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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Quarterly Period Ended
June 30, 2003.
or
/ / Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
Commission File Number: 000-31146
724 SOLUTIONS INC.
(Exact Name of Registrant as Specified in its Charter)
Ontario Inapplicable
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
4101 Yonge Street, Suite 702 M2P 1N6
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Toronto, Ontario (Zip Code)
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(Address of Principal Executive Office)
(416) 226-2900
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(Registrant's Telephone Number, Including Area Code).
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes / / No /x/
--- ---
Common Shares, no par value - 5,983,349 shares outstanding as of August 6, 2003
(together with associated rights to purchase additional Common Shares)
724 SOLUTIONