreement"). The May
2000 Agreement contained language which Qwest claims obligates us to indemnify
Qwest for any loss it may sustain by reason of the class action. We maintain
that we have no liability in the matter. In November 2002, we commenced an
arbitration against Qwest to recover certain moneys due us pursuant to the May
2000 Agreement. In December 2002, Qwest filed counterclaims in the arbitration
relating to the Fly Free America program. Qwest asserts that we must indemnify
Qwest for, among other things, fines and penalties amounting to approximately
$1.5 million which Qwest claims it paid in con-
7
nection with a number of consent decrees it entered into with various State
Attorneys General, an unspecified amount of attorneys' fees, and any and all
expenses, penalties or other amounts Qwest becomes liable for in connection with
the class action. Qwest also seeks reimbursement of approximately $3.1 million
it paid us pursuant to the May 2000 Agreement. We believe that there is no merit
to Qwest's counterclaims and intend vigorously to defend against them, as well
as to pursue our claim.
COLUMBIA HOUSE/RYDEL
In or about August 2002, Sony Music Entertainment, Inc., d/b/a Columbia
House, one of our clients, notified us of an indemnification claim relating to a
class action filed against Columbia House, among others, in Illinois. RYDEL V.
COMTRAD INDUSTRIES, INC. ET AL., Circuit Court of Cook County, Illinois, No. 02
CH 13269. Plaintiff claims to have received unsolicited commercial e-mail from,
among others, Columbia House, in violation of Illinois law. Columbia House
advised us that it believes that the email in question was not approved by
Columbia House when it was sent by us, and asserted a claim for indemnification
against us pursuant to our contract. We and Columbia House agreed to defer
resolution of the indemnification claim (and reserved each of our respective
rights). Columbia House is defending against the class action and has filed a
motion to dismiss it. In or about January 2003, we were named as a defendant in
the class action. In an additional count in the complaint, the plaintiff asserts
that we violated the Illinois Consumer Fraud and Deceptive Business Practices
Act by providing to a co-defendant a list of consumers who had consented to
receive commercial e-mails when, the complaint alleges, they had not. The
complaint seeks injunctive relief and unspecified damages. We are currently
investigating the claim, and will timely respond to the complaint in due course.
SPRINT COMMUNICATIONS, TINA HARRISON, LISA WATTERS (UTAH CLAIMS)
Sprint Communications, one of our former clients, has notified us of an
indemnification claim relating to a class action filed against Sprint in Utah
(GILLMAN V. SPRINT COMMUNICATIONS CO. L.P., District Court of Utah, Third
Judicial District Salt Lake City, Civil No. 020406640). Plaintiff claims to have
received unsolicited commercial e-mail in violation of Utah law. Sprint has
advised us that it is defending the action and has filed a motion for summary
judgment dismissing the claims. In addition, Sprint has advised us that it has
received a settlement demand for an amount which is not material. In January
2003, we received notice of two additional claims filed in Utah state court:
WATTERS V. TRAFFIX, INC., MONGLYPH.COM, AND PHILLIP C. WILSON AND JOHN DOES ONE
THROUGH TEN, (NO. 20413327); and HARRISON V. TRAFFIX, INC. AND JOHN DOES ONE
THROUGH TEN, (No. 20414190), District Court of Utah, Third Judicial District
Salt Lake County, Sandy Department. In each of these actions, the plaintiff
claims to represent a class of Utah residents who received unsolicited
commercial e-mail in violation of Utah law. We are currently engaged in
discussions to resolve these matters for an amount that would not be material.
8
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
Our Common Stock trades on the Nasdaq National Market System. Since
September 12, 2000, the date upon which we changed our name from Quintel
Communications, Inc. to Traffix, Inc., our Common Stock has traded under the
symbol "TRFX". Prior thereto, such Common Stock traded under the symbol "QTEL".
The following table sets forth the high and low sales prices of the Common Stock
as reported by Nasdaq for each full quarterly period within the two most recent
fiscal years.
HIGH LOW
------- -------
Fiscal Year Ended November 30, 2002
First Quarter ................................. $8.1500 $5.3000
Second Quarter ................................ 8.3000 5.6900
Third Quarter ................................. 6.1000 3.5000
Fourth Quarter ................................ 3.9000 2.5600
Fiscal Year Ended November 30, 2001
First Quarter ................................. $2.9688 $1.3750
Second Quarter ................................ 3.6700 1.9375
Third Quarter ................................. 4.4500 3.0600
Fourth Quarter ................................ 6.2000 3.7400
SECURITY HOLDERS
To the best of our knowledge, at February 10, 2003, there were 71 record
holders of our Common Stock. We believe there are numerous beneficial owners of
Common Stock whose shares are held in "street name."
DIVIDENDS
We have not paid dividends during the two most recently completed fiscal
years, and have no current plans to pay dividends on our Common Stock. We
currently intend to retain all earnings for use in our business.
RECENT SALES OF UNREGISTERED SECURITIES
On December 6, 2001, we consummated the acquisition of the assets of
InfiKnowlege.com, Inc. for aggregate consideration of $1,150,000, a portion of
which consisted of $687,500 of our common stock, or 117,522 shares, valued at
$6.20 per share (the average closing prices of our common stock for the period
December 4 to December 10, 2001). In accordance with such Agreement, 39,174 of
such shares were issued on each of December 6, 2001 and 2002 (and the remaining
39,174 shares are to be issued on December 6, 2003). The foregoing issuances
were exempt from the registration requirements of the Securities Act of 1933, as
amended, by virtue of Section 4(2) of such Act as being transactions by an
issuer not involving any public offering.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents our selected historical financial data for
each of the years in the five-year period ended November 30, 2002. The financial
data set forth should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our financial
statements.
9
STATEMENT OF OPERATIONS DATA:
YEAR ENDED NOVEMBER 30,
------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- ------------
Net revenue ........................ $44,042,925 $32,209,410 $26,611,863 $42,839,840 $ 94,690,251
Costs of sales ..................... 12,243,635 9,152,462 9,057,027 26,952,097 80,037,115
Gross profit ....................... 31,799,290 23,056,948 17,554,836 15,887,743 14,653,136
Selling, general and
administrative expenses ......... 27,371,985 16,783,655 12,080,543 10,881,156 34,049,435
----------- ----------- ----------- ----------- ------------
Income (loss) from operations ...... 4,427,305 6,273,293 5,474,293 5,006,587 (19,396,299)
Interest expense ................... (101,385) (5,900) (286,655) (70,701) (186,218)
Other income, net .................. 202,364 (2,574,694) 3,430,986 1,446,494 2,212,435
----------- ----------- ----------- ----------- ------------
Income (loss) before provision for
income taxes (benefit) .......... 4,528,284 3,692,699 8,618,624 6,382,380 (17,370,082)
Provision for income taxes (benefit) 1,786,894 3,275,200 3,471,754 2,458,520 (417,464)
----------- ----------- ----------- ----------- ------------
Net income (loss) .................. $ 2,741,390 $ 417,499 $ 5,146,870 $ 3,923,860 $(16,952,618)
=========== =========== =========== =========== ============
Basic net income (loss) per share .. $ 0.21 $ 0.03 $ 0.35 $ 0.26 $ (1.00)
=========== =========== =========== =========== ============
Diluted net income (loss) per share $ 0.19 $ 0.03 $ 0.33 $ 0.26 $ (1.00)
=========== =========== =========== =========== ============
Common Shares outstanding
Basic ........................... 13,350,794 14,794,159 14,792,734 15,119,610 14,798,518
Diluted ......................... 14,247,450 15,396,619 15,494,663 15,241,662 15,965,404
BALANCE SHEET DATA:
YEAR ENDED NOVEMBER 30,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Working capital .... $39,344,095 $40,057,164 $40,178,773 $36,789,213 $34,138,388
Total assets ....... 51,190,993 52,742,584 52,198,843 57,277,279 64,413,144
Total liabilities .. 7,404,985 10,329,878 10,870,283 17,391,001 27,731,000
Stockholders' equity 43,786,008 42,412,706 41,328,560 39,886,278 36,682,144
ITEM 7. 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 us that are based on the current beliefs
and expectations of Management, as well as assumptions made by and information
currently available to us. When used in this Management's Discussion and
Analysis, and elsewhere in this Form 10-K, the words "anticipate", "believe",
"estimate", and "expect" and similar expressions, as they relate to our Company
are intended to identify forward-looking statements. Such statements reflect the
current views of our 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.
The following discussion should be read in conjunction with the
consolidated financial statements and the related notes thereto, as well as all
other related notes, and financial and operational references, appearing
elsewhere in this document.
OVERVIEW
We are a leading on-line database marketing company that uses our on-line
media network to generate leads, customers and sales for us and our corporate
clients. We provide complete end-to-end marketing solutions for companies
seeking to increase sales and customers through on-line marketing programs,
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 a 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
10
websites or web pages necessary to effect the consumer transaction that drives
the client's sales and generating comprehensive reporting in order for the
client to analyze the effectiveness of a promotion. We use our websites,
interactive games, email marketing and database of permission-based, profiled
records (and the on-line media of third parties) to generate the customers,
sales and 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,
we generate revenue from our own products and services, such as retail gift
items, which accounted for approximately 3.0% of our revenue in the fiscal year
ended November 30, 2002 ("Fiscal 2002"). Commencing in Fiscal 2003, these
products and services have been expanded, and will include an ISP service, a
long-distance telecom service, and on-line dating. We also generate revenues
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, we believe we are able to provide 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 and operate multiple on-line properties, such as GroupLotto.com, the
free on-line lottery, and AtlasCreditGroup.com, AtlasEducationGroup.com and
iMatchup.com (which commenced operations in December 2002), as well as a number
of interactive games (such as Direct Deposit Promotions and Scratch&Win), all
supplemented by other web sites and services provided on the Web. These
activities are designed to generate real-time response-based marketing results
for our corporate clients, as well as for our own offers. When visiting our
on-line properties, consumers are given the opportunity 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.
WEBSITES. 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 the bulk of our consumer
traffic to this website through proprietary and third party email marketing
programs, emailed to lists of consumers who have indicated an interest in our
product and service offers by opting in to receive information on 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 win any
number of prizes, which range from $100 to $25,000. The consumer plays the game
by "scratching" with the mouse certain parts of the entry ticket to uncover the
results. These games are presented as "pop-ups" upon browser exit, and can also
be "pushed" to consumers by delivering them to the player's email inbox. We also
11
market credit card offers through our "Direct Deposit" sweepstakes game (patent
pending), whereby a consumer can win up to $5,000 instantly if a portion of his
or her credit card number matches a pre-selected winning number.
We own and operate several other websites such as AtlasCreditGroup.com,
AtlasEducationGroup.com, prizecade.com and jewelclaimcenter.com. Such websites
are deployed to generate revenue for our clients in a similar manner as the
GroupLotto model described above. Each of these sites is designed to appeal to a
specific consumer interest category that we matched with product promotions that
appeal to such interest category.
EMAIL MARKETING.Direct marketing via email is an important business
resource. Each program that we market for our clients can be implemented not
only through the websites, interactive games and "pop-ups" discussed above, but
also, and often, through email marketing. We currently market to approximately
150 million permission-based records, which are either owned by us or are
managed by us under our revenue share arrangement.
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 (acquired in December 2001 through the acquisition of the assets
of Infiknowledge.com, a privately held Canadian technology company), which
reduces our dependence on third party vendors and further reduces the expenses
associated with delivering our monthly commercial email messages and reduces the
costs of our site maintenance and development costs. FOR A FURTHER DISCUSSION OF
RECENT BUSINESS AND LEGAL DEVELOPMENTS REGARDING THIS E-COMMERCE COMPONENT, AND
SPECIFICALLY THE LOSS OF A SIGNIFICANT CUSTOMER AND EVENTS IMPACTING EMAIL
MARKETING, SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
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, and have access to, extensive databases, manage our own
internal 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 coupled with our proprietary databases, the other
databases under our management and our delivery and reporting systems),
distinguish us from our competitors in the on-line marketing industry.
SYNDICATION. We expend a significant portion of our email resources to
generate sales for our own products and services and for traffic to our
websites. After we develop a campaign that works efficiently on our own 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 on-line 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 such media companies benefit from receiving an
immediately marketable, fully-packaged and tested marketing program. As a
result, we believe we are able to leverage campaigns we have developed
(including our own products and services) so that we can generate additional
revenue with virtually no costs or risks associated with such business
extension.
12
TRAFFIX'S 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, sells gift items (such as
DVDs, CD's and inexpensive jewelry) 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. These
products include credit card billed products in the "Voice Over Internet
Protocol" area ("TxNET-LD"), dial-up modem ISP back-up systems ("TxNET-ISP"),
dating/personal programs conducted over the Internet ("iMatchup.com"), jewelry,
voicemail, DVD's and books. One of the additional benefits of these programs is
our ability to accumulate consumer credit card data, which allows for the
subsequent use of our marketing concept of "just-one-click" credit card billing,
making on-line purchases easier for the consumer, and allowing us to more easily
process additional sales and services in the future. In addition, certain of
these services are designed as monthly recurring revenue sources, such as our
dating and long-distance service. Further, we anticipate that certain of these
services will derive monthly recurring revenue streams through the use of Local
Exchange Carrier (LEC) billing.
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 year ended November 30, 2002, the Thanksmuch.com
website generated approximately $1.3 million, or approximately 3.0% of
consolidated net revenue, with an approximate $27,000 contribution to
consolidated income from operations for such period.
Our expansion in, and dependence on, our on-line direct marketing efforts,
coupled with the potential for state and/or federal legislation limiting on-line
marketing's consumer contact capability, should all be considered when referring
to our current fiscal year's results, as well as prior year's historical
results, in evaluating the potential for our future operations, cash flows, and
financial position.
TRANSACTIONS WITH MAJOR CUSTOMERS
Transactions with major customers and related economic dependence
information is set forth (1) following our discussion of Liquidity and Capital
Resources, (2) in our discussion of Critical Accounting Policy and Accounting
Estimate Discussion (immediately following (1) previously mentioned) and (3)
under the heading Transactions with Major Customers in Note 1 to the
Consolidated Financial Statements referred to in the Financial Statements and
Supplementary Data section hereof and incorporated herein by reference.
BASIS OF PRESENTATION
Certain amounts for the prior periods that are presented in the
accompanying consolidated financial statements, and referred to in the
discussions below, have been reclassified in order to conform to the current
period presentation.
SEGMENT INFORMATION
During the fiscal year ended November 30, 2002 ("Fiscal 2002"), we
generated revenue from the following segments: E-Commerce and Off-line
Marketing. The E-Commerce segment realized significant growth during the fiscal
year ended November 30, 2002, when compared to the prior fiscal 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 email promotions. The Off-Line
Marketing services segment consists of revenue generated by us through off-line
direct marketing channels. Historically, this segment's activities consisted of
telemarketing services used for the acquisition of long distance and wireless
phone customers for various phone service providers. In Fiscal 2002, this
segment consisted exclusively of our majority owned subsidiary, Montvale
Management, LLC, and the revenues and expenses of Montvale's net branch services
provided 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
13
billed by local exchange carriers (LECs) on the consumer's telephone bill.
This segment was inactive during Fiscal 2002, but is expected to become active
again in the first quarter of Fiscal 2003, resulting from the marketing of our
products and services that will be billed to consumers on their phone bill
through the LECs. Segment information is set forth in Note 13 to the
Consolidated Financial Statements referred to in the Financial Statements and
Supplementary Data section hereof and incorporated herein by reference.
RESULTS OF OPERATIONS
Our net revenues, on a segmental basis, and with disclosure of the
components of the individual segments, for each of the fiscal years ended
November 30, 2002, 2001 and 2000 are set forth in the following tables:
SEGMENT DATA -- NET REVENUES, BY SEGMENT COMPONENT
YEAR ENDED NOVEMBER 30, 2002 2001 2000
- ----------------------- ----------- ----------- -----------
E-COMMERCE COMPONENTS
GroupLotto and other websites ................ $12,589,401 $ 7,082,587 $ 4,825,781
Net branch commission fees ................... 904,810 347,416 --
Email marketing programs ..................... 20,154,519 16,649,559 5,672,405
Data sales and rentals ....................... 3,383,079 2,389,116 --
Sales of jewelry and gifts ................... 1,332,331 -- --
Internet game development and other .......... 442,979 2,006,547 --
----------- ----------- -----------
TOTAL E-COMMERCE ............................. $38,807,119 $28,475,225 $10,498,186
----------- ----------- -----------
OFF-LINE MARKETING SERVICE COMPONENTS
Net branch commission fees ................... $ 5,166,867 $ 521,123 $ --
Other off-line marketing ..................... 68,939 1,693,453 8,958,774
----------- ----------- -----------
TOTAL OFF-LINE MARKETING SERVICES ............ $ 5,235,806 $ 2,214,576 $ 8,958,774
----------- ----------- -----------
LEC BILLED PRODUCTS AND SERVICES COMPONENTS
"900" Entertainment Service royalties ........ $ -- $ 486,406 $ 3,393,428
Enhanced Services, principally voice mail .... -- 884,373 3,590,463
Other LEC Billed Services .................... -- 148,830 150,940
----------- ----------- -----------
TOTAL LEC BILLED PRODUCTS AND SERVICES ....... $ -- $ 1,519,609 $ 7,134,831
----------- ----------- -----------
CORPORATE AND OTHER COMPONENTS
Miscellaneous products, list revenue and other $ -- $ -- $ 20,072
----------- ----------- -----------
CONSOLIDATED TOTALS ................. $44,042,925 $32,209,410 $26,611,863
=========== =========== ===========
The following table sets forth for the periods indicated the percentage of
net revenues represented by the certain items reflected in our statement of
operations:
YEAR ENDED NOVEMBER 30,
-------------------------
2002 2001 2000
------ ------ ------
Net Revenue ................................ 100.0% 100.0% 100.0%
Cost of Sales .............................. 27.8% 28.4% 34.0%
Gross Profit ............................... 72.2% 71.6% 66.0%
Selling, general and administrative expenses 60.7% 48.7% 43.4%
Bad debt expense ........................... 1.5% 3.4% 1.9%
Interest Expense ...................... 0.2% 0.0% 1.1%
Other Income (expense) ................ 0.5% (8.0)% 12.9%
Net Income ................................. 6.2% 1.3% 19.3%
14
The following is a discussion of our financial condition and results of
operations for the years ended November 30, 2002, 2001, and 2000, respectively.
This discussion may contain forward looking-statements that involve risks and
uncertainties. Our actual results could differ materially from the forward
looking-statements discussed herein. This discussion should be read in
conjunction with our consolidated financial statements, the notes thereto and
other financial information included elsewhere in the report.
YEAR ENDED NOVEMBER 30, 2002 COMPARED TO YEAR ENDED NOVEMBER 30, 2001
Our net revenues, on a segmental basis, and with the components of the
individual segments, for each of the fiscal years ended November 30, 2002 and
2001, are set forth in the following tables:
SEGMENT DATA -- NET REVENUES, BY SEGMENT COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ------------ ------------ ------------ --------
E-COMMERCE COMPONENTS
GroupLotto and other websites ............. $ 12,589,401 $ 7,082,587 $ 5,506,814 78%
Net branch commission fees ................ 904,810 347,416 557,394 160%
Email marketing programs .................. 20,154,519 16,649,559 3,504,960 21%
Data sales and rentals .................... 3,383,079 2,389,116 993,963 42%
Sales of jewelry and gifts ................ 1,332,331 -- 1,332,331 100%
Internet game development and other ....... 442,979 2,006,547 (1,563,568) (78)%
------------ ------------ ------------ ----
TOTAL E-COMMERCE .......................... 38,807,119 $ 28,475,225 10,331,894 36%
------------ ------------ ------------ ----
OFF-LINE MARKETING SERVICE COMPONENTS
Net branch commission fees ................ 5,166,867 521,123 4,645,744 891%
Other off-line marketing .................. 68,939 1,693,453 (1,624,514) (96)%
------------ ------------ ------------ ----
TOTAL OFF-LINE MARKETING SERVICES ......... 5,235,806 2,214,576 3,021,230 136%
------------ ------------ ------------ ----
LEC BILLED PRODUCTS AND SERVICES COMPONENTS
"900" Entertainment Service royalties ..... -- 486,406 (486,406) (100)%
Enhanced Services, principally voice mail . -- 884,373 (884,373) (100)%
Other LEC Billed Services ................. -- 148,830 (148,830) (100)%
------------ ------------ ------------ ----
TOTAL LEC BILLED PRODUCTS AND SERVICES .... -- 1,519,609 (1,519,609) (100)%
------------ ------------ ------------ ----
TOTAL CONSOLIDATED NET REVENUE .......... $ 44,042,925 $ 32,209,410 $ 11,833,515 37%
============ ============ ============ ====
Consolidated Net Revenue increased $11,833,515, or 37%, to $44,042,925 for
the year ended November 30, 2002 from $32,209,410 in the year ended November 30,
2001. The primary component of the increase was attributable to an approximate
$10.3 million increase in our E-commerce segment net revenues, combined with an
increase of approximately $3 million in net revenue from our Off-line Marketing
services segment. Such increases were partially offset by a decrease of
approximately $1.5 million in our LEC Billed Product and Services legacy
segment. The E-commerce segment revenue increase resulted from our increasing
focus on generating revenue from our current core business, on-line direct
marketing. We expect this segment to continue to represent the substantial part
of our revenue in future fiscal periods. Nevertheless, we continue to assess the
potential of revenue generation from off-line, conventional direct marketing
activities and will implement that strategy if deemed beneficial for our
Company. Currently, we are using our 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 our E-commerce segment was primarily attributable to
approximately $20.1 million in revenue generated from the segment's Email
marketing program sub-set. This represented a $3.5 million increase over the
prior year's $16.6 million in revenue generated from such segment's sub-set. We
believe this substantial increase of approximately 21% over the prior year was
primarily the result of our acquisition of significant volumes
15
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 our email delivery programs. In the prior year's comparable
period, specifically the first three months of the fiscal year ended November
30, 2001, we had been in the early stages of developing and carrying out our
online strategy. The revenue from the email marketing program sub-set
represented approximately 46% of our consolidated net revenue for the year ended
November 30, 2002, as compared to 52% of our consolidated net revenue for the
year ended November 30, 2001.
During the year ended November 30, 2002, specifically within the period
March 1, 2002 to November 30, 2002, we experienced problems with the delivery of
our email promotional offers. These problems caused reduced revenue and income
from the E-Commerce sub-segment. We believe 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.
We have addressed the issue by deploying new reinforced delivery platforms with
increased redundancy and expanded diversification using both internal and
external emailing resources. Although we have 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.
Various state laws exist, and federal legislation is currently pending,
that limit our ability to deliver commercial e-mail messages to consumers. The
Federal Trade Commission is convening a three-day workshop to review commercial
e-mail practices. There are presently no federal laws that explicitly regulate
sending unsolicited e-mail. The pending federal bills and existing state laws
require that certain "opt-out" procedures be included in e-mails 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 e-mail 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. Over half the states have enacted legislation
affecting the sending of unsolicited commercial e-mail. If strict federal
legislation is subsequently written into law, with its terms specifically
limiting our ability to market our offers, we could potentially realize a
material adverse impact in future fiscal period net revenue growth, and
therefore, profitability and cash flows could be adversely affected.
In November 2002, we received an inquiry from the Federal Trade Commission
questioning whether we needed to comply with the Graham Leach Bliley Act
(privacy of consumer information for financial institutions) arising from Atlas
Credit Group, one of our Internet subsidiaries. We responded by stating that we
need not comply with the Graham Leach Bliley Act because Atlas Credit Group
utilizes advertising from other financial institutions, but is not itself a
financial institution as defined under the statute. We have not received any
further comments from the Federal Trade Commission. ThanksMuch.com, LLC, another
of our Internet subsidiaries, was served with a class action lawsuit in State
Court in the County of Los Angeles, California, for damages associated with
allegedly violating the State's Shipping and Handling laws. This suit was
recently settled. The settlement offers a $5.00 certificate to California
consumers on future purchases of ThanksMuch products and provides a small
payment for attorneys' fees.
The Pennsylvania Attorney General's Office had requested us to enter into
an Assurance of Voluntary Compliance Agreement to resolve allegations concerning
certain of our sales practices. The Attorney General alleged that our Fly Free
telemarketing program, as well as certain pay-per-call services, did not
adequately disclose to the consumer the terms of the offer being made. The
Agreement also provides for a payment to the State in an amount yet to be
determined. Discussions with the Pennsylvania Attorney General's Office are
on-going.
Any changes in the Internet operating landscape that materially hinders our
current ability and/or cost to deliver commercial e-mail messages to the
consumer records in our databases, and the consumer records in the databases of
our affiliates, could potentially cause a material impact on net revenue and
gross margin and, therefore, our profitability and cash flows could be adversely
affected.
16
Revenue from our E-commerce segment's "GroupLotto and other web sites"
sub-set for Fiscal 2002 was $12.6 million, which was an increase in revenues of
$5.5 million, or 78%, to Fiscal 2001 ($7.1 million in revenue). This increase is
the result of our shift from low priced "click through" revenue to higher
revenue generating registration, lead generation and on-line customer
acquisition based revenue. We generate a significant portion of our site traffic
from email marketing. As discussed in the prior paragraph, any change in the
Internet operating landscape (such as the enactment of additional state and
Federal legislation that materially hinders our ability and/or cost to deliver
commercial email messages to consumers) could potentially cause a material
adverse impact on net revenue and gross margin and, therefore, our profitability
and cash flows.
Additional increases in our consolidated revenues were attributable to new
sub-sets added to the E-commerce segment during the year ended November 30, 2002
when compared to the year ended November 30, 2001. The combined revenue
resulting from the new sub-sets amounted to approximately $3.1 million and is
detailed as follows: (a) $904,810 of such increase relates to our 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 $5.2 million within our Off-line Marketing Services segment; (b)
$1.3 million of such increase relates to the on-line sales of jewelry and gifts
by our new subsidiary, ThanksMuch, Inc., which was formed after the acquisition
of the assets of a closely held private company on December 14, 2001, all as
more fully described in Note 1 to the financial statements; (c) $342,979 of such
increase relates to the Internet game development revenues generated by our new
subsidiary, InfiKnowledge ULC, which was formed after the acquisition of the
assets of a closely held private Canadian company on December 6, 2001, all as
more fully described in Note 1 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 us during the three months ended
February 28, 2002.
The increases in revenues from our E-commerce segment and Off-line
Marketing Services segment were partially offset by a decrease of $1,519,609 in
revenues from our LEC Billed Products and Services segment. A portion of the
decrease, or $486,406, resulted from the expiration in the three months ended
February 28, 2001, of certain agreements pursuant to which we 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.
Fiscal 2002 did not include any revenue related to these services, but we do
expect such segment to become active again during the first quarter of Fiscal
2003, resulting from the marketing of our products and services that will be
billed to consumers on their phone bills through the LECs. The balance of the
decrease in LEC Billed Product and Service segment revenue, or $1,033,203,
resulted from our elimination of billing voice mail services under our 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, loss of significant customer, critical accounting policies and
estimates, and other factors that could affect future results.
Our cost of revenues during the years ended November 30, 2002 and 2001, are
comprised of (1) direct and indirect marketing costs associated with the
acquisition and retention of consumers for our 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.
17
Our cost of sales, on a segmental basis, and with disclosure of the
components of the individual segments, for each of the years ended November 30,
2002 and 2001, are set forth below:
CONSOLIDATED COST OF SALES, BY SEGMENT, BY COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ----------- ----------- ----------- --------
E-COMMERCE
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Email marketing and related delivery costs . $ 5,103,777 $ 4,046,881 $ 1,056,896 26%
Data purchases and premium costs ........... 5,983,008 3,357,308 2,625,700 78%
Promotional, creative and other costs ...... 191,960 115,322 76,638 66%
----------- ----------- ----------- ----
Total E-commerce Advertising ............ 11,278,745 7,519,511 3,759,234 50%
----------- ----------- ----------- ----
SERVICE BUREAU FEES
Contingent based prize indemnification costs 345,559 381,525 (35,966) (9)%
----------- ----------- ----------- ----
Total E-commerce Cost of Sales .......... 11,624,304 7,901,036 3,723,268 47%
----------- ----------- ----------- ----
OFF-LINE MARKETING SERVICES
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Telemarketing, direct mail and related costs 619,331 1,283,035 (663,704) (52)%
Premium fulfillment costs .................. -- (89,009) 89,009 (100)%
----------- ----------- ----------- ----
Total Off-line Marketing Cost of Sales .. 619,331 1,194,026 (574,695) (48)%
----------- ----------- ----------- ----
LEC BILLED PRODUCTS AND SERVICES
SERVICE BUREAU FEES
Billing and collection fees ................ -- 57,400 (57,400) (100)%
----------- ----------- ----------- ----
Total LEC Billed Cost of Sales .......... -- 57,400 (57,400) (100)%
----------- ----------- ----------- ----
CONSOLIDATED COST OF SALES .............. $12,243,635 $ 9,152,462 $ 3,091,173 34%
----------- ----------- ----------- ----
Cost of sales on a consolidated basis increased $3.1 million, or 34%, to
$12,243,635 for the year ended November 30, 2002, from $9,152,462 in the year
ended November 30, 2001.
On a segmental level, our E-commerce segment cost of sales increased, on a
net basis, approximately $3.7 million, or 47%, to $11.6 million during the year
ended November 30, 2002, when compared to $7.9 million incurred in the prior
fiscal year. Our continuing strategy of generating revenues primarily from
direct marketing campaigns delivered on-line was the significant factor
contributing to this increase. We realized marketing costs for email delivery of
approximately $5.1 million in the year ended November 30, 2002, representing an
increase of $1.1 million, or 26%, when compared to approximately $4 million in
email delivery costs incurred in the year ended November 30, 2001. In December
2001, we acquired the assets of a Canadian-based technology company
(InfiKnowledge). We believe that the integration of Infiknowledge's assets,
technology and human resources into our operations and email delivery platform
will continue to reduce the unitary costs of our 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.
We realized costs of approximately $4.5 million for data purchases
necessary to build and maintain our marketing databases and approximately $1.5
million for premium costs related to premium redemption obligations for certain
of our marketing program offers. These costs represent an increase of
approximately $2.6 million, or 78%, over data purchase and fulfillment costs of
approximately $3.4 million incurred during the year ended November 30, 2001. In
the prior fiscal year, we incurred approximately $158,000 in costs relative to
premium redemption obligations. The costs associated with data purchase
increases were due, in combination, to our (a) increasing the volume of data
acquired for our marketing activities and (b) our increased allocation of data
purchases for opt-in data.
We use 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 in Fiscal 2002 approximately $35,966, or 9%,
when compared with Fiscal
18
2001. The primary reason for this decrease was due to a slight decrease in the
games played at the GroupLotto.com website during the year ended November 30,
2002 when compared to the year ended November 30, 2001.
Our Off-line Marketing Services segment's cost of sales decreased $574,695,
or 48%, to $619,331, when compared to $1,194,026 during the year ended November
30, 2001. The Fiscal 2002 Off-line Marketing Services segment's cost of sales
result from our majority-owned-subsidiary, Montvale Management LLC, which was
consolidated with our activities effective September 1, 2001. Prior to such
consolidation, the subsidiary was primarily inactive. In the fiscal year ended
November 30, 2001, our Off-line Marketing Services segment primarily consisted
of a contingent marketing fee that became payable upon the settlement of related
litigation, in which we were granted an arbitration award, thus triggering the
contingency.
The balance of the decrease in cost of goods sold relates to the LEC Billed
Product and Services segment and amounted to a reduction of $57,400. This
reduction resulted from our elimination of billing voice mail services under our
contract with the service bureau Federal Transtel, Inc. ("FTT") in October 2001.
FTT has since filed for protection under the United States Bankruptcy Code.
Our gross profit in terms of dollars, on a segmental basis, and our gross
profit percentage, on a segmental basis, for each of the years ended November
30, 2002 and 2001 are set forth below:
CONSOLIDATED GROSS PROFIT, BY SEGMENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ----------- ----------- ----------- --------
E-commerce ..................... $27,182,815 $20,574,189 $ 6,608,626 32%
Off-line Marketing services .... 4,616,475 1,020,550 3,595,925 352%
LEC Billed products and services -- 1,462,209 (1,462,209) (100)%
----------- ----------- ----------- ----
CONSOLIDATED TOTALS ......... $31,799,290 $23,056,948 $ 8,742,342 38%
=========== =========== =========== ====
CONSOLIDATED GROSS PROFIT PERCENTAGES, BY SEGMENT
ABSOLUTE RELATIVE
PERCENTAGE PERCENTAGE
CHANGE CHANGE
YEAR ENDED NOVEMBER 30, 2002 2001 INC(DEC) INC(DEC)
- -------------------------------- ---- ---- ---------- ----------
E-commerce ..................... 70.0% 72.3% (2.3)% (3.1)%
Off-line Marketing services .... 88.2% 46.1% 42.1% 91.3
LEC Billed products and services 0.0% 96.2% (96.2)% (100.0)%
---- ---- ---- -----
CONSOLIDATED GROSS PROFIT
PERCENTAGE ................. 72.2% 71.6% 0.6% 0.9%
==== ==== ==== =====
Consolidated Gross Profit ("Gross Margin") as a percentage of net revenue
was 72.2% during the year ended November 30, 2002, compared to 71.6% in the year
ended November 30, 2001, representing an absolute percentage point increase of
0.6%, or a 0.9% increase on a relative basis. On a segmental basis, our
E-commerce segment realized a decrease in margin in Fiscal 2002 when compared to
Fiscal 2001. The 2.3% absolute percentage point decrease resulted from our
increased costs associated with data purchases (which are fully expensed at the
time of receipt) and a significant increase in premium fulfillment obligation
costs. We anticipate that the immediate expensing policy regarding data
purchases could provide a margin improvement benefit in future fiscal periods
through the continued marketing to such acquired data. The costs of premium
fulfillment obligations related to our marketing of a program for a long
distance service provider, with such costs approximating $1.5 million in the
year ended November 30, 2002. We began marketing this premium fulfillment
sensitive program in the fourth quarter of Fiscal 2001, pursuant to which we
incurred approximately $158,000 in accrued premium fulfillment costs. Offsetting
the decrease in gross margins, as described above, our gross margin benefited
from the acquisition of the assets of Infiknowledge. The Infiknowledge asset
acquisition allowed us to develop our own email delivery platform, through which
we were able to decrease our reliance on third party email vendors.
19
By decreasing this third party reliance, we were able to decrease the unitary
costs relative to email delivery. Changes in the gross margins generated from
our Off-line Marketing Services segment and LEC Billed Product and Services
segment primarily offset each other in terms of percentage changes. See the
previous discussions of net revenues and cost of sales for a more detailed
discussion of such segments.
Our Selling Expenses and General and Administrative Expenses for each of
the years ended November 30, 2002 and 2001 are presented, on a segmental basis,
and with the components of the individual segments, in the tables set forth
below:
SEGMENT DATA -- SELLING EXPENSES
CONSOLIDATED SELLING EXPENSES, BY SEGMENT, BY COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ----------- ----------- ----------- --------
E-COMMERCE
Fee share commissions ............... $ 5,711,535 $ 2,157,921 $ 3,553,614 165%
Other commissions ................... 1,595,209 356,133 1,239,076 348%
Selling salaries and related expenses 1,671,661 1,372,934 298,727 22%
Occupancy and equipment costs ....... 22,715 23,118 (403) (2)%
Travel and entertainment ............ 243,789 244,913 (1,124) 0%
----------- ----------- ----------- ----
TOTAL SELLING-- E-COMMERCE SEGMENT .. 9,244,909 4,155,019 5,089,890 122%
----------- ----------- ----------- ----
OFF-LINE MARKETING SERVICES
Fee share commissions ............... -- -- -- 0%
Other commissions ................... -- -- -- 0%
Selling salaries and related expenses 2,048,015 87,573 1,960,442 2239%
Occupancy and equipment costs ....... 143,959 191,211 (47,252) (25)%
Travel and entertainment ............ 35,805 3,470 32,335 932%
----------- ----------- ----------- ----
TOTAL SELLING-- OFF-LINE SEGMENT .... 2,227,779 282,254 1,945,525 689%
----------- ----------- ----------- ----
CONSOLIDATED TOTALS .............. $11,472,688 $ 4,437,273 $ 7,035,415 159%
----------- ----------- ----------- ----
Selling expenses on a consolidated basis increased approximately $7
million, or 159%, from $4.4 million during the year ended November 30, 2001 to
$11.5 million during the year ended November 30, 2002. The increase was
attributable to increases of approximately $5.1 million in the E-commerce
segment, and increases of approximately $1.9 million in the Off-line Marketing
Services segment.
The significant factors contributing to the increase in selling expenses
were (a) increased fee share commissions incurred in our E-commerce segment of
approximately $3.6 million; and (b) increased selling-based commissions and
compensation costs ($1.2 million and $299,000, 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, we significantly expanded the practice of marketing
promotional offers on behalf of our marketing clients ("Clients") to third party
databases on a fee share commission basis. The fee share commission relationship
generally arises after we conclude a contractual arrangement with a Client
pursuant to which we modify or develop the copy, offer form and promotional
materials for the Client's product or service. We then test the promotion, and
agree to deliver a minimum level of new customers, and/or targeted leads to the
Client. Simultaneously with the execution of these contractual arrangements, we
often obtain the rights from the Client to market its promotions to a list of
third parties with whom we have marketing relationships (the "Third Parties").
We enter into contracts with each Third Party with whom we intend 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 our Company for
20
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 us for marketing that offer to the Third Party database. We
utilize 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 us, and we
are able to account for revenue generated under the fee share arrangement with
Third Parties. During the fiscal year ended November 30, 2002, we significantly
increased the number of third party databases and lists under management, which
is the primary factor contributing to the increase in the fee share commissions
expense category. Additionally, the other commission expense category increase
was attributable to agency commissions paid on the sales to one of our largest
customers, which customer is no longer conducting business with us (see " --
Transactions with Major Customers").
Selling expenses within the Off-line Marketing Services segment for Fiscal
2002 increased approximately $1.9 million, or 689%, when compared to the prior
year's comparable period. This increase is attributable to the activities of our
majority owned subsidiary, Montvale Management, LLC. This subsidiary was active
for the entire fiscal year ended November 30, 2002, whereas in Fiscal 2001 such
subsidiary was only active for the fourth quarter.
SEGMENT DATA -- GENERAL AND ADMINISTRATIVE EXPENSES
CONSOLIDATED GENERAL AND ADMINISTRATIVE EXPENSES, BY SEGMENT, BY COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ----------- ----------- ----------- --------
E-COMMERCE
Compensation costs and related expenses $ 4,668,160 $ 2,558,010 $ 2,110,150 82%
Professional fees ..................... 1,408,053 853,050 555,003 65%
Insurance costs ....................... 477,656 532,901 (55,245) (10)%
Occupancy and equipment costs ......... 347,170 284,148 63,022 22%
Site development, maintenance and
Modifications ...................... 868,755 1,750,638 (881,883) (50)%
All other G&A expenses ................ 1,592,736 740,883 851,853 115%
----------- ----------- ----------- ----
TOTAL G&A -- E-COMMERCE SEGMENT ........ 9,362,530 6,719,630 2,642,900 39%
----------- ----------- ----------- ----
OFF-LINE MARKETING SERVICES
Compensation costs and related expenses -- 217,327 (217,327) (100)%
Professional fees ..................... 32,312 158,821 (126,509) (80)%
Insurance costs ....................... 3,754 84,142 (80,388) (96)%
Occupancy and equipment costs ......... -- 22,550 (22,550) (100)%
All other G&A expenses ................ 1,607,910 55,050 1,552,860 2821%
----------- ----------- ----------- ----
TOTAL G&A -- OFF-LINE SEGMENT .......... 1,643,976 537,890 1,106,086 206%
----------- ----------- ----------- ----
LEC BILLED PRODUCTS AND SERVICES
Compensation costs and related expenses -- 146,200 (146,200) (100)%
Insurance costs ....................... -- 84,142 (84,142) (100)%
Occupancy and equipment costs ......... -- 22,549 (22,549) (100)%
All other G&A expenses ................ -- 15,097 (15,097) (100)%
----------- ----------- ----------- ----
TOTAL G&A -- LEC SEGMENT ............... -- 267,988 (267,988) (100)%
----------- ----------- ----------- ----
CORPORATE AND OTHER
Compensation costs and related expenses 2,361,991 2,054,173 307,818 15%
Professional fees ..................... 747,864 1,183,800 (435,936) (37)%
Insurance costs ....................... 475,775 3,474 472,301 100%
All other G&A expenses ................ 659,286 495,601 163,685 33%
----------- ----------- ----------- ----
TOTAL G&A -- CORPORATE AND OTHER ....... 4,244,916 3,737,048 507,868 14%
----------- ----------- ----------- ----
CONSOLIDATED TOTALS ................ $15,251,422 $11,262,556 $ 3,988,866 35%
----------- ----------- ----------- ----
21
General and Administrative expenses ("G&A") on a consolidated basis
increased approximately $4 million, or 35%, when comparing G&A of $11.3 million
for the year ended November 30, 2001 to G&A of $15.3 million for the year ended
November 30, 2002. The net increase was attributable to (a) the E-commerce
segment (approximately $2.6 million, or 66% 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 our web sites, all
required to support the 37% increase in revenues generated by such segment
during the year ended November 30, 2002, (b) the Off-line Marketing Services
Segment (approximately $1.1 million, or 27% of total increase), with such
increase related to G&A necessary to support the segment's growth in revenues
from Montvale Management, LLC (our majority owned subsidiary) of $868,539 in
Fiscal 2001 to approximately $6.1 million during Fiscal 2002, and c) other
corporate overhead (approximately $508,000, or 13% of total increase) not
specifically identified to our 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. These overhead increases were partially offset by an
approximate $268,000 decrease in overhead attributable to our currently inactive
LEC Billed Product and Services segment.
CONSOLIDATED BAD DEBT EXPENSE, BY SEGMENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- -------- ---------- --------- --------
E-commerce ..................... $647,875 $ 301,933 $ 345,942 115%
Off-line Marketing Services .... -- -- -- 0%
LEC Billed Products and Services -- 826,893 (826,893) (100)%
Corporate and other ............ -- (45,000) 45,000 (100)%
-------- ---------- --------- ----
CONSOLIDATED TOTALS ......... $647,875 $1,083,826 $(435,951) (40)%
-------- ---------- --------- ----
Bad Debt expense decreased $435,951, or 40%, to $647,875 in Fiscal 2002
from approximately $1.1 million in Fiscal 2001.
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 amount that reflects their probable realizable value.
Provisions for bad debts are also recorded resulting from the review of other
factors, including (a) length of time the receivables are past due, (b)
historical experience and (c) other factors obtained during collection efforts.
If circumstances related to specific customers change, our estimates for bad
debt provisions could be further increased.
22
OTHER INCOME (EXPENSE)
The components of "Other income (expense)" for the years ended November 30,
2002 and 2001 are set forth below:
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ----------- ----------- ----------- --------
Other income (expense):
Interest expense ........................ $ (101,385) $ (5,900) $ (95,485) 1618%
Interest income and dividends ........... 783,143 1,780,546 (997,403) (56)%
Realized gains on sale of marketable
securities ........................... 76,607 387,948 (311,341) (80)%
Permanent impairment charges ............ -- (4,690,258) 4,690,258 (100)%
Other non-operating income (expense):
Talk.com Arbitration Settlement ...... 2,342,123 -- 2,342,123 100%
P.M. Thomas Arbitration Settlement ... (2,710,000) -- (2,710,000) 100%
Residual loss from terminated Programs -- (57,344) 57,344 (100)%
Other miscellaneous income(expense) .. (11,793) 74,043 (85,835) (116)%
Liquidation proceeds on prior year
impairment loss .................... 125,000 -- 125,000 100%
Minority interest (income) loss ......... (402,716) (69,629) (333,087) 478%
----------- ----------- ----------- ----
TOTAL CONSOLIDATED OTHER
INCOME (EXPENSE) ................... $ 100,979 $(2,580,594) $ 2,681,574 204%
----------- ----------- ----------- ----
Consolidated Other Income (Expense) increased approximately $2.7 million,
from approximately $2.6 million in net expense for the year ended November 30,
2001 to $100,980 of net income for the year ended November 30, 2002.
The primary factors contributing to the net increase, in the order of the
table set forth above, are as follows:
(a) We incurrred a decrease in interest and dividend income of
approximately $1 million resulting from significant decreases in the
interest rates available on short-term commercial paper during the year
ended November 30, 2002 when compared with interest rates available for
short-term investment during the year ended November 30, 2001.
(b) We incurred a decrease in gains realized through sales of
marketable securities approximating $311,000 in the year ended November 30,
2002.
(c) We had no material losses in Fiscal 2002 from asset impairments,
whereas, during the year ended November 30, 2001 we realized losses,
through a permanent impairment, of approximately $4.1 million on marketable
securities resulting from significant declines in the values of the
marketable securities held in our investment portfolio. These losses were
deemed to be other than temporary. Additionally, during the year ended
November 30, 2001, we realized a permanent impairment of $500,051 on a
long-term investment in an entity that discontinued its operations in
Fiscal 2001. We believe that we have significantly reduced our exposure to
market fluctuations in our investment portfolio by limiting the contents of
such portfolio to approximately $13.2 million in high grade, short term,
commercial paper and auction rate securities (with yields ranging from
1.44% to 2.04%, with maturities of 28 to 58 days), and approximately $1.1
million in higher risk investments, consisting of common stock equities and
real estate investment trust equities.
(d) We realized an increase of $125,000 attributable to liquidation
proceeds received from a long-term investment that was entirely written off
through an impairment charge in the fiscal year ended November 30, 2000.
(e) We included in Fiscal 2002 the final installment related to the
Talk.com arbitration victory ($2.3 million) awarded to us in November 2001,
offset by a $2.7 million award and settlement paid to the claimants in the
Phillip Michael Thomas arbitration.
23
PROVISION FOR INCOME TAXES
Our 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.
We recorded income tax expense of $1,786,894 for the year ended November 30,
2002 on pre-tax income of $4,528,284. This equates to an effective tax rate of
approximately 39.5%. This effective tax rate is similar to our historically
recognized tax rate. In the year ended November 30, 2002, we realized previously
devalued deferred tax assets related to capital losses (see Note 8 to the
Financial Statements for further details of our income tax accounts). We had
recorded income tax expense of $3,275,200 for the year ended November 30, 2001
on a pre-tax profit of approximately $3,692,699. This effective tax rate
relationship is the result of our taking a full valuation allowance during the
year ended November 30, 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 had been
recorded during the 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.
YEAR ENDED NOVEMBER 30, 2001 COMPARED TO YEAR ENDED NOVEMBER 30, 2000
The Company's net revenues, on a segmental basis, and with the components
of the individual segments, for the fiscal years ended November 30, 2001 and
2000, are set forth in the following tables:
SEGMENT DATA -- NET REVENUES, BY SEGMENT COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2001 2000 $ %
- ----------------------- ----------- ----------- ----------- --------
E-COMMERCE COMPONENTS
Long distance customer acquisitions .......... $ 3,992,147 $ 4,913,703 $ (921,556) (19)%
GroupLotto and other websites ................ 7,082,587 4,825,781 2,256,806 47%
Net branch commission fees ................... 347,416 -- 347,416 100%
Email ........................................ 14,663,959 758,702 13,905,257 1833%
Data sales and rentals ....................... 2,389,116 -- 2,389,116 100%
----------- ----------- ----------- ----
TOTAL E-COMMERCE ............................. 28,475,225 10,498,186 17,977,039 171%
----------- ----------- ----------- ----
OFF-LINE CUSTOMER ACQUISITION
SERVICES COMPONENTS
Long distance customer acquisitions .......... 1,693,453 4,565,435 (2,871,982) (63)%
Long distance usage commissions .............. -- 4,387,149 (4,387,149) (100)%
Net branch commission fees ................... 521,123 -- 521,123 100%
Other customer acquisition services .......... -- 6,190 (6,190) (100)%
----------- ----------- ----------- ----
TOTAL OFF-LINE CUSTOMER ACQUISITION SERVICES 2,214,576 8,958,774 (6,744,198) (75)%
----------- ----------- ----------- ----
LEC BILLED PRODUCTS AND SERVICES COMPONENTS
"900" Entertainment Service royalties ........ 486,406 3,393,428 (2,907,022) (86)%
Club 900 Products ............................ 148,830 85,417 63,413 74%
Enhanced Services, principally voice mail .... 884,373 3,590,463 (2,706,090) (75)%
Telephone number list revenue ................ -- 65,523 (65,523) (100)%
----------- ----------- ----------- ----
TOTAL LEC BILLED PRODUCTS AND SERVICES ....... 1,519,609 7,134,831 (5,615,222) (79)%
----------- ----------- ----------- ----
CORPORATE AND OTHER COMPONENTS
Miscellaneous products, list revenue and other -- 20,072 (20,072) (100)%
----------- ----------- ----------- ----
CONSOLIDATED NET REVENUES .................. $32,209,410 $26,611,863 $ 5,597,547 21%
=========== =========== =========== ====
24
Net Revenue increased $5,597,547, or 21%, to $32,209,410 for the year ended
November 30, 2001 ("Fiscal 2001") when compared to revenues of $26,611,863 in
the year ended November 30, 2000 ("Fiscal 2000"). This increase was specifically
attributable to the Company's E-commerce segment, which recognized a net
increase in revenue of approximately $18 million, offset by combined declines in
net revenue from the Company's legacy segments of approximately $12.4 million.
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 a
substantial part of the Company's revenue in future fiscal periods. As a
percentage of consolidated net revenue, the Company's on-line direct marketing
activities constituted 88% of Fiscal 2001 revenues, compared to 39% in Fiscal
2000.
The declines in the Company's Off-line Customer Acquisition Services
Segment (decrease of $6.7 million) and LEC Billed Products and Services Segment
(decrease of $5.6 million) were attributable to the Company's termination of the
active marketing of such products and services during prior fiscal periods and
the Company's intentional migration to the Internet for the generation of the
bulk of its revenue. The Company's on-line revenues are generated on a higher
margin basis when compared to such legacy segments' operating activities. This
migration commenced at the end of the fiscal year ended November 30, 1999
("Fiscal 1999") and became fully implemented during Fiscal 2000.
During the year ended November 30, 2001, the Company executed an on-line
customer acquisition program for a prominent long distance service provider.
Under such arrangement, the Company generated approximately $2 million of
revenue in Fiscal 2001, specifically during the fourth quarter. This represented
6.2% and 14.2% of consolidated net revenues for Fiscal 2001 and the fourth
quarter thereof, respectively. The Company's agreement with such long distance
carrier terminated during the first quarter of the fiscal year ending November
30, 2002 ("Fiscal 2002"). Although the Company has entered into a new agreement
with such long distance carrier, the Company anticipates that the impact thereof
on fiscal periods beyond the first quarter of Fiscal 2002 will not be material.
The revenue generated in Fiscal 2001 from the Company's original agreement with
this long distance carrier, coupled with the on-line portion of the TALK.com
settlement (more fully described below) of approximately $2 million, accounted
for Fiscal 2001's $3,992,147 of "long distance customer acquisitions"
sub-segment revenue included in the Company's E-commerce segment. This
represented a decline in such sub-segment of approximately $922,000 when
compared to Fiscal 2000. Fiscal 2000's E-commerce "long distance customer
acquisition" sub-segment revenues were entirely attributable to TALK.com
customer acquisition activity prior to the October 2000 termination of the
Company's agreement therewith.
The net growth in the Company's E-commerce segment was primarily
attributable to an approximate $13.9 million increase in revenue generated from
the Company's E-mail marketing programs, as compared to only $758,702 of
revenues during Fiscal 2000. This substantial increase of approximately 1800%
over the prior year was the result of the Company generating significantly more
on-line generated consumer data and a number of on-line contracts with new
customers during the fiscal year ended November 30, 2001. During the prior year,
the Company had not significantly penetrated this method of revenue generation.
During the second half of Fiscal 2001, the Company began the practice of
marketing E-mail promotional offers to third party databases on a revenue share
basis. The Company becomes obligated to pay these third parties only when a
transaction occurs and payment is made to the Company by the third parties whose
promotion was mailed. These "fee share basis" revenues provide operating income
at a reduced operating margin when compared to E-mail promotional offers mailed
to the Company's proprietary database. The Company reports the fees paid to the
owners of the third party databases as a component of "Selling Expenses". It is
the Company's intent to limit Fiscal 2002's "fee share basis" expenses to
approximately 10% of consolidated revenues, compared to approximately 7% in
Fiscal 2001.
25
The second material factor contributing to the growth of the Company's
E-commerce segment was the approximately $2.4 million in on-line data sales and
rentals generated in Fiscal 2001 when compared to a negligible amount generated
in Fiscal 2000. The Company believes it was able to identify itself as a source
of valuable permission based data and nurtured relationships with third parties
to facilitate the sale and rental of such data.
The third material factor contributing to the growth of the Company's
E-commerce segment was the approximately $2.3 million (or 47% increase) in net
revenues earned from the "GroupLotto and other website" sub-segment. The
GroupLotto site has developed increased brand recognition on the Internet and
has enabled the Company's sales force to increase its revenue generating
customer base on the site.
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 wrongful termination of an agreement between the parties.
This wrongful termination occurred during the fourth quarter of Fiscal 2000. The
Company recognized $3.7 million of revenue (11.5% of consolidated Fiscal 2001
revenues; this represented Talk's acceptance of such delivered customers, thus
fulfilling the Company's revenue recognition criteria.) from the settlement
during the year ended November 30, 2001, resulting from the receipt of Talk's
first of two installments due on the total award. The first installment was
comprised of approximately $2 million of revenue attributable to the "long
distance customer acquisition" sub-segment of the Company's E-commerce segment.
The balance of the first installment, or approximately $1.7 million of revenue,
was attributable to the Company's Off-line customer acquisition (legacy) segment
(primarily telemarketing). The Company recognized an approximate $1.25 million
contingent telemarketing cost as a result of this settlement. This contingent
cost is discussed in further detail in the following "Cost of Goods Sold"
section. The second, and final, installment of approximately $2.5 million, plus
interest at 6%, is due on April 1, 2002. If the Company receives the second
installment in Fiscal 2002, it will record the revenue at that time. The Company
expects that the segment distribution of such second installment will be as
follows: (a) approximately $1.4 million of E-commerce revenue within that
segment's "long distance customer acquisition" sub-segment; and (b)
approximately $1.1 million of Off-line Customer Acquisition segment revenue.
Based on the telecommunications industry's present weakened state of financial
affairs, and specifically management's estimation of Talk's ability to pay,
management determined that the second installment of the settlement was a gain
contingency and, as such, will record any related revenue only upon collection.
During the year ended November 30, 2001, revenues from the Company's 51%
majority owned subsidiary, Montvale Management LLC, contributed approximately
$868,539, or 2.7% of consolidated net revenues. The subsidiary generates revenue
by operating under net branch agreements, whereby it originates residential
mortgages and refinancings for licensed mortgage banking and brokerage
companies. The subsidiary became active as a result of reduced mortgage and
refinance loan interest rates, and increased government funds for low-income
homebuyers. The subsidiary's revenue was generated through on-line sources
($347,416, included in the E-commerce segment) and through conventional
marketing efforts, consisting of outbound telemarketing, direct mail and print
media ($521,123, included in the off-line customer acquisition segment).
Pursuant to a full year of consolidated operations, and management's
anticipation that the interest rate environment will remain stable and
beneficial to new homebuyers and people interested in refinancing, the Company
anticipates that the subsidiary will generate significantly more revenue in the
fiscal year ending November 30, 2002.
See "Transactions with Major Customers and Termination of Economic
Dependence", "Prior Year Transactions Impacting Current and Future Fiscal
Periods" and "Service Bureaus and Local Exchange Carriers" following the
"Liquidity and Capital Resources" section for a detailed discussion of other
revenue decreases as they relate to the Company's comparative and future
revenues.
26
In the fiscal periods prior to November 30, 1999, the Company's cost of
revenues were offset by net revenue generated from certain premium offerings
made in conjunction with the Company's marketing of other products and services.
The Company terminated the marketing of these products and services in
conjunction with the Transaction Agreements, all as more fully described in "--
Prior Year Transactions Impacting Current and Future Fiscal Periods". All such
residual revenue from those premium offerings have been reflected in the
Company's other income (expense) section. For the year ended November 30, 2001,
such income(expense) included in "Other nonoperating income" was approximately
($57,000), compared to approximately $1,021,401 for the prior year.
The Company's cost of sales, on a segmental basis, and with the components
of the individual segments, for each of the years ended November 30, 2001 and
2000 are set forth below:
CONSOLIDATED COST OF SALES, BY SEGMENT, BY COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2001 2000 $ %
- ----------------------- ---------- ----------- ----------- --------
E-COMMERCE ADVERTISING, PROMOTION AND
FULFILLMENT COSTS
Email marketing and related delivery costs .... $4,046,881 $ 631,446 $ 3,415,435 541%
Data purchases and premium costs .............. 3,357,308 3,718,460 (361,152) (10)%
Promotional and creative development costs .... 115,322 121,417 (6,095) (5)%
---------- ----------- ----------- ----
TOTAL E-COMMERCE ADVERTISING ............... $7,519,511 $ 4,471,323 $ 3,048,188 68%
---------- ----------- ----------- ----
SERVICE BUREAU FEES
Contingent based prize indemnification costs .. $ 381,525 $ 1,151,758 $ (770,233) (67)%
---------- ----------- ----------- ----
TOTAL E-COMMERCE COST OF SALES ............. $7,901,036 $ 5,623,081 $ 2,277,955 41%
---------- ----------- ----------- ----
OFF-LINE CUSTOMER ACQUISITION SERVICES
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Telemarketing and related costs ............... $1,283,035 $ 4,985,183 $(3,702,148) (74)%
Premium fulfillment costs ..................... (89,009) (1,823,449) 1,734,440 (95)%
---------- ----------- ----------- ----
TOTAL OFF-LINE ACQUISITION COST OF SALES ... $1,194,026 $ 3,161,734 $(1,967,708) (62)%
---------- ----------- ----------- ----
LEC BILLED PRODUCTS AND SERVICES ADVERTISING,
PROMOTION AND FULFILLMENT COSTS
Telemarketing and related costs ............... $ -- $ (17,643) $ 17,643 (100)%
Premium fulfillment costs ..................... -- 2,286 (2,286) (100)%
---------- ----------- ----------- ----
TOTAL LEC BILLED ADVERTISING ............... $ -- $ (15,357) $ 15,357 (100)%
---------- ----------- ----------- ----
SERVICE BUREAU FEES
Billing and collection fees ................... $ 57,400 $ 287,569 (230,169) (80)%
---------- ----------- ----------- ----
TOTAL LEC BILLED COST OF SALES ................ $ 57,400 $ 272,212 $ (214,812) (79)%
---------- ----------- ----------- ----
CONSOLIDATED COST OF SALES ................. $9,152,462 $ 9,057,027 $ 95,435 1%
---------- ----------- ----------- ----
Cost of sales on a consolidated basis remained relatively stable with a 1%
increase of approximately $95,000 over the fiscal year ended November 30, 2000.
On a segmental level, the Company's E-commerce segment cost of sales
increased, on a net basis, approximately $2.3 million, or 41%, to $7.9 million,
when compared to $5.6 million incurred in the prior fiscal year. The Company's
increased focus on generating revenues from direct marketing campaigns delivered
on-line was the primary factor contributing to this increase. During the course
of the year, the Company realized increased costs for e-mailing on an absolute
basis (approximate increase of $3.4 million over $631,446 for Fiscal 2000), but
recognized decreased costs on a per-unit basis for e-mail services obtained from
third party e-mailers. As of the fourth quarter of Fiscal 2001, the price of
third party e-mail service provision was in the range of $.75 to $1.00 per
thousand e-mails sent. In prior fiscal periods, the Company paid as much as
$1.50 per thousand e-mails sent.
27
This per-unit price reduction is the contributing factor that enabled the
Company to increase e-mail related revenue approximately 1800%, while
recognizing a smaller, 541% increase in e-mail and related delivery costs over
the comparable prior year. In December 2001, the Company acquired the assets of
a Canadian-based technology company and, with the integration of this entity in
Fiscal 2002, the Company believes it will further reduce the unitary costs of
its e-mailing promotions.
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. During the fourth quarter of Fiscal 2000,
the Company restructured its lottery game prizes and concurrently reduced the
costs of the related premiums for the indemnification coverage. This premium
cost savings was realized in the year ended November 30, 2001 and is reflected
by a 67% indemnification cost decrease, compared to a 47% increase in related
revenues generated at the GroupLotto site. In October 2001, the Company had a $1
million winner on its GroupLotto site. The Indemnification agency acknowledged
the winner's claim, awarded payment, and the Company did not incur any
additional expense beyond the premiums. Additionally, the Company's premium
costs per game did not increase as a result of the winner's claim.
The Company's Off-line Customer Acquisition segment had been primarily
inactive for the first nine months of Fiscal 2001. During the fourth quarter,
the Company received the first of the two scheduled installments from the Talk
arbitration victory and recorded a portion of the revenue in the Off-line
Customer Acquisition segment. Pursuant to the receipt of the first installment
in November 2001, the Company recorded its obligation to make an approximate
$1.25 million contingent payment to a telemarketing vendor for their services
performed for the Company relating to marketing for Talk. The Company does not
have any other contingent liabilities related to the second, and final,
settlement installment that is scheduled for receipt in April 2002. In the
fourth quarter of Fiscal 2001, the Company released approximately $130,000 in
excess premium accruals from terminated off-line customer acquisition marketing
programs.
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
years ended November 30, 2001 and 2000 are presented below:
CONSOLIDATED GROSS PROFIT, BY SEGMENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2001 2000 $ %
- ----------------------- ----------- ----------- ----------- --------
E-commerce ..................... $20,574,189 $ 4,875,105 $15,699,084 322%
Customer Acquisition services .. 1,020,550 5,797,040 (4,776,490) (82)%
LEC Billed products and services 1,462,209 6,862,619 (5,400,410) (79)%
Corporate and other ............ -- 20,072 (20,072) (100)%
----------- ----------- ----------- ----
CONSOLIDATED GROSS PROFIT ... $23,056,948 $17,554,836 $ 5,502,112 31%
=========== =========== =========== ====
CONSOLIDATED GROSS PROFIT PERCENTAGES, BY SEGMENT
ABSOLUTE RELATIVE
PERCENTAGE PERCENTAGE
CHANGE CHANGE
YEAR ENDED NOVEMBER 30, 2001 2000 INC(DEC) INC(DEC)
- ----------------------- ---- ----- ---------- ----------
E-commerce ............................ 72.3% 46.4% 25.8% 55.6%
Customer Acquisition services ......... 46.1% 64.7% (18.6)% (28.8)%
LEC Billed products and services ...... 96.2% 96.2% 0.0% 0.0%
Corporate and other ................... 0.0% 100.0% (100.0)% (100.0)%
---- ----- ----- -----
CONSOLIDATED GROSS PROFIT PERCENTAGE 71.6% 66.0% 5.6% 8.5%
==== ===== ===== =====
28
Consolidated Gross Profit Percentage ("Gross Margin") as a percentage of
net revenue was 71.6% in Fiscal 2001, compared to 66.0% in Fiscal 2000,
representing an absolute percentage point increase of 5.6%, and an 8.5% increase
on a relative basis.
On a segmental basis, the Company's E-commerce segment Gross Margin
increased to 72.3% in Fiscal 2001 compared to 46.4% in Fiscal 2000. The 25.8%
percentage point increase resulted from (a) the Company benefiting from the
cost-free revenue generating effect of databases purchased in the fiscal year
ended November 30, 2000 (the databases were fully expensed in Fiscal 2000 and
the Company owns and continues to use these databases in Fiscal 2001 without
additional cost); (b) decreased costs on a unitary-basis associated with the
Company's e-mailing activities; and (c) a significant decline in the Company's
free on-line lottery prize indemnification costs.
The Company's Off-line Customer Acquisition Services segment's Gross Margin
declined to 46.1% in Fiscal 2001, compared to 64.7% in Fiscal 2000. The 18.6%
percentage point decline resulted from the costs of a contingent liability
realized upon the settlement of the arbitration dispute with Talk. The
contingency was of a higher cost relationship to revenues than historically
recognized within the segment, due to the fact that the total contingency became
payable as a result of the first installment. The second installment will not
have any contingent payables if such second installment is collected in Fiscal
2002. To the extent that the balance of the Talk settlement is received in
Fiscal 2002, the Company will report Gross Margin in its Off-line Customer
Acquisition segment in excess of 90%.
The Company's LEC Billed Products and Services segment ("LEC Segment")
Gross Margin remained stable at 96.2%. See "Service Bureaus, Local Exchange
Carriers and Service Bureau Bankruptcy" following the "Liquidity and Capital
Resources" section for a detailed discussion of the LEC Segment gross profit
decreases as it relates to the Company's comparative and future operations.
The Company's Selling Expenses and General and Administrative Expenses for
each of the years ended November 30, 2001 and 2000 are presented, on a segmental
basis, and with the components of the individual segments, in the tables set
forth below:
SEGMENT DATA -- SELLING EXPENSES
CONSOLIDATED SELLING EXPENSES, BY SEGMENT, BY COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2001 2000 $ %
- ----------------------- ---------- ---------- ---------- --------
E-COMMERCE
Fee share commissions ................ $2,157,921 $ 224,109 $1,933,812 863%
Other commissions .................... 356,133 -- 356,133 100%
Selling salaries and related expenses 1,372,934 659,747 713,187 108%
Occupancy and equipment costs ........ 23,118 -- 23,118 100%
Travel, entertainment and other ...... 244,913 87,998 156,915 178%
---------- ---------- ---------- ----
TOTAL E-COMMERCE SELLING EXPENSE .. $4,155,019 $ 971,854 $3,183,165 328%
---------- ---------- ---------- ----
OFF-LINE CUSTOMER ACQUISITION SERVICES
Fee share commissions ................ $ -- $ 189,139 $ (189,139) (100)%
Other commissions .................... 87,573 -- 87,573 100%
Selling salaries and related expenses 191,211 274,137 (82,926) (30)%
Travel, entertainment and other ...... 3,470 36,565 (33,095) (91)%
---------- ---------- ---------- ----
TOTAL OFF-LINE SELLING EXPENSE ....... $ 282,254 $ 499,841 $ (217,587) (44)%
---------- ---------- ---------- ----
Lec billed products and services ..... $ -- $ -- $ -- 0
---------- ---------- ---------- ----
Corporate and other .................. $ -- $ -- $ -- 0
---------- ---------- ---------- ----
CONSOLIDATED SELLING EXPENSES ..... $4,437,273 $1,471,695 $2,965,578 202%
---------- ---------- ---------- ----
29
Selling expenses on a consolidated basis increased approximately $3
million, or 202%, from $1,471,695 in Fiscal 2000 to $4,437,273 in Fiscal 2001.
The increase was attributable to the Company's E-commerce segment, with an
increase of approximately $3.2 million in selling expenses, offset by a decrease
of $217,588 in the Company's selling expenses within its Off-line Customer
Acquisition 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 $1.9 million (see below for a detailed description of
this expense category); and (b) increased compensation and related selling costs
($713,187 and $536,166, respectively) arising from the expansion of the
Company's E-commerce segment's sales force and selling activities.
Regarding the increase in fee share commissions, in the second half of
Fiscal 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 copy, offer form
and 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 obtains the exclusive 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 sets
forth the terms of the Third Party's compensation, which range from fixed fees
paid for each customer or lead, generated for the Client, to 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 Customer Acquisition
Services segment declined 44%, or $217,588 in Fiscal 2001, when compared to
Fiscal 2000. The Company expects that in the fiscal year ended November 30, 2002
it will realize an increase in this segment's selling expenses. The anticipated
increase arises from the Company's expected 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
SEGMENT DATA -- GENERAL AND ADMINISTRATIVE EXPENSES
CONSOLIDATED GENERAL AND ADMINISTRATIVE EXPENSES, BY SEGMENT, BY COMPONENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ---------- ---------- ---------- --------
E-COMMERCE
Compensation costs and related expenses $2,558,010 $ 807,412 $1,750,598 217%
Professional fees ..................... 853,050 311,193 541,857 174%
Insurance costs ....................... 532,901 211,504 321,397 152%
Occupancy and equipment costs ......... 284,148 97,490 186,658 191%
Site development, maintenance and
modifications ...................... 1,750,638 2,623,173 (872,535) (33)%
All other G&A expenses ................ 740,883 743,921 (3,038) 0%
---------- ---------- ---------- ---
TOTAL G&A -- E-COMMERCE SEGMENT ....... $6,719,630 $4,794,693 $1,924,937 40%
---------- ---------- ---------- ---
OFF-LINE CUSTOMER ACQUISITION SERVICES
Compensation costs and related expenses $ 217,327 $ 351,502 $ (134,175) (38)%
Professional fees ..................... 158,821 33,534 125,287 374%
Insurance costs ....................... 84,142 205,299 (121,157) (59)%
Occupancy and equipment costs ......... 22,550 97,490 (74,940) (77)%
All other G&A expenses ................ 55,050 309,602 (254,552) (82)%
---------- ---------- ---------- ---
TOTAL G&A-- OFF-LINE SEGMENT .......... $ 537,890 $ 997,427 $ (459,537) (46)%
---------- ---------- ---------- ---
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2002 2001 $ %
- ----------------------- ----------- ----------- ---------- --------
LEC BILLED PRODUCTS AND SERVICES
Compensation costs and related expenses $ 146,200 $ 541,646 $ (395,446) (73)%
Professional fees ..................... -- 7,758 (7,758) (100)%
Insurance costs ....................... 84,142 177,506 (93,364) (53)%
Occupancy and equipment costs ......... 22,549 83,956 (61,407) (73)%
All other G&A expenses ................ 15,097 (233,465) 248,562 (106)%
----------- ----------- ---------- ----
TOTAL G&A -- LEC SEGMENT ............... $ 267,988 $ 77,401 $ (309,413) (54)%
----------- ----------- ---------- ----
CORPORATE AND OTHER
Compensation costs and related expenses $ 2,054,173 $ 1,692,637 $ 361,536 21%
Professional fees ..................... 1,183,800 1,437,860 (254,060) (18)%
Insurance costs ....................... 3,474 2,330 1,144 49%
Occupancy and equipment costs ......... -- 7,940 (7,940) (100)%
All other G&A expenses ................ 495,601 580,657 (85,056) (15)%
----------- ----------- ---------- ----
TOTAL G&A -- CORPORATE AND OTHER ....... $ 3,737,048 $ 3,721,424 $ 15,624 0%
----------- ----------- ---------- ----
CONSOLIDATED TOTALS ................ $11,262,556 $10,090,945 $1,171,611 12%
----------- ----------- ---------- ----
General and Administrative expenses ("G&A") on a consolidated basis
increased approximately $1.2 million, or 12%, when comparing G&A of $10,090,945
in Fiscal 2000 to G&A of $11,262,556 in Fiscal 2001. The net increase was
attributable to the Company's E-commerce segment, with a net increase of
approximately $1.9 million in such segment's G&A expenses, offset by net
declines of $459,537 and $309,413 in G&A within the Company's Off-line Customer
Acquisition Services segment and LEC Billed Product and Services segment,
respectively.
The E-commerce segment's 40% net increase in G&A expenses was the result of
(a) increased compensation expenses ($1.75 million) and (b) increased
professional fee, insurance and occupancy expenses (combined at $1,049,912),
with such increases necessary to support the 171% increase in net revenues
reported by the Company's E-commerce segment. These net increases were partially
offset by a decline in the E-commerce segment's costs ($872,535, or 33%)
realized in operating, maintaining and modifying the Company's GroupLotto
31
website. During the year ended November 30, 2001, the Company was able to
negotiate more favorable terms with third party hosting facilities resulting in
the reduced expense.
The Company's Off-line Customer Acquisition Services segment G&A expenses
declined $459,537, or 46%, when compared to the prior fiscal year. The segment's
expense decreases directly correlate to the significant decline in such
segment's activity during the year ended November 30, 2001.
The Company's LEC Billed Products and Services segment G&A expenses
declined $309,413, or 54%, when compared to the prior fiscal year. The segment's
expense decreases directly correlate to the significant decline in such
segment's activity during the year ended November 30, 2001. The Company does not
anticipate conducting business within this segment in future fiscal periods and,
as such, does not expect a material contribution to G&A expenses from this
segment in future fiscal periods. See "Service Bureaus, Local Exchange Carriers
and Service Bureau Bankruptcy" following the "Liquidity and Capital Resources"
section for a detailed discussion of factors impacting the LEC Billed Products
and Services segment.
CONSOLIDATED BAD DEBT EXPENSE (RECOVERY), BY SEGMENT
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2001 2000 $ %
---------- -------- --------- --------
Segment
E-Commerce ....................... $ 301,933 $517,903 $(215,970) (42%)
Off-line Customer Acquisitions ... -- -- -- 0%
LEC Billed Products and Services . 826,893 -- 826,893 100%
Corporate and Other .............. (45,000) -- (45,000) (100%)
---------- -------- --------- ----
CONSOLIDATED NET BAD DEBT
EXPENSE ............... $1,083,826 $517,903 $ 565,923 109%
---------- -------- --------- ----
Bad Debt expense increased $565,923, or 109%, to $1,083,826 in Fiscal 2001
from $517,903 in Fiscal 2000. The material portion of the increase was
attributable to an $826,893 bad debt recognized as a result of the bankruptcy
filing of the Company's inactive LEC Billed Product segment's primary service
bureau.
The Company continuously evaluates 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 amount that reflects their probable
realizable value. Provisions for bad debts are also recorded resulting from 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
collection efforts. If circumstances related to specific customers change, our
estimates for bad debt provisions could be further increased.
32
OTHER INCOME (EXPENSE)
The Company's components of "Other income(expense)" for the years ended
November 30, 2001 and 2000 are presented below:
CONSOLIDATED OTHER INCOME (EXPENSE)
CHANGE CHANGE
INC(DEC) INC(DEC)
YEAR ENDED NOVEMBER 30, 2001 2000 $ %
- ----------------------- ----------- ----------- ----------- --------
Other income (expense):
Interest expense ...................... $ (5,900) $ (286,655) 280,755 (98%)
Interest income and dividends ......... 1,780,546 2,646,622 (866,076) (33%)
Realized gains on marketable
securities ....................... 387,948 863,384 (475,436) (55%)
Permanent impairment charges .......... (4,690,258) (2,139,315) (2,550,943) 119%
Gain on nonmonetary cost basis
exchange ......................... -- 565,572 (565,572) (100%)
Other nonoperating income (expense):
Sale of telecommunications license
assets ......................... -- 135,000 (135,000) (100%)
Residuals from terminated
programs-revenue (loss) ........ (57,344) 1,021,401 (1,078,745) (106%)
Other non-operating .............. 74,043 198,322 (124,279) (63%)
Minority interest ..................... (69,629) 140,000 (209,629) (150%)
----------- ----------- ----------- ----
TOTAL CONSOLIDATED OTHER
INCOME (EXPENSE) ........... $(2,580,594) $ 3,144,331 (5,724,925) (182%)
----------- ----------- ----------- ----
Consolidated Other Income (Expense) decreased approximately $5.7 million,
from $3.1 million for the year ended November 30, 2000 to $2.6 million for the
year ended November 30, 2001.
The primary factors contributing to the decrease, in the order of the table
detailed above, are as follows:
(a) a decrease in interest and dividend income of approximately
$866,000 resulting from significant decreases in the interest rates
available on short-term commercial paper during the year ended November 30,
2001, coupled with a decreased amount of cash available for commercial
paper investment, resulting from an approximate $6 million stock redemption
and net federal income tax payments of approximately $6.1 million for a
settlement of tax audits relating to the calendar years 1996 through 1998
(for which the related federal tax expense had been charged to operations
in prior fiscal periods);
(b) a decrease in gains realized on marketable securities of
approximately $475,000 resulting from significant declines in the values of
marketable equity securities held in the Company's investment portfolio. As
of the November 30, 2001 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 $22.9 million in
high grade, short term, commercial paper and auction rate securities (with
yields ranging from 2.4% to 3.8%, with maturities of 30 to 180 days), with
only approximately $760,000 in high risk investments, consisting
exclusively of real estate investment trust equities;
(c) increases in impairment losses of $2.5 million. During the year
ended November 30, 2001 (specifically within the three months ended
February 28, 2001), the Company recognized losses due to "other than
temporary" declines in the value of its marketable security portfolio.
These securities had "mark-to-mar-
33
ket" valuation adjustments in previous quarters, with such adjustments
being classified in "other comprehensive income (loss)" (a contra equity
account on the Company's balance sheet) pursuant to their
"available-for-sale" classification. Such noncash pretax losses recognized
during the year ended November 30, 2001 were $4,190,207. During the year
ended November 30, 2000, the Company recognized approximately $2.1 million
in long-term investment impairment charges. Additionally, during the year
ended November 30, 2001, the Company had evaluated its long-term
investments (specifically within the quarter ended February 28, 2001 and
during the period March 1, 2001 to April 1, 2001) and determined that an
investment made in a privately held company during Fiscal 2000 was
impaired. A long-lived asset impairment write down, related to this
continuing evaluation, of $500,051 was charged to the "permanent impairment
charge" account during the year ended November 30, 2001. During Fiscal 2002
this entity effectively wound down operations and ceased doing business;
and
(d) the reduction in the pre-tax net income attributable to the
residual activity related to the Company's terminated legacy 900 business,
as such activity decreased to a loss of approximately $57,000 in Fiscal
2001, from income of approximately $1 million in the year ended November
30, 2000.
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 $3,275,200 for the year ended
November 30, 2001 on pre-tax income of approximately $3,692,699. This equates to
an effective tax rate of approximately 88.6% and is the result of the Company
taking a full valuation allowance in Fiscal 2001 against the future tax benefits
attributable to the Fiscal 2002 capital loss carryover arising from permanent
impairment charges of $4,690,258, net of realized capital gains of $387,948.
This deferred tax asset valuation allowance has been recorded in 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 Fiscal 2001 impairment charges.
The Company's effective tax rate was approximately 40% for the year ended
November 30, 2000. The majority of impairment losses, recognized in such fiscal
year were related to partnership flow-through investments and, therefore, such
impairments did not generate capital losses, subject to deductibility
limitations, deferred tax asset valuations and effective rate distortions. For
additional discussion and detail on the Company's tax expense see Note 6 of the
Consolidated Financial Statements that appear elsewhere in this report.
LIQUIDITY AND CAPITAL RESOURCES
Our financial and liquidity position remained strong as exhibited by our
cash, cash equivalents, short-term marketable securities and marketable equity
securities of approximately $37.3 million at November 30, 2002. Cash, cash
equivalents, short-term marketable securities and equity securities were
approximately $38.1 million at November 30, 2001. This decrease of approximately
$0.8 million was the result of cash flows generated from operating activities of
approximately $4 million, cash flows generated from investing activities of
approximately $6.8 million, comprised of net proceeds on sales of securities of
$9.5 million, capital expenditures of $1.9 million, payments for asset
acquisitions, net of cash received of $545,500 and approximately $2.2 million
used in financing activities (comprised of treasury stock purchases of $3.6
million, net of cash collected on (a) option exercises of $1.2 million and (b) a
nonmanagement Section 16-b settlement of $114,403 net of direct costs and after
related taxes).
Trade accounts receivable at November 30, 2002, as a percentage of net
revenues earned during the year ended November 30, 2002, was 11.5%, as compared
to 22.8%, at the end of the fiscal year ended November 30,
34
2001. Our days-sales-outstanding ("DSO") in accounts receivable at November 30,
2002 was 42 days for the year ended November 30, 2002, compared to 83 days at
November 30, 2001. We believe the decrease in the current year's DSO compared to
the prior year relates to shortened collection periods on the outstanding
accounts receivables from our customer base, pursuant to our continued emphasis
on receivables analysis and expedited collections efforts.
The majority of our customers are extended 30-day credit terms. We
continually monitor customer adherence to such terms and constantly strive to
improve the effectiveness of our 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 42-day DSO recognized during the year ended
November 30, 2002.
Cash used in financing activities during the year ended November 30, 2002
amounted to $2.2 million, and included cash outflows of approximately $3.6
million for purchases of our common stock, primarily in open market transactions
(with 667,206 shares retired, and the balance of 548,025 held in treasury). It
is our intention to retire all treasury shares in the quarter ending February
28, 2003. On June 19, 2002, we announced that our Board of Directors authorized
a stock repurchase plan, which allowed for the buyback of up to two million
shares of our outstanding common stock. Under such plan, we acquired 1,215,231
shares for $3,849,870, at an average price of $3.17 per share in open market
transactions. The above referenced financing cash outflows were partially offset
by cash proceeds generated by the exercise of stock options, which amounted to
approximately $1,224,697, 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 to us his deemed insider trading gains.
Historically, our 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, further development of businesses being test marketed and for
the development of the equipment infrastructure of newly formed subsidiaries
resulting from asset purchases.
During the fiscal year ended November 30, 2000, we commenced our on-line
direct marketing strategy. Our future plans and business strategy continue to
call for our Internet based E-commerce segment to be our primary operating
focus, with such segment generating a material portion of future revenues. If
our on-line activities fail to generate sufficient revenue, then the
continuation of our year over year on-line growth in that segment could have a
material adverse impact on our 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 year ended
November 30, 2002, we expended approximately $1.9 million in capital
expenditures to support our E-commerce activities and administrative activities.
Obsolescence, changes in the Internet operating landscape, government regulation
and/or other unexpected events impacting Internet direct marketing, or the
economy in general, could individually, or in combination have an adverse effect
on the carrying value of the capital expenditures procured in Fiscal 2002, as
well as the carrying value of other asset acquisitions made in Fiscal 2002 and
earlier that have not yet been fully depreciated or amortized.
In December 2001, we acquired the assets of InfiKnowledge, a closely held
private Canadian based Internet technology company. We believe that this
acquisition will continue to decrease certain costs relative to our 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 us. To date such capital expenditures approximated $1.3
million.
35
During the nine-month period ended November 30, 2002, we experienced
problems with the delivery of our email promotional offers. Such problems
reduced revenue and income from the E-Commerce sub-segment. We believe 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. We have addressed the issue by deploying new reinforced
delivery platforms with increased redundancy and expanded diversification using
both internal and external emailing resources. Although we have 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 our ability and/or cost to deliver commercial email messages to the
consumer records in our databases, and the consumer records in the databases of
our affiliates, could potentially cause a material adverse impact in future
fiscal period net revenue growth and gross margin, and, therefore, our
profitability and cash flows could be adversely affected. There are a variety of
legislative proposals at state and Federal levels regarding email marketing.
Certain of these proposals, if implemented, could negatively affect our email
marketing programs which could cause a material adverse impact in future fiscal
period net revenue, profitability and cash flows.
Should the business climate, Internet operating environment or technology
environment change significantly, we could be faced with circumstances that
would limit or prevent our utilization of these capital expenditures.
We expended approximately $200,000 in cash in Fiscal 2002 as partial
consideration for the Infiknowledge asset acquisition (net of cash received of
approximately $63,000). We also expended an additional $200,000 on December 6,
2002 (Fiscal 2003), regarding the final cash installment related to the
InfiKnowledge asset acquisition.
In December 2001, we also acquired the assets of ThanksMuch.com, a closely
held private company for approximately $361,000 (net of cash received of
approximately $74,000). We do not anticipate that this asset acquisition will
require significant capital expenditures to maintain or improve its operations
and we have not made significant capital expenditures regarding such entity to
the date of this filing.
In September 2002, we disbursed $2,710,000 in final settlement of an
arbitration award. The total payments made exceeded the award by approximately
$435,000. The excess related to an additional settlement agreement that
precludes the claimants from further proceeding with the action in civil court.
The total disbursement of $2.7 million was made during the three months ended
November 30, 2002, and is reflected on the income statement as a component of
"Other non-operating income(expense)" for the year then ended.
We received final notice regarding the Internal Revenue Service tax audits
covering the years 1996 to 1998. The final notice of settlement approximated
$900,000, was paid in November 2002, and included unbilled interest expense on
such tax audits. We had provided for the income statement impact of such outlay
in a prior year and, therefore, the outlay has not impacted earnings in the
quarter ended November 30, 2002.
During the fiscal year ended November 30, 1999, our Internet business plan
and strategy prompted us to terminate the active marketing of our legacy
products and services. Accordingly, this legacy activity may contribute, but in
a significantly decreasing degree, to our cash flows and net income in
subsequent fiscal periods, as was the case during the year ended November 30,
2002 when compared to the years ended November 30, 2001 and 2000. This should be
considered when using our historical results in evaluating future operations,
cash flows and financial position. Nevertheless, we will continue to explore
opportunities to offer other Off-line Marketing Services and, for Fiscal 2003,
have reentered the LEC Billed Products and Services market.
36
Under current operating plans and assumptions, management believes that
projected cash flows from operations and available cash resources will be
sufficient to satisfy our anticipated cash requirements for at least the next
twelve months. Currently, we do not have any material long-term obligations
other than those described in the note "Commitments and Contingent Liabilities"
included in the financial statements included in this document, nor have we
identified any long-term obligations that we contemplate incurring in the near
future. We are currently considering the acquisition of a building in Canada to
house our technology and email platforms. The estimated price range of such
building, with necessary improvements, is not expected to exceed $725,000.
Additionally, we anticipate that capital expenditures will approximate $1
million in the upcoming fiscal year, the majority of which will be for computer
and related peripheral equipment to be used in our E-commerce activities. As we
seek to further extend our reach into the E-commerce arena, as well as identify
new and other consumer oriented products and services in the off-line arena, we
may use existing cash reserves, long-term financing, or other means to finance
such diversification.
TRANSACTIONS WITH MAJOR CUSTOMERS
During the year ended November 30, 2002, we had 5 major customers in our
E-commerce segment, which in combination accounted for approximately $22 million
of consolidated net revenue, respectively, or 50% of consolidated net revenues.
Approximately $3.4 million, or 68.2% of consolidated net accounts receivable was
attributable to such major customer group as of November 30, 2002. The five
major customers referenced above accounted for 21.5%, 8.5%, 7.9%, 7.5% and 4.5%
of consolidated net revenue, respectively, for the year ended November 30, 2002.
Of the remaining approximate 100 active customers in the year ended November 30,
2002, no other single customer had net revenue that equaled or exceeded 2.7% of
consolidated net revenue.
We continued to conduct business with these major customers as of January
28, 2003, with the exception of the customer that accounted for 21.5% of our net
revenue for the year ended November 30, 2002. This customer had notified us in
September 2002 that it was exercising its right to terminate the relationship in
accordance with the terms of the underlying agreement, and, as such, had phased
out its business with us during the ninety-day period ended December 7, 2002.
See "Year Ended November 30, 2002 Compared to Year Ended November 30, 2001" for
a more detailed discussion of the impact of such termination on our operations
and cash flows.
During the year ended November 30, 2001, we had six major customers, five
within our E-commerce segment and one within our Off-line Marketing Services
segment, which, in the aggregate, accounted for approximately 54.9% of
consolidated net revenues during the year ended November 30, 2001, and
approximately 69.1% of consolidated net accounts receivable as of November 30,
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", we have set
forth below what we believe to be the most pervasive accounting policies and
estimates that could have a material effect on our 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.
37
FACTORS THAT COULD EFFECT FUTURE RESULTS
REVENUE RECOGNITION, VARIABLE COSTS AND BAD DEBTS
We currently earn the most significant portion of our revenue from the
E-commerce segment pursuant to marketing agreements with marketing partners and
corporate customers. The provisions of each agreement determine the type and
timing of revenue to be recorded. We invoice our 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. Our revenues
are adjusted in later fiscal periods if 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 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, we 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 respective promotion and all other
variable costs directly associated with completing our obligations relative to
the revenue being recognized.
Should the Internet operating landscape change resulting in (a) higher
costs of acquiring consumer data and registered users for our 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 InfiKnowledge asset
acquisition failing to reduce the cost of our email delivery activities and
other web hosting service costs, or us being required to depend on third party
emailing service bureaus to provide an increased portion of our commercial email
delivery at a cost in excess of anticipated internally generated costs, or other
third party influence on our ability to deliver email messages to the records in
our databases, or the records in our marketing affiliates' databases; (d) our
contingent based prize indemnification premiums for indemnification coverage
increasing due to an increase in the number of prize winners at the site, as a
result of the insurance industry in general, or other currently unknown factors;
(e) our accruals for fulfillment obligations arising out of 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 we
could suffer material deterioration in future fiscal period revenue growth and
gross margins, and, therefore, our profitability and cash flows could be
materially adversely affected.
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 the length of time the receivables are
past due, historical experience and 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, profitability and cash flows.
38
CONTINUATION OF MAJOR CUSTOMERS, LOSS OF MAJOR CUSTOMER, AND PROSPECTS OF
MAJORITY-OWNED SUBSIDIARY
During the year ended November 30, 2002, we had five major customers in our
E-commerce segment, which in combination accounted for approximately $22 million
of consolidated net revenue, or 50% of consolidated net revenues. Approximately
$3.4 million, or 56% of consolidated net accounts receivable, was attributable
to such major customers as of November 30, 2002. The five major customers
referenced above accounted for 21.5%, 8.5%, 8.0%, 7.5% and 4.5% of consolidated
net revenue, respectively, for the year ended November 30, 2002. Of the
remaining approximate 100 active customers in the year ended November 30, 2002,
no other single customer had net revenue that equaled or exceeded 2.7% of
consolidated net revenue.
We continued to conduct business with all such five major customers as of
January 28, 2003, with the exception of the customer that accounted for 21.5% of
our net revenue for the year ended November 30, 2002. This customer had notified
us in September 2002 that it was exercising its right to terminate the
relationship in accordance with the terms of the underlying agreement, and, as
such, had phased out its business with us during the ninety-day period ended
December 7, 2002. It is our belief that this customer loss will be immaterial at
our operations level due to the fact that the operating margin earned from such
activity was less than that recognized from our other marketing activities. We
believe that we will be able to use our media channels, creative department and
senior management's time, all of which, we believe, were disproportionately
dedicated to this customer, more profitably by improving results of existing
customer relationships and developing new relationships and proprietary products
and services. We expect an immaterial decline in future fiscal income from
operations related to such termination, and look to realize improved margins at
both the contribution and operating level. Additionally, we anticipate that we
will recognize improved contribution and operating margins in future fiscal
quarters due to the reduction in our cost of sales that is expected to arise
from the elimination of fulfillment costs as they relate to the termination of
this contract.
Should we not be able to continue conducting business with the balance of
our significant customers, or maintain relationships with such companies on
equivalent, or similarly favorable terms; or replace the loss of the significant
income generated by the lost customer pursuant to our above-discussed
expectations; or replace any of the other significant customers with other third
parties on similar revenue and gross margin generating terms, we 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 reductions in our workforce and
other cost reducing measures. It is not known how rapidly we could respond with
such measures, if at all.
During the year ended November 30, 2002, our 51% majority-owned subsidiary,
Montvale Management LLC, contributed approximately $6.1 million, or 14% of
consolidated net revenues. The subsidiary became active in September 2001. 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 2002 as a result of reduced mortgage and
refinance loan interest rates, and increased government funds for low-income
homebuyers. Our future business plans and operating assumptions anticipate that
the subsidiary will contribute an increasing amount of our revenue in terms of
absolute dollars, and in terms of percentage of total revenues and operating
income. Such assumptions are subject to the continuation of the current interest
rate market which favors refinancings, the continued acceptance by the general
public of off-line and on-line marketing promotions for mortgage and mortgage
related products, 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, our continued
equity ownership interest in such majority-owned subsidiary, as well as other
factors currently not identifiable. We can make no assurance that we will
realize an increased contribution of revenue and related profits from the
majority owned subsidiary in future fiscal periods.
39
Our 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 our revenue generating
cycle or cost structure. Therefore, it is difficult to predict revenue and gross
margin trends. Actual trends may cause us to adjust our operating emphasis,
which could result in continued period-to-period fluctuations in our results of
operations. Historically, we have had to react to rapid changes in the business
environment within which we operate. 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 our 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 our business model in response to unforeseen rapid
changes in future fiscal periods.
IMPAIRMENT OF GOODWILL, OTHER INTANGIBLES AND INVESTMENT PORTFOLIOS COULD
IMPACT NET INCOME
We carry Goodwill and other Intangibles on our balance sheet arising from
current and prior year acquisitions. We must review, at least annually, such
Goodwill and other Intangibles for any asset impairment. If the review of the
Goodwill and Intangibles related to the subsidiaries organized to acquire such
assets determine that such assets are impaired, then we 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, we 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.
MARKET FLUCTUATION AND DEBT REPAYMENT RISK OF MARKETABLE SECURITIES
INVESTMENT PORTFOLIO
We maintain an investment portfolio that is managed by prominent financial
institutions. 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
fair value of our investments in the common stock of publicly traded companies,
as of November 30, 2002 amounted to approximately $1.1 million. These
investments are subject to 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 to fulfill their responsibility of adhering to the
repayment of principal upon maturity. Additionally, our cash flows and interest
income could be negatively impacted from continued Federal Reserve Bank interest
rate reductions.
POTENTIAL OF FEDERAL, AND/OR STATE ENACTED LEGISLATION
There are a variety of legislative proposals at state and federal levels
regarding email marketing, as discussed elsewhere herein. Certain of these
proposals, if implemented, could negatively affect our email marketing programs
which could cause a material adverse impact in net revenue, gross margins,
profitability and cash flows.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets." 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 respec-
40
tive 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. We did not elect earlier adoption pursuant to the terms of
SFAS 142. However, goodwill and intangible assets acquired after June 30, 2001
are subject immediately to the nonamortization 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 us.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS 143 sets forth the guidelines regarding the
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and any costs associated with the
related assets' retirement. The provisions of SFAS 143 will be effective for our
fiscal year ending November 30, 2003. Based on the relative components of our
balance sheet at November 30, 2002, we believe that the adoption of SFAS 143
will have an immaterial impact on our consolidated financial position and
results of operations, if at all.
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 criteria 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 components of our balance sheet at November 30, 2002, we believe
that the adoption of SFAS 144 will have an immaterial impact on our consolidated
financial position and results of operations, if any effect at all.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB No. 13, and Technical Corrections". SFAS 145
promulgates rules regarding the financial accounting and reporting requirements,
which include gains and losses resulting from the extinguishments of debt and
the treatment of sale-leaseback transactions. The provisions of SFAS 145 will be
effective for our fiscal year ending November 30, 2003. Based on the components
of our balance sheet at November 30, 2002, we believe that the adoption of SFAS
145 will have an immaterial impact on our consolidated financial position and
results of operations, if at all.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS 146 promulgates rules
regarding exit or disposal activities that are initiated after December 31,
2002. SFAS 146 requires companies to recognize costs associated with the exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan and nullifies the requirements under the
"Emerging Issues Task Force No. 94-3", "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs in a Restructuring)". We believe that the adoption of SFAS 146
will have an immaterial impact on our consolidated financial position and
results of operations, if at all.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). This Interpretation requires
that, upon issuance of a guarantee, a guarantor must recognize a liability for
the fair market value of an obligation assumed under the guarantee. Disclosures
by the guarantor in the interim and quarterly financial statements, specific to
obligations associated with guarantees issued, are also required by FIN 45. The
recognition requirements of FIN 45 are effective for guarantees that are issued
after December 31, 2002.
41
We believe that the adoption of this Interpretation will have an immaterial
impact on our consolidated financial position and results of operations, if any
effect at all.
In October 2002, Statement of Financial Accounting Standards No. 147
"Acquisitions of Certain Financial Institutions ("FAS 147") was issued. The
statement addresses the financial accounting and reporting for the acquisition
of all or a part of a financial institution. Additionally, FAS 147 also provides
guidance on the accounting for the impairment or disposal of acquired long-term
customer-relationship intangible assets. The provisions of this statement will
be effective for acquisitions on or after October 1, 2002. Based on our initial
review of FAS 147 we believe that its adoption will have no material impact on
either our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation -- Transition and Disclosure ("FAS 148"). This statement amends
SFAS No. 123 "Accounting for Stock Based Compensation", providing alternative
methods of voluntarily transitioning to the fair value based method of
accounting for stock-based employee compensation. FAS 148 also requires
disclosure of the method used to account for stock-based employee compensation
and the effect of the method in both annual and interim financial statements.
The provisions of this statement related to transition methods are effective for
fiscal years ending after December 15, 2002 while provisions related to
disclosure requirements are effective in financial reports for interim periods
beginning after December 31, 2002. We believe that the adoption of this
statement will have an immaterial impact on our consolidated financial position
and results of operation.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Financial Statements referred to in the
accompanying Index, setting forth the consolidated financial statements of
Traffix, Inc. and subsidiaries, together with the report of
PricewaterhouseCoopers LLP dated February 3, 2003.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
Set forth below are the directors and executive officers of our Company,
their respective names and ages, positions with our Company, principal
occupations and business experiences during at least the past five years and the
dates of the commencement of each individual's term as a director and/or
officer.
NAME AGE POSITION
- ----- --- -------
Jeffrey L. Schwartz ..... 54 Chairman of the Board and Chief Executive Officer
Andrew Stollman ......... 37 President, Secretary and Director
Joshua B. Gillon, Esq. .. 40 Executive Vice President and General Counsel
Daniel Harvey ........... 44 Chief Financial Officer
Richard Wentworth ....... 53 Chief Operating Officer
Gary Salmirs ............ 38 Executive Vice President -- Marketing and Sales
Murray L. Skala ......... 56 Director
Edwin A. Levy ........... 65 Director
Lawrence Burstein ....... 60 Director
Jack Silver ............. 59 Director
42
DIRECTORS
Jeffrey L. Schwartz has been our Chairman and Chief Executive Officer since
January 1995, Secretary/Treasurer from September 1993 to December 1994 and a
director since our inception in 1993. From January 1979 until May 1998, Mr.
Schwartz was also Co-President and a director of Jami Marketing Services, Inc.,
a list brokerage and list management consulting firm, Jami Data Services, Inc.,
a database management consulting firm, and Jami Direct, Inc., a direct mail
graphic and creative design firm (collectively, the "Jami Companies"). The Jami
Companies were sold by the principals thereof in May 1998.
Andrew Stollman has been our President since November 21, 2002, Chief
Operating Officer from January 1, 2001 to November 21, 2002, and Secretary and a
director since January 1995. From February 2000 until January 2001, Mr. Stollman
was also our Executive Vice President and from January 1995 until February 2000,
he was Senior Vice President. Mr. Stollman was our President from September 1993
to December 1994.
Murray L. Skala has been a director since October 1995. Mr. Skala has been
a partner in the law firm of Feder, Kaszovitz, Isaacson, Weber, Skala, Bass &
Rhine, LLP since 1976. Mr. Skala is also a director of JAKKS Pacific, Inc., a
publicly held company in the business of developing, marketing and distributing
children's toys.
Edwin A. Levy has been a director since November 1995. Mr. Levy has been
the Chairman of the Board of Levy, Harkins & Co., Inc., an investment advisor,
since 1979, and is also a director of Coastcast Corp., a publicly held company
in the business of manufacturing golf club heads.
Lawrence Burstein has been a director since April 1999. Since March 1996,
Mr. Burstein has been Chairman of the Board and a principal shareholder of Unity
Venture Capital Associates, Ltd., a private venture capital firm. For
approximately ten years prior thereto, Mr. Burstein was the President, a
director and principal stockholder of Trinity Capital Corporation, a private
investment banking concern. Trinity ceased operations upon the formation of
Unity Venture in 1996. Mr. Burstein is a director of several companies, being,
respectively, THQ, Inc., engaged in the development and marketing of games for
Sony, Nintendo and Sega game systems; CAS Medical Systems, Inc., engaged in the
manufacture and marketing of blood pressure monitors and other disposable
products, principally for the neonatal market; Gender Sciences, Inc., engaged in
the manufacturing and distribution of nutritional supplements; and I.D. Systems
Inc., engaged in the design, development and production of a wireless monitoring
and tracking system which uses radio frequency technology.
Jack Silver has been a director since January 1, 2001. He is the principal
investor and manager of SIAR Capital, an independent investment fund that
invests primarily in undervalued, emerging growth companies. Mr. Silver, a
certified public accountant by background, has managed SIAR capital for over
twenty years.
All directors hold office until the next annual meeting of stockholders and
the election and qualification of their successors. Directors receive no cash
compensation for serving on the Board of Directors other than reimbursement of
reasonable expenses incurred in attending meetings. Directors who are not our
employees are compensated for their services and attendance at meetings through
the grant of options pursuant to our Stock Option Plan.
EXECUTIVE OFFICERS
Officers are elected annually by the Board of Directors and serve at the
direction of the Board of Directors. Two of our executive officers, Jeffrey L.
Schwartz and Andrew Stollman, are also directors of our Company. Information
with regard to such persons is set forth above under the heading "Directors."
43
The remaining executive officers are Joshua B. Gillon, Esq., Executive Vice
President and General Counsel, Mr. Daniel Harvey, Chief Financial Officer, Mr.
Richard Wentworth, Chief Operating Officer, and Mr. Gary Salmirs, Executive Vice
President -- Marketing and Sales.
Mr. Gillon, age 40, was appointed our Chief Investment Officer and General
Counsel in April 2000. In April 2001, Mr. Gillon's title was changed to
Executive Vice President -- Corporate Affairs and General Counsel. In November
2002, Mr. Gillon's title was changed to Executive Vice President and General
Counsel. From April 1999 through March 2000, Mr. Gillon served as the Project
Director for Total Energy, Inc., a home heating oil industry consolidation. From
February 1996 to March 1999, he was a partner at the law firm of Schneck,
Weltman & Hashmall, LLP, specializing in mergers, acquisitions and securities
law. From 1990 to 1996, he was an associate with the law firm of Kronish Lieb
Weiner & Hellman, LLP and from 1988 to 1990, he was an associate with the law
firm of Seward & Kissel, LLP. Mr. Gillon is also a director of CRIIMI MAE, Inc.,
a publicly held commercial mortgage company.
Mr. Harvey, age 44, has been our Chief Financial Officer since January
1997. He joined us in September 1996. From November 1991 to August 1996, he was
a Senior Manager with the accounting firm of Feldman, Gutterman, Meinberg & Co.
Mr. Harvey is a Certified Public Accountant.
Mr. Wentworth, age 53, has been our Chief Operating Officer since November
21, 2002. He initially joined us in 1998, and had served as our Vice President
of Data Operations since January 2000. From November 1994 to 1999, Mr. Wentworth
was the President and Chief Operating Officer of TIAC, a prominent New England
based regional Internet Service Provider.
Mr. Salmirs, age 38, has been Executive Vice President -- Marketing and
Sales since November 21, 2002. He joined us in 1994, and had served as our
Senior Vice President -- Marketing and Sales since December 1995. From 1991 to
1994, Mr. Salmirs was the President, Chief Operating Officer and primary
shareholder of GKS Marketing, Inc., a direct mail marketing and fulfillment
service bureau.
We haves obtained "key man" life insurance in the amount of $1,000,000 on
each of the lives of Jeffrey L. Schwartz and Andrew Stollman.
THE COMMITTEES
The Board of Directors has an Audit Committee, a Compensation Committee and
a Stock Option Committee. The Board of Directors does not have a Nominating
Committee, and the usual functions of such a committee are performed by the
entire Board of Directors.
AUDIT COMMITTEE. The functions of the Audit Committee are to recommend to
the Board of Directors the engagement of the independent accountants, review the
audit plan and results of the audit engagement, review the independence of the
auditors and review the adequacy of our system of internal accounting controls.
The current members of the Audit Committee are Messrs. Levy, Burstein and
Silver.
COMPENSATION COMMITTEE. The function of the Compensation Committee is to
make recommendations to the Board with respect to compensation of management
employees. In addition, the Compensation Committee administers plans and
programs, with the exception of our stock option plans, relating to employee
benefits, incentives and compensation. The current members of the Compensation
Committee are Messrs. Skala and Burstein.
STOCK OPTION COMMITTEE. The Stock Option Committee determines the persons
to whom options should be granted under our stock option plans and the number of
options to be granted to each person. The current members of the Stock Option
Committee are Messrs. Levy and Burstein.
44
ATTENDANCE AT MEETINGS
From December 1, 2001 through November 30, 2002, the Board of Directors,
Stock Option Committee, Audit Committee and Compensation Committee each met or
acted without a meeting pursuant to unanimous written consent five times, six
times, one time and one time, respectively.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
To the best of our knowledge, during the fiscal year ended November 30,
2002, (i) Gary Salmirs and Richard Wentworth each untimely filed one report on
Form 3; (ii) Lawrence Burstein, Joshua B. Gillon, Daniel Harvey, Edwin Levy,
Jack Silver and Murray L. Skala each untimely filed one report on Form 4, each
reporting one transaction; and (iii) Eric Aroesty untimely filed one report on
Form 4 reporting one transaction and failed to file one report on Form 5
reporting three transactions. These individuals were executive officers,
directors and/or beneficial owners of more than 10% of our Common Stock during
the fiscal year ended November 30, 2002. To the best of our knowledge, all other
Forms 3, 4 and 5 required to be filed during the fiscal year ended November 30,
2002 were done so on a timely basis.
45
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the executive compensation paid during the
three fiscal years ended November 30, 2002, 2001 and 2000 for (i) our Chief
Executive Officer; (ii) our four most highly compensated executive officers
(other than the Chief Executive Officer) whose cash compensation for the fiscal
year ended November 30, 2002 exceeded $100,000; and (iii) up to two additional
individuals for whom disclosure would have been provided under the above clause
(ii) but for the fact that the individuals were not serving as executive
officers at the end of the last completed fiscal year (the "Named Officers").
LONG TERM COMPENSATION
----------------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
--------------------------------------- ---------------------- ----------------------
(A) (B) (C) (D) (E) (F) (G) (H) (I)
- ------------------------------ ---- --------- --------- --------- ---------- ---------- ----------- ---------
OTHER SECURITIES ALL OTHER
ANNUAL RESTRICTED UNDERLYING COMPEN-
NAME AND SALARY BONUS COMPENSA- STOCK OPTIONS PLAN SATION
PRINCIPAL POSITION YEAR ($) ($) TION ($) AWARDS (#) PAYOUTS ($) ($)
- --------------- ---- --------- --------- --------- ---------- ---------- ----------- ---------
Jeffrey L. Schwartz .......... 2002 $500,000 $185,707 0 0 105,000 0 0
Chairman and 2001 $444,000 $200,000 0 0 150,000 0 0
Chief Executive Officer 2000 $405,000 $185,000 0 0 100,000 0 0
Andrew Stollman .............. 2002 $450,000 $185,707 0 0 105,000 0 0
President and 2001 $401,000 $200,000 0 0 135,000 0 0
Secretary 2000 $367,000 $165,000 0 0 100,000 0 0
Eric Aroesty ................. 2002 $363,377 0 0 0 0 0 0
Former President (1) 2001 $294,000 $150,000 0 0 0 0 0
2000 $185,000 0 0 0 0 0 0
Joshua B. Gillon, Esq. ....... 2002 $244,244 $ 50,000 0 0 0 0 0
Executive Vice President 2001 $225,000 $ 50,000 0 0 175,000 0 0
and General Counsel 2000 $133,000(2) $ 25,000 0 0 100,000 0 0
Daniel Harvey ................ 2002 $196,706 $ 40,000 0 0 0 0 0
Chief Financial 2001 $184,000 $ 40,000 0 0 79,000 0 0
Officer 2000 $177,000 $ 30,000 0 0 29,000 0 0
Gary Salmirs ................. 2002 $240,000 $100,000 0 0 0 0 0
Executive Vice 2001 $240,000 $117,345 0 0 120,050 0 0
President -- Marketing and 2000 $240,000 0 0 0 0 0 0
Sales (3)
- --------------
(1) Mr. Aroesty resigned as an executive officer, employee and director of our
Company on November 21, 2002. See "Certain Relationships and Related
Transactions".
(2) Mr. Gillon's salary during 2000 was $200,000 per annum, however, he was
first employed by us on April 5, 2000.
(3) Mr. Salmirs has served as our employee since 1995, but first became an
executive officer in November 2002 upon his appointment as Executive Vice
President -- Marketing and Sales.
46
The following table sets forth certain information regarding the granting
of options to the Named Officers during the fiscal year ended November 30, 2002.
OPTION GRANTS IN LAST FISCAL YEAR
POTENTIAL
REALIZABLE
VALUE AT ASSUMED
ANNUAL
RATES OF STOCK
PRICE APPRECIATION
FOR OPTION
INDIVIDUAL GRANTS TERM (2)
------------------------------------------------------- -------------------
(A) (B) (C) (D) (E) (F) (G)
- ------------------------------- ----------- --------------- ----------- ---------- -------- --------
NUMBER OF
SECURITIES % OF TOTAL
UNDERLYING OPTIONS GRANTED EXERCISE OR
OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION
NAME GRANTED (#) FISCAL YEAR (1) ($/SHARE) DATE 5%($) 10%($)
- ----- ----------- --------------- ----------- ---------- -------- --------
Jeffrey L. Schwartz ............ 105,000(3) 12.97% $5.70 12/1/2011 $376,394 $953,855
Andrew Stollman ................ 105,000(3) 12.97% 5.70 12/1/2011 376,394 953,855
- -------------
(1) Options to purchase a total of 809,250 shares of Common Stock were granted
to our employees and consultants, including the Named Officers, during the
fiscal year ended November 30, 2002.
(2) Based upon the closing price of the Common Stock, as listed by the Nasdaq
National Market, on the date of grant of the respective options.
(3) One-third (1/3) of these options became exercisable on their date of grant
and on the one-year anniversary thereof, and the remaining one-third (1/3)
becomes exercisable on the two-year anniversary thereof.
The following table sets forth certain information regarding options
exercised and exercisable during the fiscal year ended November 30, 2002 and the
value of the options held as of November 30, 2002 by the Named Officers.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUE
(A) (B) (C) (D) (E)
- ------------------------------- -------------- ------------ ------------------------------ --------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END (#) AT FISCAL YEAR-END (1)($)
------------------------------ ---------------------------
SHARES ACQUIRED VALUE
NAME ON EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----- -------------- ------------ ----------- ------------- ----------- -------------
Jeffrey L. Schwartz .......... 0 0 422,245 70,000 $185,611 0
Andrew Stollman .............. 0 0 375,010 70,000 149,213 0
Eric Aroesty ................. 365,789 $281,658 0 0 0 0
Joshua B. Gillon ............. 0 0 183,335 91,665 42,834 $21,416
Daniel Harvey ................ 22,000 85,533 39,333 26,332 2,070 14,620
Gary Salmirs ................. 17,500 92,603 91,384 16,666 60,834 --
- ------------
(1) The product of (x) the difference between $2.91 (the closing price of our
Common Stock at November 29, 2002, as reported by Nasdaq) and the exercise
price of the unexercised options, multiplied by (y) the number of
unexercised options.
47
BOARD COMPENSATION
As a result of our policy to compensate non-employee directors for their
services, our 1996 Stock Option Plan, as amended and restated (the "Plan"),
provides for an automatic one-time grant to all non-employee directors of
options to purchase 25,000 shares of Common Stock and for additional automatic
quarterly grants of options to purchase 6,250 shares of Common Stock. The
exercise prices for all of such non-employee director options are the market
value of the Common Stock on their date of grant.
EMPLOYMENT AGREEMENTS
We have entered into employment agreements, effective December 1, 2001,
with each of Jeffrey L. Schwartz and Andrew Stollman, which expire on November
30, 2004. Pursuant to such agreements, (i) Mr. Schwartz is employed as Chairman
and Chief Executive Officer and Mr. Stollman is employed as Chief Operating
Officer (which title has since been changed to President); (ii) Messrs. Schwartz
and Stollman were paid $500,000 and $450,000 per annum, respectively, for the
fiscal year ended November 30, 2002, and in each subsequent 12 month period will
be paid at a rate to be determined by our Board of Directors, but that is at
least ten percent (10%) more than the annual rate in the immediately preceding
year; (iii) Messrs. Schwartz and Stollman will each receive bonuses upon our
Company's achievement of certain pre-tax income milestones, as well as
discretionary bonuses subject to approval of our Board of Directors; (iv)
Messrs. Schwartz and Stollman were each issued 10 year options to acquire
105,000 shares of our Common Stock at an exercise price of $5.70 per share; (v)
Messrs. Schwartz and Stollman each agreed not to compete or engage in a business
competitive with our business during the term of the agreement and for a period
of one year thereafter; (vi) if an employee's employment is terminated other
than as a result of a "For Cause Event" (as defined in the agreements), such
employee shall be entitled to receive additional compensation and other
consideration, all as more fully described in the agreements; and (vii) if an
employee's employment is terminated as a result of a "Change in Control" (as
defined in the agreements), such employee shall be entitled to receive a
one-time payment in an amount equal to 2.99 times his "base amount" determined
in accordance with the applicable provisions of the Internal Revenue Code. The
foregoing is only a summary of the material terms of our employment agreements
with the Named Officers. For a complete description, copies of such agreements
are annexed hereto in their entirety as exhibits or are otherwise incorporated
herein by reference.
COMPENSATION COMMITTEE INTERLOCK AND INSIDER PARTICIPATION
The Compensation Committee of our Board of Directors from December 1, 2001
through November 30, 2002 consisted of Murray L. Skala and Lawrence Burstein.
See "Certain Relationships and Related Transactions."
48
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of February 10, 2003, based
upon information obtained from the persons named below, regarding beneficial
ownership of our Common Stock by (i) each person who is known by us to own
beneficially more than 5% of the outstanding shares of our Common Stock, (ii)
each director of our Company, (iii) each of the Named Officers, and (iv) all
executive officers and directors of our Company as a group.
NAME AND ADDRESS OF NUMBER OF SHARES PERCENT
BENEFICIAL OWNER (1) BENEFICIALLY OWNED (2) OF CLASS (2)
- -------------------- ---------------------- ------------
Jeffrey L. Schwartz ....................................... 2,555,110(3) 17.35%
Jack Silver ............................................... 1,762,450(4) 12.28
660 Madison Avenue
New York, NY 10021
Michael G. Miller ......................................... 1,645,723 11.53
5 Sky Drive
New City, NY 10956
Andrew Stollman ........................................... 1,257,242(5) 8.57
Joshua B. Gillon, Esq ..................................... 225,001(6) 1.55
Edwin A. Levy ............................................. 200,100(7) 1.39
570 Lexington Avenue
New York, NY 10022
Murray L. Skala ........................................... 142,750(8) *
750 Lexington Avenue
New York, NY 10022
Lawrence Burstein ......................................... 118,750(9) *
245 Fifth Avenue
New York, NY 10016
Gary Salmirs .............................................. 74,717(10) *
Eric Aroesty .............................................. 74,000 *
Daniel Harvey ............................................. 65,665(11) *
All executive officers and directors as a group (9 persons) 6,527,452(12) 40.63
- ------------
* Less than 1% of our outstanding shares.
(1) Unless otherwise provided, such person's address is c/o Traffix, Inc., One
Blue Hill Plaza, Pearl River, New York 10965.
(2) The number of shares of Common Stock beneficially owned by each person or
entity is determined under the rules promulgated by the Securities and
Exchange Commission (the "Commission"). Under such rules, beneficial
ownership includes any shares as to which the person or entity has sole or
shared voting power or investment power. The percentage of our outstanding
shares is calculated by including among the shares owned by such person any
shares which such person or entity has the right to acquire within 60 days
after February 10, 2003. The inclusion herein of any shares deemed
beneficially owned does not constitute an admission of beneficial ownership
of such shares.
(3) Includes 457,245 shares of Common Stock issuable upon exercise of options
held by Mr. Schwartz.
(4) Includes (i) 992,300 shares of Common Stock owned by a profit sharing plan
of which Mr. Silver is a Trustee; (ii) 117,000 shares of Common Stock owned
by Mr. Silver's children; (iii) 148,000 shares of Common Stock owned by a
pension plan of which Mr. Silver is a Trustee; (iv) 423,900 shares of
Common Stock held by
49
a trust for the benefit of Mr. Silver's children, of which Mr. Silver was
the donor; and (v) 81,250 shares of Common Stock issuable upon the exercise
of options held by Mr. Silver.
(5) Includes 410,010 shares of Common Stock issuable upon exercise of options
held by Mr. Stollman.
(6) Represents shares of Common Stock issuable upon the exercise of options
held by Mr. Gillon.
(7) Represents 25,100 shares of Common Stock held by a fund of which Mr. Levy
is the General Partner and 175,000 issuable upon exercise of options held
by Mr. Levy.
(8) Includes 138,750 shares of Common Stock issuable upon exercise of options
held by Mr. Skala.
(9) Represents shares of Common Stock issuable upon exercise of options held by
Mr. Burstein.
(10) Represents shares of Common Stock issuable upon exercise of options held by
Mr. Salmirs.
(11) Represents shares of Common Stock issuable upon the exercise of options
held by Mr. Harvey.
(12) Includes 1,798,055 shares of Common Stock issuable upon the exercise of
options held by our executive officers and directors. See footnotes (3)
through (11), above.
EQUITY COMPENSATION PLAN INFORMATION
The table below sets forth the following information as of the fiscal year
ended November 30, 2002 for (i) all compensation plans previously approved by
our stockholders and (ii) all compensation plans not previously approved by our
stockholders, if any:
(a) the number of securities to be issued upon the exercise of
outstanding options, warrants and rights;
(b) the weighted-average exercise price of such outstanding options,
warrants and rights; and
(c) other than securities to be issued upon the exercise of such
outstanding options, warrants and rights, the number of securities
remaining available for future issuance under the plans.
(C)
NUMBER OF
(A) SECURITIESREMAINING
NUMBER OF SECURITIES TO (B) AVAILABLE FOR FUTURE
BE ISSUED UPON WEIGHTED-AVERAGE ISSUANCE UNDER EQUITY
EXERCISE OF OUTSTANDING EXERCISE PRICE OF COMPENSATION PLANS
OPTIONS, WARRANTS AND OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY(1) RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
- --------------- ----------------------- -------------------- ------------------------
Equity Compensation Plans
Approved by Securityholders ........... 2,783,677 $4.40 1,282,145
Equity Compensation Plans
Not Approved by Securityholders ....... 0 0 0
--------- ----- ---------
Total ............................ 2,783,677 $4.40 1,282,145
--------- ----- ---------
- -----------------
(1) Equity compensation plans approved by our stockholders include the 1995
Employee Stock Option Plan and the Fourth Amended and Restated 1996
Employee Stock Option Plan. We do not have an equity compensation plan that
has not been approved by our stockholders.
50
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 14, 2001, each of Jeffrey L. Schwartz and Andrew Stollman,
executive officers of our Company, entered into a Purchase Agreement with a
group of investment funds unaffiliated with us, pursuant to which Messrs.
Schwartz and Stollman each sold 200,000 shares of Common Stock (400,000 shares
in the aggregate), at a price of $5.75 per share (for proceeds of $1,150,000 to
each of Messrs. Schwartz and Stollman). Such individuals also agreed, that for a
period of six (6) months after such sale, they would not (with certain limited
exceptions, as enumerated in the Purchase Agreements), without the consent of
the investment funds, sell, assign, pledge, transfer or otherwise dispose of any
securities of our Company. In such Purchase Agreements, we provided several
covenants, including (i) the obligation to register such 400,000 shares with the
Commission on Form S-3; (ii) use all reasonable best efforts to cause such
registration statement to be declared effective within 120 days after filing;
and (iii) cause such registration statement to remain continuously effective
until December 13, 2003. Such registration statement was declared effective by
the Commission on January 31, 2002. We agreed to indemnify the investment funds
(limited to the amount of the proceeds received by Messrs. Schwartz and
Stollman) in the event we breach any of the covenants we made in the Purchase
Agreements.
Murray L. Skala, a director of our Company, is a partner in the law firm of
Feder, Kaszovitz, Isaacson, Weber, Skala, Bass & Rhine LLP, our attorneys
("Feder Kaszovitz"). We incurred charges of approximately $798,000 during the
fiscal year ended November 30, 2002. Feder Kaszovitz continues to provide
services to us during our current fiscal year. Its fees are based primarily on
hourly rates. We believe that our relationship with such firm is on terms no
less favorable to us than could have been obtained from unaffiliated third
parties.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our Chief Executive Officer and Chief Financial Officer, after evaluating
the effectiveness of our disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14(c) and 15-d-14(c) as of a date within 90 days of the
filing date of this Annual Report (the "Evaluation Date") have concluded that as
of the Evaluation Date, our disclosure controls and procedures were adequate and
effective to ensure that material information relating to us and our
consolidated subsidiaries would be made known to us and them by others within
those entities, particularly during the period in which this Annual Report was
being prepared.
(b) Changes in internal controls.
There were no significant changes in our internal controls or in other
factors that could significantly affect our disclosure controls and procedures
subsequent to the Evaluation Date, nor any significant deficiencies or material
weaknesses in such disclosure controls and procedures requiring corrective
actions. As a result, no corrective actions were taken.
51
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.
(I) FINANCIAL STATEMENTS:
See Index to Financial Statements.
(II) FINANCIAL STATEMENT SCHEDULES:
Schedule of Valuation and Qualifying Accounts and Reserves
All other financial statement schedules have been omitted since either (i)
the schedule or condition requiring a schedule is not applicable or (ii) the
information required by such schedule is contained in the Consolidated Financial
Statements and Notes thereto or in Management's Discussion and Analysis of
Financial Condition and Results of Operation.
(B) REPORTS ON FORM 8-K.
On November 26, 2002, we filed a Current Report on Form 8-K reporting the
consummation of the transactions contemplated by the November 20, 2002
Redemption Agreement with Eric Aroesty, a former principal stockholder,
executive officer and director of our Company (the "Closing"), including:
(i) Our redemption from Mr. Aroesty of 262,243 shares of Common Stock at a
price of $2.52 per share for aggregate consideration of $660,852.
(ii) Mr. Aroesty's exercise of options to purchase 365,789 shares of Common
Stock at an exercise price of $1.75 per share, for total proceeds to us of
$640,131.
(iii) Our redemption of the 365,789 shares acquired upon Mr. Aroesty's
option exercise at a purchase price of $2.52 per share for aggregate
consideration of $921,788, and after the transactions described in (i) and (ii)
above, resulting in (a) net proceeds to Mr. Aroesty of $942,510, and (b) our
redemption of Mr. Aroesty's 623,032 shares of Common Stock.
(iv) Mr. Aroesty's agreement that for a period of 6 months after the date
of the Redemption Agreement, he would not sell, assign, transfer (including
without limitation by gift) or otherwise dispose of any of our securities, or
any interest therein or right thereto, except under certain "change of control"
circumstances.
(v) Mr. Aroesty's undertaking not to, directly or indirectly, compete with
us for a period of one year after the Closing.
(vi) Mr. Aroesty's resignation as our President and as a member of our
Board of Directors.
Other than the foregoing, we did not file any Current Reports on Form 8-K
during the quarter ended November 30, 2002.
52
(C) 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 Bylaws of the Company (3)
10.1 Fourth Amended and Restated 1996 Stock Option Plan (4)
10.2 Lease of the Company's offices at One Blue Hill Plaza, Pearl River,
New York (5)
10.3.1 December 1, 2001 Employment Agreement by and between the Company and
Jeffrey L. Schwartz (6)
10.3.2 December 1, 2001 Employment Agreement by and between the Company and
Andrew Stollman (6)
21* Subsidiaries of the Company
- -------------
* Filed herewith.
(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.
(4) Filed as an Exhibit to the Company's Proxy Statement filed with the
Commission, dated July 17, 2002 and incorporated herein by reference.
(5) Filed as an Exhibit to the Company's Current Report on Form 8-K dated
December 26, 2000 and incorporated herein by reference.
(6) Filed as an Exhibit to the Company's Form 10-K for the year ended November
30, 2001 and incorporated herein by reference.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
Dated: February 27, 2003 CHAIRMAN AND CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ---- -----
/s/ JEFFREY L. SCHWARTZ Chairman and Chief Executive Officer February 27, 2003
- -------------------------- (Principal Executive Officer)
Jeffrey L. Schwartz
/s/ DANIEL HARVEY Chief Financial Officer (Principal February 27, 2003
- -------------------------- Financial and Accounting Officer)
Daniel Harvey
/s/ ANDREW STOLLMAN President, Secretary and Director February 27, 2003
- --------------------------
Andrew Stollman
/s/ MURRAY L. SKALA Director February 27, 2003
- --------------------------
Murray L. Skala
/s/ EDWIN A. LEVY Director February 27, 2003
- --------------------------
Edwin A. Levy
/s/ LAWRENCE BURSTEIN Director February 27, 2003
- --------------------------
Lawrence Burstein
/s/ JACK SILVER Director February 27, 2003
- --------------------------
Jack Silver
54
CERTIFICATIONS
I, Jeffrey L. Schwartz, certify that:
1. I have reviewed this annual report on Form 10-K of Traffix, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a)designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b)evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c)presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions):
a)all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b)any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: February 27, 2003
By: /s/ JEFFREY L. SCHWARTZ
-------------------
Jeffrey L. Schwartz
Chairman and Chief Operating Officer
55
I, Daniel Harvey, certify that:
1. I have reviewed this annual report on Form 10-K of Traffix, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a)designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b)evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c)presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: February 27, 2003
By: /s/ DANIEL HARVEY
-------------------
Daniel Harvey
Chief Financial Officer
56
TRAFFIX, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
PAGE
----
Report of Independent Accountants ...................................... F-1
Consolidated Balance Sheets as of November 30, 2002 and 2001 ........... F-2
Consolidated Statements of Operations for the years ended November 30,
2002, 2001 and 2000 .................................................. F-3
Consolidated Statements of Shareholders' Equity for the years ended
November 30, 2002, 2001 and 2000 ..................................... F-4
Consolidated Statements of Cash Flows for the years ended November 30,
2002, 2001 and 2000 .................................................. F-5
Notes to Consolidated Financial Statements ............................. F-6
Schedule II -- Valuation and Qualifying Accounts and Reserves ........... S-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Traffix, Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Traffix, Inc. and its Subsidiaries (the "Company") at November 30,
2002 and 2001, and the results of their operations and their cash flows for each
of the three years in the period ended November 30, 2002 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
RICEWATERHOUSEcOOPERS LLP
Florham Park, New Jersey
February 3, 2003
F-1
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF NOVEMBER 30, 2002 AND 2001
2002 2001
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ............................................ $ 23,136,341 $ 14,458,055
Marketable securities ................................................ 14,249,406 23,677,999
Accounts receivable, trade, net of allowance for doubtful accounts
of $326,127 and $383,676 in 2002 and 2001, respectively ............ 5,050,218 7,326,032
Deferred income taxes ................................................ 1,524,821 3,242,815
Due from related parties ............................................. 57,548 106,654
Prepaid income taxes ................................................. 1,195,808 --
Prepaid expenses and other current assets ............................ 1,138,362 1,415,836
------------ ------------
Total current assets .......................................... 46,352,504 50,227,391
Property and equipment, at cost, net of accumulated depreciation ........ 2,169,156 951,702
Goodwill and identifiable intangibles, net .............................. 2,619,707 1,362,407
Deferred income taxes ................................................... 49,626 147,084
Other long-term assets .................................................. -- 54,000
------------ ------------
Total assets .................................................. $ 51,190,993 $ 52,742,584
============ ============
LIABILITIES
Current liabilities:
Accounts payable ..................................................... $ 2,197,458 $ 3,928,418
Accrued expenses ..................................................... 4,457,644 4,098,921
Due to related parties ............................................... 353,307 469,935
Income taxes payable ................................................. -- 1,672,953
------------ ------------
Total current liabilities ..................................... 7,008,409 10,170,227
Deferred income taxes ................................................... 89,559 --
------------ ------------
Total liabilities ............................................. 7,097,968 10,170,227
------------ ------------
Commitments and contingencies (Note 11)
Minority interest ....................................................... 307,017 159,651
------------ ------------
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
14,216,729 shares and 14,290,491 shares in 2002 and 2001, respectively 14,215 14,289
Common stock issuable--$.001 par value; 78,347 shares ................... 485,758 --
Additional paid-in capital .............................................. 41,692,066 41,395,784
Retained earnings ....................................................... 5,948,160 3,206,770
Accumulated other comprehensive income .................................. 33,056 72,577
Common stock held in treasury, at cost, 1,509,428 and 961,403
shares in 2002 and 2001, respectively ................................ (4,387,247) (2,276,714)
------------ ------------
Total shareholders' equity .................................... 43,786,008 42,412,706
------------ ------------
Total liabilities and shareholders' equity .................... $ 51,190,993 $ 52,742,584
============ ============
See accompanying notes to consolidated financial statements
F-2
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED NOVEMBER 30, 2002, 2001 AND 2000
2002 2001 2000
------------ ------------ ------------
Net revenue ....................................... $ 44,042,925 $ 32,209,410 $ 26,611,863
Cost of sales ..................................... 12,243,635 9,152,462 9,057,027
------------ ------------ ------------
Gross profit ................................. 31,799,290 23,056,948 17,554,836
Selling expenses .................................. 11,472,688 4,437,273 1,471,695
General and administrative expenses ............... 15,251,422 11,262,556 10,090,945
Bad debt expense .................................. 647,875 1,083,826 517,903
------------ ------------ ------------
Income from operations ....................... 4,427,305 6,273,293 5,474,293
Other income (expense):
Interest expense ............................... (101,385) (5,900) (286,655)
Interest income and dividends .................. 783,143 1,780,546 2,646,622
Realized gains on marketable securities ........ 76,607 387,948 863,384
Permanent impairment charges ................... -- (4,690,258) (2,139,315)
Gain on nonmonetary cost basis exchange ........ -- -- 565,572
Other non-operating income (expense) ........... (254,670) 16,699 1,354,723
Minority interest in (income) loss of subsidiary (402,716) (69,629) 140,000
------------ ------------ ------------
Income before provision for income taxes ..... 4,528,284 3,692,699 8,618,624
Provision for income taxes ........................ 1,786,894 3,275,200 3,471,754
------------ ------------ ------------
Net income ................................... $ 2,741,390 $ 417,499 $ 5,146,870
============ ============ ============
Basic earnings per share (Note 12):
Net income ..................................... $ 0.21 $ 0.03 $ 0.35
------------ ------------ ------------
Weighted average shares outstanding ............ 13,350,794 14,794,159 14,792,734
============ ============ ============
Diluted earnings per share (Note 12):
Net income ..................................... $ 0.19 $ 0.03 $ 0.33
------------ ------------ ------------
Weighted average shares outstanding ............ 14,247,450 15,396,619 15,494,663
============ ============ ============
See accompanying notes to consolidated financial statements
F-3
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED NOVEMBER 30, 2002, 2001 AND 2000
COMMON STOCK COMMON ADDITIONAL TREASURY STOCK
--------------------- STOCK PAID-IN RETAINED ------------------------
SHARES AMOUNTS ISSUABLE CAPITAL EARNINGS SHARES AMOUNT
---------- -------- -------- ------------ ----------- --------- ------------
BALANCE, NOVEMBER 30, 1999 .......... 15,469,590 $ 15,469 $ 37,482,479 $ 3,544,568 942,853 $ (2,201,900)
Net income for the year ............. 5,146,870
Unrealized (losses) on
available-for-sale securities .....
Comprehensive income (loss) .....
Stock option exercises .............. 211,526 211 408,479
Tax benefit from exercise of
stock options ..................... 448,880
Common stock issued in connection
with long-term investment ......... 229,862 230 1,615,976
Purchase and retirement of
common stock ...................... (229,862) (230) (746,822)
---------- -------- ------------ ----------- --------- ------------
BALANCE, NOVEMBER 30, 2000 .......... 15,681,116 15,680 -- 39,208,992 8,691,438 942,853 (2,201,900)
Net income for the year ............. 417,499
Realized losses on
available-for-sale securities .....
Comprehensive income (loss) .....
Stock option exercises .............. 273,132 273 480,633
Tax benefit from exercise of
stock options ..................... 240,265
Compensation expense
related to options ................ 116,218
Common stock issued in connection
with acquisition of minority
interest .......................... 336,243 336 1,445,509
Purchase of common stock, held in
treasury, at cost ................. 18,550 (74,814)
Purchase and retirement of
common stock ...................... (2,000,000) (2,000) (95,833) (5,902,167)
---------- -------- ------------ ----------- --------- ------------
BALANCE, NOVEMBER 30, 2001 .......... 14,290,491 14,289 -- 41,395,784 3,206,770 961,403 (2,276,714)
Net income for the year ............. 2,741,390
Unrealized losses on
available-for-sale securities .....
Foreign Currency
Translation adjustment ............
Comprehensive income (loss) .......
Stock option exercises .............. 554,270 554 1,224,143
Tax benefit from exercise of
stock options ..................... 171,909
Common stock issued in
connection with acquisition ....... 39,174 39 242,840
Net proceeds on non-management
trading gain disgorgement ......... 114,402
Common stock issuable in
connection with acquisition ....... 485,758
Purchase of common stock,
held in treasury, at cost ......... 548,025 (2,110,533)
Purchase and retirement of .......... --
common stock ...................... (667,206) (667) (1,457,012) --
---------- -------- -------- ------------ ----------- --------- ------------
BALANCE, NOVEMBER 30, 2002 .......... 14,216,729 $ 14,215 $485,758 $ 41,692,066 $ 5,948,160 1,509,428 $ (4,387,247)
========== ======== ======== ============ =========== ========= ============
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE SHARE-
(LOSS) HOLDERS'
INCOME EQUITY
------------- ------------
BALANCE, NOVEMBER 30, 1999 .......... $ 1,045,662 $ 39,886,278
Net income for the year ............. 5,146,870
Unrealized (losses) on
available-for-sale securities ..... (5,431,312) (5,431,312)
------------
Comprehensive income (loss) ..... (284,442)
------------
Stock option exercises .............. 408,690
Tax benefit from exercise of
stock options ..................... 448,880
Common stock issued in connection
with long-term investment ......... 1,616,206
Purchase and retirement of
common stock ...................... (747,052)
----------- ------------
BALANCE, NOVEMBER 30, 2000 .......... (4,385,650) 41,328,560
Net income for the year ............. 417,499
Realized losses on
available-for-sale securities ..... 4,458,227 4,458,227
------------
Comprehensive income (loss) ..... 4,875,726
------------
Stock option exercises .............. 480,906
Tax benefit from exercise of
stock options ..................... 240,265
Compensation expense
related to options ................ 116,218
Common stock issued in connection
with acquisition of minority
interest .......................... 1,445,845
Purchase of common stock, held in
treasury, at cost ................. (74,814)
Purchase and retirement of
common stock ...................... (6,000,000)
----------- ------------
BALANCE, NOVEMBER 30, 2001 .......... 72,577 42,412,706
Net income for the year ............. 2,741,390
Unrealized losses on
available-for-sale securities ..... (40,692) (40,692)
Foreign Currency
Translation adjustment ............ 1,171 1,171
------------
Comprehensive income (loss) ....... 2,701,869
------------
Stock option exercises .............. 1,224,697
Tax benefit from exercise of
stock options ..................... 171,909
Common stock issued in
connection with acquisition ....... 242,879
Net proceeds on non-management
trading gain disgorgement ......... 114,402
Common stock issuable in
connection with acquisition ....... 485,758
Purchase of common stock,
held in treasury, at cost ......... (2,110,533)
Purchase and retirement of ..........
common stock ...................... (1,457,679)
----------- ------------
BALANCE, NOVEMBER 30, 2002 .......... $ 33,056 $ 43,786,008
=========== ============
See accompanying notes to consolidated financial statements
F-4
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED NOVEMBER 30, 2002, 2001 AND 2000
2002 2001 2000
------------- ------------- -------------
Cash flows from operating activities:
Net income ................................................................... $ 2,741,390 $ 417,499 $ 5,146,870
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .............................................. 1,173,123 389,404 263,669
Reserve for customer chargebacks ........................................... -- (1,223,562) (3,393,068)
Provision for uncollectible accounts ....................................... 647,875 1,083,826 517,903
Deferred income taxes ...................................................... 1,905,011 (1,282,347) 653,809
Compensation expense related to stock options .............................. -- 116,218 --
Net gains on sale of marketable securities ................................. (76,607) (390,560) (863,384)
Gain on nonmonetary cost basis exchange .................................... -- -- (565,572)
Permanent impairment charges ............................................... 54,000 4,750,258 2,139,315
Equity in net losses of joint ventures ..................................... -- -- 11,952
Amortized discounts and premiums on marketable securities .................. (54,808) (362,359) (330,843)
Minority interest .......................................................... 402,716 134,649 (140,000)
Changes in assets and liabilities of business:
Accounts receivable ...................................................... 1,327,939 (4,666,714) 1,450,920
Due from related parties ................................................. 49,106 361,223 121,283
Prepaid expenses and other current assets ................................ 277,474 98,939 (826,461)
Accounts payable ......................................................... (1,730,960) 1,837,087 297,700
Income taxes prepaid/payable ............................................. (2,696,851) (1,521,776) (281,229)
Due to related parties ................................................... (116,628) (976,684) 1,078,443
Other, principally accrued expenses ...................................... 158,724 1,484,397 (2,935,830)
------------- ------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES .............................. 4,061,504 249,498 2,345,477
------------- ------------- -------------
Cash flows from investing activities:
Purchases of securities ...................................................... (177,342,682) (225,810,152) (333,623,263)
Proceeds from sales of securities ............................................ 186,861,999 241,829,982 329,205,886
Capital expenditures ......................................................... (1,873,743) (719,709) (225,410)
Distributions to minority interest ........................................... (255,350)
Payments for asset acquisitions, net of cash received ........................ (545,500) -- --
Purchases of long-term investments ........................................... -- (49,000) (892,551)
------------- ------------- -------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES .................... 6,844,724 15,251,121 (5,535,338)
------------- ------------- -------------
Cash flows from financing activities:
Purchases of common stock .................................................... (3,568,212) (6,074,814) (747,052)
Capital contribution from minority interest .................................. -- -- 140,000
Proceeds from stock options exercised ........................................ 1,224,697 480,906 408,690
Proceeds-net on settled nonmanagement Section 16-b action .................... 114,402 -- --
------------- ------------- -------------
NET CASH USED IN FINANCING ACTIVITIES .................................. (2,229,113) (5,593,908) (198,362)
------------- ------------- -------------
Effect of exchange rate changes on cash and cash equivalents ................. 1,171 -- --
Net increase (decrease) in cash and cash equivalents ......................... 8,678,286 9,906,711 (3,388,223)
Cash and cash equivalents, beginning of year ................................. 14,458,055 4,551,344 7,939,567
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF YEAR ....................................... $ 23,136,341 $ 14,458,055 $ 4,551,344
============= ============= =============
Supplemental disclosures:
Cash paid during the year for:
Interest ................................................................... $ 368,345 $ -- $ --
Income tax payments net of refunds ......................................... $ 2,997,160 6,079,114 3,065,105
Noncash investing activities:
During the fiscal year ended November 30, 2002, the Company has 117,521 shares of its common stock, issued and issuable, valued
at $728,636, in connection with the purchase of the assets of a closely held, private company (See note 1)
During the fiscal year ended November 30, 2001, the Company issued 336,243 shares of its common stock, valued at $1,445,845, in
connection with the purchase of a minority interest (See note 6).
During the fiscal year ended November 30, 2000, the Company issued 229,862 shares of its common stock, valued at$1,616,206, in
connection with the purchase of a long-term investment (See note 6).
Details of Acquisitions (Note 1): ............................................... InfiKnowledge ThanksMuch Combined
------------- ------------- -------------
Fair value of assets acquired ................................................ $ 1,379,975 $ 559,924 $ 1,939,899
Liabilities assumed .......................................................... (388,838) (124,924) (513,762)
Stock issued ................................................................. (242,879) -- (242,879)
Stock issuable ............................................................... (485,758) -- (485,758)
------------- ------------- -------------
Cash paid ................................................................ 262,500 435,000 697,500
Less: cash acquired ........................................................ (77,767) (74,233) (152,000)
------------- ------------- -------------
Net cash paid for acquisitions ........................................... $ 184,733 $ 360,767 $ 545,500
============= ============= =============
See accompanying notes to consolidated financial statements
F-5
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Traffix, Inc. and its consolidated subsidiaries (collectively, "Traffix" or
the "Company", formerly known as Quintel Communications, Inc.) provide consumer
targeted direct marketing and customer acquisition services for businesses. The
Company utilizes its proprietary and affiliate on-line databases to generate its
revenue from direct marketing activities delivered by the Internet. The
Company's on-line databases grow through on-line marketing and data acquisition
programs. The Company's direct marketing activities have historically been
divided into three principle operating segments: a) E-commerce, b) Off-line
Marketing Services, and c) LEC Billed Products and Services, with (c)
principally inactive during the fiscal year ended November 30, 2002. In fiscal
2000, the Company changed its name to Traffix, Inc. This name change was made to
better reflect the Company's business of generating and directing on-line
consumer traffic for businesses. The Company's main focus and business strategy
is to create compelling content as marketing vehicles that generate revenue for
its corporate advertisers and marketing affiliates who seek access to the
Company's databases, and the databases of its affiliates under management. Prior
to December 1, 1999, the Company had relied exclusively on conventional
("off-line") marketing channels, specifically television broadcast media,
telemarketing, direct-mail, and print advertising to facilitate its consumer
targeted direct marketing activities.
Our expansion in, and dependence on, our on-line direct marketing efforts,
coupled with the potential for state and/or federal legislation limiting on-line
marketing's consumer contact capability and the potential for seasonality within
the E-commerce marketplace, should all be considered when referring to our
current fiscal year's results, as well as prior year's historical results, in
evaluating the potential for our future operations, cash flows, and financial
position.
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
It is the Company's policy to prepare its financial statements on the
accrual basis of accounting in conformity with accounting principles generally
accepted in the United States of America.
The consolidated financial statements of the Company include the accounts
of its wholly-owned and majority-owned subsidiaries. Any losses allocated to
minority interests are limited to contributed minority interest capital. The
Company's other investments (classified in the "Other long-term assets"
financial caption, See Note 6) that are accounted for under the equity method,
are immaterial, with the majority of its investments valued under the cost
method of accounting. Such cost method investments represent ownership interests
of less than 20%, with the absence of control and significant influence over
such investments. All significant intercompany accounts and transactions have
been eliminated in consolidation. Certain amounts for prior periods have been
reclassified to conform to current year presentations.
ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires the
Company's management 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 the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from those estimates. The Company's most significant estimates relate to the
accruals for fulfillment redemptions, reserves for uncollectible receivables,
data qualification allowances, recoverability of long-lived assets, and the
realizability of deferred tax assets. Additionally, the Company has potential
exposure resulting from pending and/or threatened litigation for which the
Company currently assesses no risk and does not provide for loss, as well as the
potential for future actions naming the Company as defendant in future fiscal
periods.
F-6
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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., do you need a new credit card?), (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 and purchases a product with a credit card), (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 Traffix' proprietary products and
services directly to consumers (e.g., jewelry, dvds, books, etc.), (7) rentals
and sales of copies of specific segments of our 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 a qualified mortgage banking establishment.
The Company invoices its customers in accordance with the terms of each
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. The Company records all related obligations associated with the
related net revenue at its point of recognition. The obligations, previously
mentioned, include costs payable to other on-line, as well as off-line,
advertisers for registered user acquisitions, fee sharing costs under database
management agreements, email delivery costs, contingent based prize
indemnification coverage (for potential free on-line lottery winners) and all
other variable costs directly associated with completing the Company's
obligations relative to the revenue recognized. Such revenue recognition is also
subject to provisions based on the probability of collection. In certain cases,
the Company receives advances prior to fulfilling its obligations. Such advances
are deferred until the obligation is fulfilled. At November 30, 2002, the
Company's accrued expenses included approximately $729,000 of advances from
customers relating to such receipts; at November 30, 2001, advances from
customers included in accrued expenses was approximately $632,000. 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.
Revenues from the Company's off-line marketing services segment currently
include the revenue earned by Montvale Management, LLC, the Company's
majority-owned subsidiary. Such revenues are currently 14% of the Company's
consolidated net revenues for the year ended November 30, 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 its commission upon the closing of the
loan, with a provision for recessions, where appropriate.
F-7
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Prior to September 1, 2001, revenues from the Company's off-line marketing
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
redemption rates, and actual fulfillment 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
redemptions rates, augmented by 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. At November
30, 2002 and 2001, accrued expenses, applicable to such E-commerce fulfillment
liability, included $629,000 and $158,000 of such costs, respectively. Any
variance in the initial accrual as compared to the actual experience is taken
into operations in the period that the variance is determinable. See Note 15,
"Quarterly Results of Operations (Unaudited)."
Revenue from the Company's LEC Billed Product and Service segment (the
Company has not marketed such services since November 1998, but had recorded
residual revenue from such segment during the years ended November 30, 2001 and
2000), consisted of various enhanced telephone services, principally voicemail
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 year ended November 30, 2002. On December 11, 2001, Federal TransTel,
Inc. ("FTT"), the Company's sole operating service bureau for billing and
collecting on the LEC segment activity, filed for bankruptcy protection under
Chapter 11 of the United States Bankruptcy Code. In response to FTT's bankruptcy
filing the Company, as at November 30, 2001, netted its chargeback liability
from FTT against its gross receivable from such company, resulting in an
approximate $826,000 bad debt charge in fiscal 2001.
During the fiscal year ended November 30, 2000, based on the fact that a
significant portion of previously offered LEC segment services had reached their
contractual settlement phase, it was determined that certain chargeback reserves
were no longer necessary, and approximately $1.8 million was credited to income
for the year ended November 30, 2000. During the fiscal year ended November 30,
2001, approximately $148,000 of such reserves were credited to income; in the
current fiscal year, similar adjustments were immaterial in amount.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration
of credit risk have historically consisted of cash and cash equivalents,
marketable securities and accounts receivable. Currently the Company invests the
majority of its excess cash in high-grade commercial paper, with maturities
ranging from three months to two years. Consistent with the above, the Company
has historically invested a portion of its excess cash in debt instruments and
has maintained guidelines relative to diversification yielding safety and
liquidity; the bulk of such funds (approximately $13 million at November 30,
2002) are professionally managed by a major investment bank pursuant to
guidelines established by the Company's Board of Directors.
During the prior fiscal years ended November 30, 2000 and 1999, the Company
had invested approximately $1.9 and $3.9 million, respectively, at cost, in
equity-based marketable securities, with a significant concentration in the
Internet industry. Such investments were made pursuant to the potentially
significant synergistic ben-
F-8
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
efits to the Company's operations resulting from associated marketing agreements
executed at the time of the, Internet industry based, equity security purchases.
During the prior fiscal year ended November 30, 2001, the Company recognized
losses (through a permanent impairment charge) of $4,190,207 on the cost basis
investments noted above. The impairment charge and subsequent disposition of
these securities eliminated their related credit risk as of November 30, 2001.
At November 30, 2000, the related cost basis of these securities amounted to
approximately $5.6 million (See Note 6).
Cash and cash equivalent balances are principally held at four financial
institutions and may, at times, exceed insurable amounts. The Company believes
it mitigates its risks by investing in or through major financial institutions.
Recoverability is dependent upon the performance of the institutions.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable consist of trade accounts receivable from the Company's
customer base, with extension of credit varying between 30 to 60 days, with the
majority at 30 days. The Company's customer base is comprised of domestic
entities with diverse demographics. The allowance for doubtful accounts is based
on management's evaluation of the collectibility of receivables after giving
consideration to current delinquency data, historical loss experience and
general economic conditions, both at the Company level and sector/industry
level. The accounts receivable balances are continually reviewed by management
and when situations dictate, provisions for losses are recorded. Additional
allowances might be required if the original estimates for loss prove to be
inadequate.
MARKETABLE SECURITIES AND LONG-TERM INVESTMENTS, AT COST
The Company's Long-term investments, at cost, have historically included
investment interests of less than 20% in private companies without a readily
determinable market value. At November 30, 2002, the Company does not hold any
Long-term investments. If circumstances indicated that the carrying value of
such investments is less than their recoverable value, the Company assesses the
need to record an impairment loss. Key criteria that the Company considers in
its evaluation of potential impairment events include, but are not limited to:
the underlying investment's failure to meet its operating projections; failure
of the investment to raise additional capital or acquire debt financing; failure
to obtain and/or maintain key employees or acquire, or maintain, a specific
market share; and the failure of the investments to achieve initial short-term
goals as defined in their business plans.
TRANSACTIONS WITH MAJOR CUSTOMERS
During the year ended November 30, 2002, the Company had five major
customers in its E-commerce segment, which in combination accounted for
approximately $22 million of consolidated net revenue, respectively, or 50% of
consolidated net revenues. Approximately $3.4 million, or 68.2% of consolidated
net accounts receivable was attributable to such major customer group as of
November 30, 2002. The five major customers referenced above accounted for
21.5%, 8.5%, 7.9%, 7.5% and 4.5% of consolidated net revenue, respectively, for
the year ended November 30, 2002. Of the remaining approximate 100 active
customers in the year ended November 30, 2002, no other single customer had net
revenue that equaled or exceeded 2.7% of consolidated net revenue.
The Company continued to conduct business with these major customers as of
January 28, 2003, with the exception of the customer, which accounted for over
21.5% of the Company's net revenue for the year ended November 30, 2002. This
customer had notified the Company in September 2002, that it was exercising its
right to terminate the relationship in accordance with the terms of the
underlying agreement, and as such has phased out its business with the Company
during the ninety-day period ending December 7, 2002.
F-9
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During the year ended November 30, 2001, the Company had six major
customers, five within its E-commerce segment and one within its Off-line
Marketing Services segment, which, in the aggregate, accounted for approximately
54.9% of consolidated net revenues during the year ended November 30, 2001, and
approximately 69.1% of consolidated net accounts receivable as of November 30,
2001.
CASH AND CASH EQUIVALENTS
All short-term investments with an original maturity of three months or
less are considered to be cash equivalents.
MARKETABLE SECURITIES
The Company's marketable securities have historically consisted of
corporate commercial paper, auction rate securities, equity securities and real
estate investment trusts ("REITs"), all of which are held for varying and
indefinite periods of time, pursuant to maturity dates, market conditions and
other factors. It is the Company's intent to maintain a liquid portfolio to take
advantage of investment opportunities; therefore, all marketable securities are
considered to be available-for-sale and are classified as current assets.
Accordingly, such securities are stated at fair value, with unrealized gains and
losses, net of estimated tax effects, included in other comprehensive income
(loss) as a separate component of shareholders' equity, until realized. Actual
sales of securities resulting in realized gains and losses on marketable
securities are included in the statement of operations, as a component of "Other
income (expense)" and are derived using the specific identification method for
determining the cost of securities.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated using the
straight-line method over a three to five year useful life depending on the
nature of the asset. Leasehold improvements are amortized over the life of the
improvement or the term of the lease, whichever is shorter. Expenditures for
maintenance and repairs are expensed as incurred while renewals and betterments
are capitalized.
Upon retirement or disposal, the asset cost and related accumulated
depreciation and amortization are eliminated from the respective accounts and
the resulting gain or loss, if any, is included in the results of operations for
the period.
GOODWILL AND OTHER IDENTIFIABLE INTANGIBLES
Goodwill and other identifiable intangibles represent the excess of
purchase price over the fair value of minority interest in GroupLotto, Inc. a
wholly owned subsidiary. The aggregate amount of such cost was $1,445,845, which
will be amortized on a straight-line basis over five years. Amortization expense
was approximately $533,000 and $108,000, in the fiscal year's ended November 30,
2002 and 2001, respectively.
Also included in Goodwill and other identifiable intangibles are the
current years asset acquisitions of $1,499,512 (see notes 1 and 4).
LONG-LIVED ASSETS
If events or changes in circumstances indicate that the carrying amount of
a long-lived asset may not be recoverable, the Company estimates: (a) the future
cash flows expected to result from the use of such asset over its remaining
useful life and (b) the potential cash flows realizable from its possible
disposition. If the sum of the
F-10
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
expected future cash flows (undiscounted and without interest charges) is less
than the carrying amount of the long-lived asset, an impairment loss is measured
as a difference between carrying amount and the future discounted cash flows
(See Notes 1, 4, 5 and 6).
INCOME TAXES
Deferred tax assets and liabilities are based on the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Deferred tax assets and liabilities are determined based on the
difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are provided against
deferred tax assets, which are not likely to be realized (see Note 8).
ADVERTISING AND MARKETING EXPENSES
The Company's advertising and marketing costs, incurred in the advertising
and marketing of the products, services and promotional offers of its marketing
clients, are comprised of (1) costs associated with the transmission of email
marketing messages, both from internal sources and external third party vendors,
(2) costs associated with on-line customer acquisition data, (3) costs
associated with the fulfillment obligations relating to premiums offered in
conjunction with the Company's promotions, and (4) 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 customer
acquisition data, (3) at the time the premium obligation related revenue is
recorded, and (4) at the time the promotional and creative services are
provided, respectively, and are included as a component of cost of sales.
Total advertising and marketing expenses by segment for fiscal 2002, 2001
and 2000 were as follows:
CONSOLIDATED ADVERTISING AND MARKET COSTS
YEAR ENDED NOVEMBER 30,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
E-commerce ........................ $11,278,745 $ 7,519,511 $ 5,611,762
Off-line Marketing Services ....... 619,331 1,194,026 3,010,215
----------- ----------- -----------
Consolidated totals ......... $11,898,076 $ 8,713,537 $ 8,621,977
=========== =========== ===========
COMPREHENSIVE INCOME (LOSS)
The Company presents unrealized gains and losses on its marketable
securities as a component of "Comprehensive income (loss)" and are presented
below:
YEAR ENDED NOVEMBER 30,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
Net income .......................................... $ 2,741,390 $ 417,499 $ 5,146,870
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment ............. 1,171 -- --
Unrealized gain (loss) from available-for-sale
securities, net of income taxes of, $0 for 2002,
$0 for 2001 and $0 for 2000 .................... (40,692) 614,561 (5,431,312)
Less: reclassification adjustment for losses
realized in net income ......................... -- 4,188,957 --
Add: reclassification adjustment for gains
realized in net income ......................... -- (345,291) --
----------- ----------- -----------
Comprehensive income (loss) ............. $ 2,701,869 $ 4,875,726 $ (284,442)
=========== =========== ===========
F-11
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. The Company's three principle operating
segments are: a) E-commerce, b) Off-line Marketing Services, and c) LEC Billed
Products and Services, with the related segment disclosure information presented
in Note 14.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets." 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 nonamortization
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 August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS 143 sets forth the guidelines regarding the
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and any costs associated with the
related assets' retirement. The provisions of SFAS 143 will be effective for our
fiscal year ending November 30, 2003. Based on the relative components of our
balance sheet at November 30, 2002 we believe that the adoption of SFAS 143 will
have an immaterial impact on the Company's consolidated financial position and
results of operations, if any effect at all.
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 criteria 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 November 30, 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.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB No. 13, and Technical Corrections". SFAS 145
promulgates rules regarding the financial accounting and reporting requirements,
which include gains and losses resulting from the extinguishments of debt and
the treatment of sale-leaseback transactions. The provisions of SFAS 145 will be
effective for our fiscal year ending November 30, 2003. Based on the relative
components of our balance sheet at November 30, 2002 we believe that the
adoption of SFAS 145 will have an immaterial impact on the Company's
consolidated financial position and results of operations, if any effect at all.
F-12
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS 146 promulgates rules
regarding exit or disposal activities that are initiated after December 31,
2002. SFAS 146 requires companies to recognize costs associated with the exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan and nullifies the requirements under the
"Emerging Issues Task Force No. 94-3", "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs in a Restructuring)". The Company believes that the adoption of
SFAS 146 will have an immaterial impact on the Company's consolidated financial
position and results of operations, if any effect at all.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). This Interpretation requires
that upon issuance of a guarantee, a guarantor must recognize a liability for
the fair market value of an obligation assumed under the guarantee. Disclosures
by the guarantor in its interim and quarterly financial statements about
obligations associated with guarantees issued are also required by FIN 45. The
recognition requirements of FIN 45 are effective for guarantees that are issued
after December31, 2002. The Company feels that the adoption of this
Interpretation will have little, if any, effect on the Company's consolidated
financial position and results of operations.
In October 2002, Statement of Financial Accounting Standards No. 147
"Acquisitions of Certain Financial Institutions ("FAS 147") was issued. The
statement addresses the financial accounting and reporting for the acquisition
of all or a part of a financial institution. Additionally, FAS 147 also provides
guidance on the accounting for the impairment or disposal of acquired long-term
customer-relationship intangible assets. The provisions of this statement will
be effective for acquisitions on or after October 1, 2002. Based on our initial
review of FAS 147 we believe that its adoption will have no material impact on
either our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation -- Transition and Disclosure ("FAS 148"). This statement amends
SFAS No. 123 "Accounting for Stock Based Compensation", providing alternative
methods of voluntarily transitioning to the fair value based method of
accounting for stock-based employee compensation. FAS 148 also requires
disclosure of the method used to account for stock-based employee compensation
and the effect of the method in both annual and interim financial statements.
The provisions of this statement related to transition methods are effective for
fiscal years ending after December 15, 2002 while provisions related to
disclosure requirements are effective in financial reports for interim periods
beginning after December 31, 2002. The company believes that the adoption of
this statement will have an immaterial impact on the Company's consolidated
financial position and results of operation.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year balances in order to
conform to the current year presentation.
ASSET ACQUISITIONS
In December 2001, the Company acquired 100% of 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, possess the capa-
F-13
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bilities 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
management 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 November 30, 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
November 30, 2002. Goodwill and other intangible assets recognized in the
transactions amounted to $1,499,512, 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.
2. RELATED PARTY TRANSACTIONS
The Company incurred approximately $798,000, $745,000 and $630,000,
respectively, during fiscal 2002, 2001 and 2000, in legal fees to a firm having
a member who is also a director of the Company. The fees charged by such firm
were at rates comparable to rates obtainable from other firms for similar
services.
3. MARKETABLE SECURITIES
The carrying amount of the Company's marketable securities is shown in the
table below:
NOVEMBER 30,
-------------------------------------------------------
2002 2001
-------------------------- --------------------------
COST MARKET VALUE COST MARKET VALUE
----------- ------------ ----------- ------------
Available-for-sale securities:
Equity securities ......... $ 1,067,522 $ 1,099,406 $ 759,730 $ 812,999
Corporate commercial paper 13,150,000 13,150,000 22,845,692 22,865,000
----------- ----------- ----------- -----------
Total ............ $14,217,522 $14,249,406 $23,605,422 $23,677,999
=========== =========== =========== ===========
Marketable securities shown in the above table are carried at historical
cost, net of unamortized discounts of $0 and $54,308 as at November 30, 2002 and
2001, respectively, and stated at fair value; the cost basis of marketable
securities with scheduled maturities within one year were $13,150,000 and
$22,845,692 for fiscal 2002 and fiscal 2001, respectively.
F-14
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Proceeds, realized gains and realized losses from sales of securities
classified as available-for-sale for fiscal year 2002, 2001 and 2000 consisted
of the following:
2002 2001 2000
------------ ------------ ------------
Proceeds from sales of securities $186,861,999 $241,829,982 $329,205,886
Gross realized gains ............ 103,729 412,115 943,143
Gross realized losses ........... (27,122) (24,168) (79,759)
4. GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows:
AS OF NOVEMBER 30, 2002 AS OF NOVEMBER 30, 2001
------------------------- -------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
---------- ------------ ---------- ------------
Amortized intangible assets:
GroupLotto identifiable intangibles $1,445,845 $ 407,246 $1,445,845 $ 108,438
Montvale identifiable intangibles . -- -- 25,000 --
Infiknowledge identifiable
intangibles .................... 502,047 98,104 -- --
Thanksmuch identifiable
intangibles .................... 60,000 13,850 -- --
Marketing Right License Fee ....... 300,000 106,450 -- --
---------- ---------- ---------- ----------
Total amortizable intangible
assets ...................... $2,307,892 $ 625,650 $1,470,845 $ 108,438
========== ========== ========== ==========
Unamortized intangible assets:
Goodwill-- Infiknowledge .......... $ 647,729 $ --
Goodwill-- Thanksmuch ............. 289,736 --
---------- ----------
Total Goodwill ................. $ 937,465 $ --
========== ==========
The future intangible amortization expense for the next five fiscal years
is estimated to be as follows:
FISCAL YEAR ENDING NOVEMBER 30,
-------------------------------
2003 ...................................................... $595,128
2004 ...................................................... 401,578
2005 ...................................................... 401,578
2006 ...................................................... 281,651
2007 ...................................................... 2,305
The amortizable intangibles listed above are deemed to have a finite life
of five years from date of acquisition; the straight-line method of amortization
has been applied to such assets in calculating their respective amortization.
For the Infiknowledge acquisition indentifiable intangibles, amortization
expense has been recorded for the period December 6, 2001 (date of acquisition)
to November 30, 2002.
For the ThanksMuch acquisition indentifiable intangibles, amortization
expense has been recorded for the period December 14, 2001 (date of acquisition)
to November 30, 2002.
F-15
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For the GroupLotto acquisition indentifiable intangibles, amortization
expense has been recorded for the July 23, 2001 (date of acquisition) to
November 30, 2002.
For all of the above referenced acquisition based intangibles, there are no
contingencies for cash and/or shares, other than those described in Note 1 to
the financial statements.
5. PROPERTY AND EQUIPMENT
Property and equipment for the years ended November 30, 2002 and 2001
consists of the following:
2002 2001
---------- ----------
Furniture and fixtures ........................... $ 375,323 $ 173,929
Computers and equipment .......................... 3,379,468 1,760,543
Leasehold improvements ........................... 97,538 44,113
---------- ----------
3,852,329 1,978,585
Less, accumulated depreciation and amortization 1,683,173 1,026,883
---------- ----------
$2,169,156 $ 951,702
========== ==========
Depreciation and amortization expense for the years ended November 30,
2002, 2001 and 2000 was approximately $656,000, $281,000 and $264,000,
respectively.
6. MARKETABLE SECURITIES AND LONG-TERM INVESTMENTS, AT COST, AND PRIOR YEAR
ACQUISITIONS
The Company's Long-term investments, at cost, include investment interests
of less than 20% in private companies without a readily determinable market
value. If circumstances exist that indicate the carrying value of such
investments is less than their recoverable value, the Company assesses the need
to record an impairment loss. Key criteria that the Company considers in its
evaluation of potential impairment events include, but are not limited to: the
underlying investment's failure to meet its operating projections; failure of
the investment to raise additional capital or acquire debt financing; failure to
obtain and/or maintain key employees or acquire, or maintain, a specific market
share; and the failure of the investments to achieve initial short-term goals as
defined in their business plans.
PRIOR YEAR COMPLETED ACQUISITIONS
In Fiscal 2001, we acquired the minority interest in GroupLotto, Inc., a
majority owned subsidiary prior to such acquisition, for consideration of
$1,445,845. The consideration consisted of 336,243 shares of Traffix, Inc.
common stock issued on July 20, 2001, at a market value of $4.30 per share. The
transaction was accounted for under the purchase method, and, accordingly, the
results of operations of the acquired minority interest are included in our
consolidated results of operations from the date of acquisition.
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 review of such investment, and the investment's continued
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 prior
fiscal year's first quarter ended February 28, 2001 amounted to $500,051, and is
included as a component of other income (expense) "Permanent impairment charges"
for the year ended November 30, 2001. During the prior fiscal year's second
quarter ended May 31, 2001, this entity effectively wound down operations and
ceased doing business.
F-16
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During the fiscal year ended November 30, 1999, the Company had invested
$2,046,500 of cash into five private companies, carried under the cost method.
As of November 30, 2000, four of those five private companies had failed to
achieve their initial goals, as set forth in their business plans, and all four
of those companies had events that fell within our impairment evaluation
criteria. This portion of the Company's impairment loss amounted to $1,546,500,
and is included as a component of fiscal 2000's other income (expense)
"Permanent impairment charges."
The remaining investee, itarget.com, Inc. (which at that time was a
privately held company that specialized in on-line permission based e-mail
marketing and consumer data information services), was an entity in which the
Company had originally invested $500,000 in November 1999. In January 2000, the
Company increased its cost-based investment position through the issuance of its
common stock pursuant to a stock swap agreement. The agreement required that
229,862 Traffix common shares be issued in exchange for 42,372 newly issued
Series B, convertible preferred shares of itarget.com, Inc. The Traffix share
issuance increased the cost-based carrying value of the itarget.com investment
by $1,616,206. On March 29, 2000, itarget.com merged with Cybergold, Inc., (at
that time a public company that traded as Nasdaq:CGLD). Pursuant to the merger,
the Company received Cybergold, Inc. shares in exchange for its itarget.com,
Inc. shares. This merger event caused the previously classified long-term,
cost-based investment to be transferred to the available-for-sale marketable
security classification. In fiscal 2000, the Company recognized a nonmonetary,
pre-tax gain of approximately $566,000 on the new accounting basis of the
Cybergold, Inc. shares, which is included as a component other income (expense).
On April 17, 2000, MyPoints.com, Inc. (Nasdaq:MYPT) agreed to acquire Cybergold,
Inc. in a tax-free, stock-for-stock, fixed share transaction. The transaction
closed on August 7, 2000, whereby the Company received approximately 117,000
shares of MyPoints.com, Inc. in return for its Cybergold, Inc. shares in
accordance with the terms of the merger. During the prior fiscal year ended
November 30, 2001, the Company recognized a loss on the MyPoints.com, Inc.
shares (through a permanent impairment charge) of $2,553,778. This permanent
impairment was the result of the Company's evaluation of its marketable
securities, in terms of measuring risk at the individual company level coupled
with risk at the market level. As a result of this analysis, the Company
determined that the decline in the related security was "other than temporary"
and, in response to such determination, recorded the aforementioned impairment
charge. On June 4, 2001, an affiliate of UAL Corp. (NYSE:UAL) announced that it
intended to acquire all of the common stock of MyPoints.com, Inc. in a cash
tender offer of $2.60 a share. The Company tendered all of its MyPoints.com,
Inc. shares during the third quarter of the fiscal year ended November 30, 2001
and recorded an approximate $224,000 gain at that time.
During the year ended November 30, 2000, the Company expended an additional
$1,060,051 on cost-based investments. As at November 30, 2000, the Company had
evaluated those long-term investment purchases and recorded an impairment loss
of $327,500 against the carrying value of such investments, and included such
adjustment as a component of other income (expense) "Permanent impairment
charges" in that year.
7. ACCRUED EXPENSES
Accrued expenses are comprised of the following at:
NOVEMBER 30,
----------------------------
2002 2001
---------- ----------
Accrued payroll and bonuses ................ $ 983,909 $ 882,817
Advances from customers .................... 729,202 631,665
Accrued fee share liabilities .............. 805,632 609,596
Other ...................................... 1,938,901 1,974,843
---------- ----------
Total accrued liabilities ............... $4,457,644 $4,098,921
========== ==========
F-17
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. INCOME TAXES
The provision (credit) for income taxes consists of the following:
YEAR ENDED NOVEMBER 30,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
Current tax provision (credit):
U.S federal taxes ............... $ 75,262 $ 3,444,673 $ 2,191,023
Foreign taxes ................... 330,401 -- --
U.S. state tax .................. 286,173 (1,154,105) 774,953
----------- ----------- -----------
691,836 2,290,568 2,965,976
----------- ----------- -----------
Deferred tax provision (credit):
U.S federal taxes ............... 870,370 1,112,875 426,922
Foreign taxes ................... (49,626) -- --
U.S. state tax .................. 274,314 (128,243) 78,856
----------- ----------- -----------
1,095,058 984,632 505,778
----------- ----------- -----------
TOTAL PROVISION ........ $ 1,786,894 $ 3,275,200 $ 3,471,754
=========== =========== ===========
The following is a reconciliation of the income tax expense computed using
the statutory federal income tax rate to the actual income tax expense and its
effective income tax rate:
YEAR ENDED NOVEMBER 30,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
Income tax expense computed
at statutory rate ................... $ 1,539,617 $ 1,217,170 $ 2,930,332
State income taxes, net of federal
income tax benefit .................. 369,921 649,857 333,813
Foreign tax statutory rate over
U.S statutory rate .................. 56,276 -- --
Tax settlements ........................ (220,472) -- --
Capital losses generating no tax benefit -- 1,456,390 --
Change in valuation allowance .......... (66,647) (133,237) (200,000)
Nondeductible items .................... 108,199 85,020 407,609
----------- ----------- -----------
$ 1,786,894 $ 3,275,200 $ 3,471,754
=========== =========== ===========
F-18
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of net deferred tax assets are as follows:
NOVEMBER 30,
--------------------------
2002 2001
----------- -----------
Deferred tax assets:
Current:
Accrued expenses and reserves not currently
deductible ................................... $ 1,238,953 $ 2,432,670
Realized capital losses on marketable securities
and long term investments .................... 1,598,180 1,641,424
Valuation allowance on realized capital losses . (1,598,180) (1,641,424)
Intangibles .................................... 9,838 278,675
Foreign Income Tax Credit carryforward ......... 276,030 --
Net operating loss carryforward ................ -- 531,470
----------- -----------
Total current assets ....................... 1,524,821 3,242,815
----------- -----------
Non-current:
Accrued expenses and reserves not currently
deductible ................................... -- 40,677
Fixed assets-Canada ............................ 49,626
Fixed assets and intangibles ................... -- 44,000
State net operating losses ..................... -- 1,408,252
Valuation allowance ............................ -- (1,345,845)
----------- -----------
Total noncurrent assets .................... 49,626 147,084
----------- -----------
Total assets ............................... 1,574,447 3,389,899
----------- -----------
Deferred tax liabilities:
State net operating losses ..................... 1,384,849 --
Valuation allowance ............................ (1,322,442) --
Fixed assets and intangibles ................... (151,966) --
----------- -----------
Total noncurrent liabilities ............... (89,559) --
----------- -----------
Net deferred tax assets .................... $ 1,484,888 $ 3,389,899
=========== ===========
At November 30, 2002 and 2001, valuation allowances of $1,322,442 and
$1,345,845, respectively were established, primarily for state tax net operating
losses, which can not be carried back by statute, and have reduced the deferred
tax assets to an amount which the Company believes is more likely than not to be
realized.
During the year ended November 30, 2001, a valuation allowance of
$1,641,424 was established for realized capital losses. During the year ended
November 30, 2002, the Company recognized $43,244 in tax savings related to net
capital gains, which were not taxed, based on the realization of the tax benefit
of the prior year's capital loss valuation allowance. At November 30, 2002, the
capital loss deferred tax asset and related valuation allowance were reduced for
the current years tax benefit realized. At November 30, 2001 the Company did not
recognize the benefit of an immaterial prior year capital gain for purposes of
establishing carryback value, and the Company did not have specific appreciated
capital gain property to provide future carryforward value, therefore a full
valuation allowance was taken at November 30, 2001 to reduce the related
deferred tax assets to an amount which the Company believed was more likely than
not to be realized. At November 30, 2002 the balance of the tax deferred asset
relating to prior year's capital losses amounted to $1,598,980, with a
corresponding full valuation allowance of $1,598,980. Such capital losses expire
on November 30, 2006.
F-19
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has approximately $52.5 million of state net operating losses
expiring through 2015.
9. REGULATORY ISSUES AND OTHER RISK CONSIDERATIONS
Various state laws exist, and federal legislation is currently pending,
that limit the Company's ability to deliver commercial e-mail messages to
consumers. The Federal Trade Commission is convening a three-day workshop to
review commercial e-mail practices. There are presently no federal laws that
explicitly regulate sending unsolicited e-mail. The pending federal bills and
existing state laws require that certain "opt-out" procedures be included in
e-mails 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 e-mail 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. Over half the
states have enacted legislation affecting the sending of unsolicited commercial
e-mail. 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.
In November 2002, the Company received an inquiry from the Federal Trade
Commission questioning whether the Company needed to comply with the Graham
Leach Bliley Act (privacy of consumer information for financial institutions)
arising from Atlas Credit Group, one of the Company's Internet subsidiaries. The
Company responded by stating that the Company need not comply with the Graham
Leach Bliley Act because Atlas Credit Group utilizes advertising from other
financial institutions, but is not itself a financial institution as defined
under the statute. The Company has not received any further comments from the
Federal Trade Commission. ThanksMuch.com, LLC, another of the Company's Internet
subsidiaries, was served with a class action lawsuit in State Court in the
County of Los Angeles, California, for damages associated with allegedly
violating the State's Shipping and Handling laws. This suit was recently
settled. The settlement offers a $5.00 certificate to California consumers on
future purchases of ThanksMuch products and provides a small payment for
attorneys' fees.
The Pennsylvania Attorney General's Office had requested the Company to
enter into an Assurance of Voluntary Compliance Agreement to resolve allegations
concerning certain of the Company's sales practices. The Attorney General
alleged that the Company Fly Free telemarketing program, as well as certain
pay-per-call services, did not adequately disclose to the consumer the terms of
the offer being made. The Agreement also provides for a payment to the State in
an amount yet to be determined. Discussions with the Pennsylvania Attorney
General's Office are on-going.
Any changes in the Internet operating landscape that materially hinder the
Company's current ability and/or cost to deliver commercial e-mail messages to
the consumer records in the Company's databases, and the consumer records in the
databases of the Company's affiliates, could potentially cause a material impact
on net revenue and gross margin and, therefore, the Company's profitability and
cash flows could be adversely affected.
10. CESSATION OF 900 PAY-PER-CALL BUSINESS
In accordance with the Company's business strategy of separating itself
from the 900 Pay-Per-Call business which was reported as a component of LEC
Billed products and services (see Note 14), on June 4, 1999, the Company entered
into an agreement with ARS (the "ARS Agreement"), pursuant to which the Company
agreed to cease conducting, marketing, advertising or promoting certain "stand
alone" 900 Pay-Per-Call Psychic Services described in the ARS Agreement (the
"900 Psychic Services") directly or indirectly through any affil
F-20
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
iate, until January 17, 2001. ARS agreed to assume responsibility for the
employees and for the lease of the premises used by this business in Fort
Lauderdale, Florida, to acquire the computer equipment and other furniture,
fixtures and leasehold improvements used by this business.
In consideration for the Company's agreement to suspend the offering of the
900 Psychic Services, ARS agreed to pay to the Company certain royalty fees for
each billable minute generated by 900 Pay-Per-Call Psychic Services on ARS' 900
numbers and on ARS' billings to membership clubs from and after the consummation
of the transactions contemplated by the ARS Agreement and until January 17,
2001, all as more fully described in the ARS Agreement.
The ARS Agreement was effective as of May 31, 1999. During the fiscal years
ended November 30, 2001 and 2000, the Company has recorded royalty revenue under
the terms of the ARS Agreement amounting to $486,000 and $3.4 million,
respectively, all of which has been collected.
11. COMMITMENTS AND CONTINGENCIES
LEASES
The Company is obligated under a noncancelable real property operating
lease agreement that expires in fiscal 2006. Future minimum rents consist of the
following at November 30, 2002:
2003 ........................................................... $ 546,017
2004 ........................................................... 384,759
2005 ........................................................... 348,440
2006 ........................................................... 215,000
Thereafter ..................................................... --
----------
$1,494,216
==========
The lease contains escalation clauses with respect to real estate taxes and
related operating costs. The accompanying financial statements reflect rent
expense on a straight-line basis over the term of the lease as required by
accounting principles generally accepted in the United States of America. Rent
expense for all leases was $571,000, $352,000 and $279,000 for fiscal 2002, 2001
and 2000, respectively.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements, effective December 1,
2001, with certain executive officers of the Company. Such agreements expire on
November 30, 2004. Pursuant to the agreements said officers are entitled to an
annual increase of at least ten percent (10%) more than the annual rate in the
immediately preceding year; said officers will each receive bonuses upon the
Company's achievement of certain pre-tax income milestones, as well as
discretionary bonuses subject to approval of the Company's Board of Directors;
said officers were each issued options to acquire 105,000 shares of the
Company's Common Stock; said officers agreed not to compete or engage in a
business competitive with the business of the Company during the term of the
agreement and for a period of one year thereafter; if an officer/employee's
employment is terminated other than as a result of a "For Cause Event" (as
defined in the agreements), he shall be entitled to receive additional
compensation and other consideration, all as more fully described in the
agreements; and, if an employee's employment is terminated as a result of a
"Change in Control" (as defined in the agreements), he shall be entitled to
receive a one-time payment in an amount equal to 2.99 times his "base amount"
determined in accordance with the applicable provisions of the Internal Revenue
Code.
F-21
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LITIGATION
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 ET AL. (EDCV 01-790 (VAP-SGLx).
Plaintiff alleged that defendants were 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 damages from alleged infringement of a
copyright. Pursuant to a settlement with the defendants other than the Company,
the action was dismissed as against the Company, with prejudice and without any
cost to the Company.
MAVIES WINGLER
On or about May 9, 2001, Mavies Wingler commenced an action against Group
Lotto, Inc. ("GLI"), one of the Company's wholly-owned subsidiaries, 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. At the end of 2002, Ms. Wingler's
attorney withdrew, and she is now representing herself. 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. The Company does not believe that there is any
merit to Ms. Wingler's claim and intends to vigorously continue its defense
thereof.
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 e-mail
advertisements and through the website of GLI. In August 2002, the Company filed
a motion to dismiss the complaint. In January 2003, the court issued an order
dismissing the action. The plaintiff may file an appeal from the decision within
a specified 30-day period, which has not yet expired.
PLASMANET
On November 21, 2002, Plasmanet, Inc., one of the Company's competitors,
commenced an action alleging patent infringement and misappropriation of trade
secrets. PLASMANET, INC. V. APAX PARTNERS, INC., ET AL., Case No. 02 CIV 9290
(S.D.N.Y.). Plasmanet operates a website, FreeLotto.com, which is similar to one
operated by GLI. Plasmanet alleges that on September 24, 2002 it obtained a
patent for a "Free Remote Lottery System" and that the Company infringed said
patent. In addition, Plasmanet asserts that the Company misappropriated
Plasmanet's trade secrets after it was shown a private placement memorandum by
an agent of Plasmanet's investment banker. The complaint seeks injunctive relief
and unspecified money damages. The Company believes there is no merit to the
claims and intends to vigorously defend against them.
F-22
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
QWEST COMMUNICATIONS
Qwest Communications, Inc. has notified the Company of an indemnification
claim relating to a class action filed against Qwest in Minnesota. BINDNER V.
LCI INTERNATIONAL TELECOM CORP. ET AL., District Court of Minnesota, County of
Sibley, Case No. C0-00-242. Plaintiffs in that action claim that in late 1999
into mid-2000, they were misled when they were solicited to change their long
distance carrier to Qwest. They assert that they were not told that they would
have to stay at certain hotels and pay their regular rates as part of a
promotion, which offered them free airline tickets. The Company introduced the
promotion ("Fly Free America") to Qwest, and had been retained by Qwest to
operate the telemarketing campaign. Fraud claims in the class action have been
dismissed, leaving breach of contract and false advertising claims. An
application for class certification is now pending. The class could be as large
as 12,000 claimants.
In or about May 2000, the Company and Qwest entered into an agreement
terminating their contract and settling the amount due the Company (the "May
2000 Agreement"). The May 2000 Agreement contained language which Qwest claims
obligates the Company to indemnify Qwest for any loss it may sustain by reason
of this class action. The Company maintains that it has no liability in the
matter. In November 2002, the Company commenced an arbitration against Qwest to
recover certain moneys due it pursuant to the May 2000 Agreement. In December
2002, Qwest filed counterclaims in the arbitration relating to the Fly Free
America program. Qwest asserts that the Company must indemnify Qwest for, among
other things, fines and penalties amounting to approximately $1.5 million which
Qwest claims it paid in connection with a number of consent decrees it entered
into with various State Attorneys General, an unspecified amount of attorneys'
fees, and any and all expenses, penalties or other amounts Qwest becomes liable
for in connection with the class action. Qwest also seeks reimbursement of
approximately $3.1 million it paid the Company pursuant to the May 2000
Agreement. The Company believes that there is no merit to Qwest's counterclaims
and intends vigorously to defend against them, as well as to pursue its claim.
COLUMBIA HOUSE/RYDEL
In or about August 2002, Sony Music Entertainment, Inc., d/b/a Columbia
House, one of the Company's clients, notified the Company of an indemnification
claim relating to a class action filed against Columbia House, among others, in
Illinois. RYDEL V. COMTRAD INDUSTRIES, INC. ET AL., Circuit Court of Cook
County, Illinois, No. 02 CH 13269. Plaintiff claims to have received unsolicited
commercial e-mail from, among others, Columbia House, in violation of Illinois
law. Columbia House advised the Company that it believes that the email in
question was not approved by Columbia House when it was sent by the Company, and
asserted a claim for indemnification against the Company pursuant to their
contract. The Company and Columbia House agreed to defer resolution of the
indemnification claim (and reserved each of their respective rights). Columbia
House is defending against the class action and has filed a motion to dismiss
it. In or about January 2003, the Company was named as a defendant in the class
action. In an additional count in the complaint, the plaintiff asserts that the
Company violated the Illinois Consumer Fraud and Deceptive Business Practices
Act by providing to a co-defendant a list of consumers who had consented to
receive commercial e-mails when, the complaint alleges, they had not. The
complaint seeks injunctive relief and unspecified damages. The Company is
currently investigating the claim, and will timely respond to the complaint in
due course.
F-23
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SPRINT COMMUNICATIONS, TINA HARRISON, LISA WATTERS (UTAH CLAIMS)
Sprint Communications, one of the Company's former clients, has notified
the Company of an indemnification claim relating to a class action filed against
Sprint in Utah (GILLMAN V. SPRINT COMMUNICATIONS CO. L.P., District Court of
Utah, Third Judicial District Salt Lake City, Civil No. 020406640). Plaintiff
claims to have received unsolicited commercial e-mail in violation of Utah law.
Sprint has advised the Company that it is defending the action and has filed a
motion for summary judgment dismissing the claims. In addition, Sprint has
advised the Company that it has received a settlement demand for an amount which
is not material. In January 2003, the Company received notice of two additional
claims filed in Utah state court: WATTERS V. TRAFFIX, INC., MONGLYPH.COM, AND
PHILLIP C. WILSON AND JOHN DOES ONE THROUGH TEN, (No. 20413327); and HARRISON V.
TRAFFIX, INC. AND JOHN DOES ONE THROUGH TEN, (No. 20414190), District Court of
Utah, Third Judicial District Salt Lake County, Sandy Department. In each of
these actions, the plaintiff claims to represent a class of Utah residents who
received unsolicited commercial e-mail in violation of Utah law. The Company is
currently engaged in discussions to resolve these matters for an amount that
would not be material.
The Company is unable to determine the ultimate outcome of the foregoing
actions, and, accordingly, no provision has been recorded in the financial
statements as of November 30, 2002.
12. EARNINGS PER SHARE
The following table sets forth the reconciliation of the weighted average
shares used for basic and diluted earnings per share:
YEAR ENDED NOVEMBER 30,
------------------------------------
2002 2001 2000
---------- ---------- ----------
Denominator:
Denominator for basic earnings per
share -- weighted average shares ........... 13,350,794 14,794,159 14,792,734
Effect of dilutive securities:
Stock options .............................. 896,656 602,460 701,929
---------- ---------- ----------
Denominator for diluted earnings per share--
adjusted weighted average shares ......... 14,247,450 15,396,619 15,494,663
========== ========== ==========
Options to purchase 919,291, 661,250 and 515,896 shares of common stock
that were outstanding at November 30, 2002, 2001 and 2000, respectively, were
not included in the computation of diluted earnings per share because their
effect would be anti-dilutive. The vesting period of the options range from
immediate vesting, to three year, pro-rata vesting, in accordance with the terms
authorized by the option compensation committee.
F-24
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. STOCK OPTION PLAN AND WARRANTS
During fiscal 1995, the Company implemented the 1995 Stock Option Plan (the
"Stock Option Plan") effective as of October 1995. The Stock Option Plan
provides for the grant of options to purchase up to 750,000 shares of the
Company's common stock either as incentive stock options ("Incentive Stock
Options") within the meaning of Section 422 of the United States Internal
Revenue Code or as options that are not intended to meet the requirements of
such section ("Nonstatutory Stock Options"). Options to purchase shares may be
granted under the Stock Option Plan to persons who, in the case of Incentive
Stock Options, are employees (including officers) of the Company or, in the case
of Nonstatutory Stock Options, are employees (including officers), consultants
or nonemployee directors of the Company. The Stock Option Plan has been amended,
most recently in August 2002 to provide for the granting of options to purchase
additional shares of the Company's common stock. After these amendments, there
were a total of 5,350,000 grants made available to purchase the Company's common
stock under the Stock Option Plans.
The exercise price of options granted under the Stock Option Plan must be
at least equal to the fair market value of such shares on the date of grant or,
in the case of Incentive Stock Options granted to a holder of 10% or more of the
Company's Common Stock, at least 110% of the fair market value of such shares on
the date of grant. The maximum exercise period for which Incentive Stock Options
may be granted is ten years from the date of grant (five years in the case of an
individual owning more than 10% of the Company's common stock).
In addition, the Company's Stock Option Plan provides for certain automatic
grants of options to the Company's nonemployee directors in consideration for
their services performed as directors of the Company and for attendance at
meetings. It provides for a one-time automatic grant of an option to purchase
25,000 shares of common stock at market value to those directors who were
serving on the Board of Directors at the inception of the Stock Option Plan and
also to those persons who become nonemployee directors of the Company in the
future, upon their appointment or election as directors of the Company. In
addition, the amended Stock Option Plan provides for quarterly grants to each
nonemployee director of the Company of options to purchase 6,250 shares of the
Company's common stock at the market value on the date of each grant. The
Company granted 106,250, 187,500 and 81,250 options to the nonemployee directors
during fiscal 2002, 2001 and 2000, respectively.
A summary of the Company's stock options is as follows:
2002 2001 2000
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
Options outstanding,
beginning of year ...................... 2,566,958 $3.45 1,636,132 $3.80 1,301,864 $2.48
Granted .................................. 809,250 5.78 1,180,062 2.55 560,250 6.11
Exercised ................................ (554,270) 2.21 (239,517) 1.79 (211,526) 1.96
Cancelled or lapsed ...................... (48,853) 6.20 (9,719) 1.85 (14,456) 1.75
--------- ----- --------- ----- --------- -----
Options outstanding,
end of year ............................ 2,773,085 $4.40 2,566,958 $3.45 1,636,132 $3.80
========= ===== ========= ===== ========= =====
Options exercisable,
end of year ............................ 2,098,025 2,025,836 1,521,633
========= ========= =========
Options available for
grant, end of year ..................... 1,282,145 1,569,957 2,741,300
========= ========= =========
Weighted average fair value of
options granted during the year ........ $3.27 $2.55 $4.60
========= ========= =========
F-25
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized with regard
to options granted under the Plan in the accompanying financial statements. If
stock-based compensation costs had been recognized based on the estimated fair
values at the dates of grant for options awarded since 1996, the Company's net
income and earnings per share would have been as follows:
YEAR ENDED NOVEMBER 30,
------------------------------------
2002 2001 2000
---------- --------- ----------
Net income-- as reported ........ $2,741,390 $ 417,499 $5,146,870
Net income (loss)-- pro forma ... $1,694,502 $(565,967) $3,653,723
Basic EPS-- as reported ......... $ 0.21 $ 0.03 $ 0.35
Diluted EPS-- as reported ....... $ 0.19 $ 0.03 $ 0.33
Basic EPS-- pro forma ........... $ 0.13 $ (0.04) $ 0.25
Diluted EPS-- pro forma ......... $ 0.12 $ (0.04) $ 0.24
The weighted average fair value of each option has been estimated on the
date of grant using the Black-Scholes options pricing model with the following
weighted average assumptions used for all grants of: volatility of 71.5% in
2002, 80.0% in 2001 and 96.5% in 2000; risk-free interest rate ranging from
2.64% to 4.38% in 2002, 3.94% to 5.31% in 2001 and 5.87% to 6.53% in 2000; and
expected lives of approximately 4.0 to 4.8 years.
The following table summarizes information about stock options outstanding
at November 30, 2002:
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISABLE SHARES EXERCISABLE
EXERCISE PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- --------- ------------ ------
$ 1.50 -- $ 2.06 681,180 3.6 $ 1.87 622,512 $ 1.88
$ 2.28 -- $ 3.35 470,916 8.5 2.74 413,918 2.73
$ 3.65 -- $ 5.44 508,748 7.8 4.35 349,084 4.47
$ 5.69 -- $ 7.74 1,043,491 8.4 6.33 643,761 6.47
$ 9.00 -- $11.31 56,250 5.3 10.07 56,250 10.07
$15.56 -- $15.56 12,500 4.6 15.56 12,500 15.56
- ---------------- --------- --- ------ --------- ------
$ 1.50 -- $15.56 2,773,085 7.1 $ 4.40 2,098,025 $ 4.19
================ ========= === ====== ========= ======
As of November 30, 2000, there were 275,818 warrants outstanding to
purchase common stock at an exercise price of $8.25 per share. The warrants
expired in December 2000.
During fiscal 2002, 2001 and 2000, options for shares of the Company's
common stock were exercised by certain employees and directors. A tax benefit of
$171,909, $240,265 and $448,880 in fiscal 2002, 2001 and 2000, respectively,
were recorded as an increase to additional paid-in capital and a reduction of
income taxes currently payable.
During fiscal 2002, an officer/director of the Company exercised
approximately 336,000 options. Subsequent to such exercise, and less than six
months from said exercise, the Company repurchased the shares acquired under the
exercise from the officer/director. In accordance with Financial Interpretation
Number 44, paragraph 14(a), such repurchase required to Company to record a
compensation charge of approximately $281,000 in the fourth quarter of fiscal
2002.
During fiscal 2001, the vesting period of an employees stock option was
accelerated, such acceleration yielded an approximate $116,000 noncash charge to
operations.
F-26
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. SEGMENT INFORMATION
The Company's segments operate principally in the United States with a
presence in Canada; the Canadian presence contributed an immaterial amount to
consolidated net revenues and consolidated net income. The accounting policies
of the Company's segments are the same as those detailed in Note 1.
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 the Company's off-line
corporate customers, including long distance carriers, wireless carriers,
financial institutions 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 in fiscal 2002).
The balance of the Company's operations, individually immaterial 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 (a) gross
profit and (b) 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) permanent impairment charges to long-lived assets,
(vi) gains on nonmonetary cost basis exchanges, (vii) other nonoperating 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
nonintersegment sources; therefore no intersegment elimination applies.
Corporate assets of approximately $20.9 million at November 30, 2002,
consist principally of cash, cash equivalents and marketable securities.
SEGMENT DATA -- NET REVENUES
YEAR ENDED NOVEMBER 30,
---------------------------------------
2002 2001 2000
----------- ----------- -----------
E-commerce ........................... $38,807,119 $28,475,225 $10,498,186
Off-line Marketing Services .......... 5,235,806 2,214,576 8,958,774
LEC Billed Products and Services ..... -- 1,519,609 7,134,831
Corporate and other .................. -- -- 20,072
----------- ----------- -----------
Consolidated totals ......... $44,042,925 $32,209,410 $26,611,863
=========== =========== ===========
SEGMENT DATA -- GROSS PROFIT
YEAR ENDED NOVEMBER 30,
---------------------------------------
2002 2001 2000
----------- ----------- -----------
E-commerce ........................... $27,182,815 $20,574,189 $ 4,875,105
Off-line Marketing Services .......... 4,616,475 1,020,550 5,797,040
LEC Billed Products and Services ..... -- 1,462,209 6,862,619
Corporate and other .................. -- -- 20,072
----------- ----------- -----------
Consolidated totals ......... $31,799,290 $23,056,948 $17,554,836
=========== =========== ===========
F-27
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SEGMENT DATA -- EBITDA*
YEAR ENDED NOVEMBER 30,
-----------------------------------------
2002 2001 2000
----------- ----------- -----------
E-commerce ........................ $ 8,826,506 $ 9,554,829 $(1,341,711)
Off-line Marketing Services ....... 743,040 200,406 4,299,772
LEC Billed Products and Services .. -- 367,328 6,285,218
Corporate and other ............... (3,969,118) (3,459,866) (3,505,317)
----------- ----------- -----------
Consolidated totals ...... $ 5,600,428 $ 6,662,697 $ 5,737,962
=========== =========== ===========
- -------------
* EBITDA is net income before interest expense, income taxes, interest and
dividend income, realized gains on marketable securities, permanent impairment
charges, gains on nonmonetary cost basis exchanges, other nonoperating income
(expense), minority interest (income) loss, depreciation and amortization.
SEGMENT DATA -- DEPRECIATION AND AMORTIZATION
YEAR ENDED NOVEMBER 30,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
E-commerce ........................... $ 876,976 $ 157,222 $ 67,634
Off-line Marketing Services .......... 20,349 -- --
LEC Billed Products and Services ..... -- -- --
Corporate and other .................. 275,798 232,182 196,035
---------- ---------- ----------
Consolidated totals ......... $1,173,123 $ 389,404 $ 263,669
========== ========== ==========
SEGMENT DATA -- LONG-LIVED ASSETS
YEAR ENDED NOVEMBER 30,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
E-commerce ........................... $4,200,376 $1,868,627 $ 65,232
Off-line Marketing services .......... 32,038 -- --
LEC Billed products and services ..... -- -- --
Corporate and other .................. 556,449 499,482 447,726
---------- ---------- ----------
Consolidated totals ......... $4,788,863 $2,368,109 $ 512,958
========== ========== ==========
SEGMENT DATA -- TOTAL ASSETS
YEAR ENDED NOVEMBER 30,
---------------------------------------
2002 2001 2000
----------- ----------- -----------
E-commerce ........................... $29,101,906 $23,087,920 $ 4,536,473
Off-line Marketing services .......... 910,617 1,057,530 856,567
LEC Billed products and services ..... 317,541 1,321,192 3,120,889
Corporate and other .................. 20,860,929 27,275,942 43,684,914
----------- ----------- -----------
Consolidated totals ......... $51,190,993 $52,742,584 $52,198,843
=========== =========== ===========
F-28
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
for fiscal 2002, 2001 and 2000:
QUARTER ENDED
-----------------------------------------------------
NOVEMBER 30, AUGUST 31, MAY 31, FEBRUARY 28,
----------- ----------- ----------- -----------
2002:
Net revenues .................... $10,203,244 $10,664,246 $10,804,538 $12,370,897
Gross profit .................... 7,939,584 7,446,086 7,421,334 8,992,286
Income before income taxes ...... 882,199 177,615 1,182,583 2,285,887
Net income ...................... 516,550 108,380 713,043 1,403,417
Basic income per share .......... $ 0.04 $ 0.01 $ 0.05 $ 0.10
Diluted income per share ........ $ 0.04 $ 0.01 $ 0.05 $ 0.10
2001:
Net revenues .................... $14,050,493 $ 7,404,820 $ 5,828,543 $ 4,925,554
Gross profit .................... 9,805,348 5,123,105 4,180,806 3,947,689
Income (loss) before income taxes 2,875,971 2,260,304 1,695,865 (3,139,441)
Net income (loss) ............... 1,709,882 1,462,992 1,015,484 (3,770,859)
Basic income (loss) per share ... $ 0.13 $ 0.10 $ 0.07 $ (0.26)
Diluted income (loss) per share . $ 0.12 $ 0.10 $ 0.07 $ (0.26)
2000:
Net revenues .................... $ 8,829,967 $ 7,862,386 $ 7,220,864 $ 2,698,646
Gross profit .................... 3,878,148 5,480,259 5,856,759 2,399,670
Income before income taxes ...... 853,284 2,616,751 3,210,748 1,937,841
Net income ...................... 516,705 1,561,600 1,906,859 1,161,706
Basic income per share .......... $ 0.03 $ 0.11 $ 0.13 $ 0.08
Diluted income per share ........ $ 0.03 $ 0.10 $ 0.12 $ 0.07
During the fourth quarter of fiscal 2002, the Company adjusted certain
accrued expenses related to fulfillment accruals, such adjustment effectively
reduced cost of sales by approximately $500,000 in such quarter.
During the fourth quarter of fiscal 2001, the Company recorded $3.7 million
in revenue related to an arbitration award granted to the Company regarding the
settlement of a dispute brought against Talk.com (NASDAQ:TALK). The Company's
total award was approximately $6.2 million with $3.7 million having been
collected in November 2001 and recorded as revenue at the time of the receipt.
The balance of the award was treated as a gain contingency pursuant to the
overall financial condition of the telecommunications sector at that time, and
management's estimation of Talk.com's ability to pay. As a result of the award's
collection, the Company recognized a $1.25 million liability in the fourth
quarter of fiscal 2001 relative to telemarketing costs incurred in the prior
fiscal year. The collection of the Talk.com award triggered the recognition of
the liability. There are no other contingencies related to the potential
collection of the balance of the award, which was collected in fiscal 2002 and
included as other nonoperating income.
During the fourth quarter of fiscal 2001, the Company charged approximately
$826,000 to bad debt expense related to the bankruptcy of its LEC Billed Product
and Service segment's billing and collection service bureau.
During the fourth quarter of fiscal 2000, the Company adjusted certain
accrued expenses related to fulfillment accruals ($1,007,237), and accrued
annual bonuses ($260,060), the combined effect of which increased fiscal 2000's
fourth quarter pre-tax income by $1,267,297. The fourth quarter of fiscal 2000
was negatively impacted by long-lived asset impairment charges of $602,500. The
combined effect of these fourth quarter fiscal 2000 adjustments increased
pre-tax income by $664,797.
F-29
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
COL. A COL. B COL. C COL. D COL. E
----------- ---------- ----------------------- ----------- ----------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER DEDUCTIONS- END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DESCRIBE PERIOD
----------- ---------- ---------- ---------- ----------- ----------
YEAR ENDED NOVEMBER 30, 2002
Reserve for customer
chargebacks .............. $ 1,478 $ -- (1) $ 1,478(3) $ --
---------- ------ ---------- ---------- ----------
Reserve for fulfillment costs $ 763,443 $ -- $2,020,297(2) $1,550,442(7) $1,233,298
---------- ------ ---------- ---------- ----------
Allowance for doubtful
accounts ................. $ 383,676 $ -- $ 643,453(4) $ 701,002(5) $ 326,127
---------- ------ ---------- ---------- ----------
YEAR ENDED NOVEMBER 30, 2001
Reserve for customer
chargebacks .............. $1,225,040 $ -- $ 574,969(1) $1,798,531(8) $ 1,478
---------- ------ ---------- ---------- ----------
Reserve for fulfillment costs $ 746,415 $ -- $ 158,228 $ 141,200(9) $ 763,443
---------- ------ ---------- ---------- ----------
Allowance for doubtful
accounts ................. $ 795,024 $ -- $8,369,011(4) $8,780,359(5) $ 383,676
---------- ------ ---------- ---------- ----------
YEAR ENDED NOVEMBER 30, 2000
Reserve for customer
chargebacks .............. $4,618,108 $ -- $ 988,669(1) $4,381,737(6) $1,225,040
---------- ------ ---------- ---------- ----------
Reserve for fulfillment costs $4,132,809 $ -- $ 518,335(2) $3,904,729 $ 746,415
---------- ------ ---------- ---------- ----------
Allowance for doubtful
accounts ................. $ -- $ -- $3,885,656(4) $3,090,635(5) $ 795,021
---------- ------ ---------- ---------- ----------
- -------------
(1) Charges against revenues.
(2) Charges against cost of sales.
(3) Chargebacks refunded to consumers.
(4) Charges to allowance
(5) Charges against the allowance
(6) Chargebacks refunded to consumers ............... $2,556,119
Prior year chargebacks credited to income ....... $1,825,618 $4,381,737
-----------------------
(7) Payments made to fulfillment vendors ............ $1,050,937
Prior year accrual reversals reducing costs ..... $ 0
Current year (4th qtr.) accrual reversals ....... $ 499,505 $1,550,442
-----------------------
(8) Reserves written off with corresponding
receivables-- FTT bankruptcy .................. $1,384,483
Reserves written off because of immaterial
chargeback activity-- West .................... $ 60,535
Chargebacks refuded to customers ................ $ 353,513 $1,798,531
-----------------------
(9) Payments made to fulfillment vendors ............ $ 10,317
Prior year accrual exceeded actual redemptions .. $ 130,883 $ 141,200
-----------------------
S-1
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 Bylaws of the Company. (3)
10.1 Fourth Amended and Restated 1996 Stock Option Plan. (4)
10.2 Lease of the Company's offices at One Blue Hill Plaza, Pearl River,
New York. (5)
10.3.1 December 1, 2001 Employment Agreement by and between the Company and
Jeffrey L. Schwartz (6)
10.3.2 December 1, 2001 Employment Agreement by and between the Company and
Andrew Stollman (6)
21* Subsidiaries of the Company
- -----------
* Filed herewith.
(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.
(4) Filed as an Exhibit to the Company's Proxy Statement filed with the
Commission, dated July 17, 2002 and incorporated herein by reference.
(5) Filed as an Exhibit to the Company's Current Report on Form 8-K dated
December 26, 2000 and incorporated herein by reference. (6) Filed as an
Exhibit to the Company's Form 10-K for the year ended November 30, 2001 and
incorporated herein by reference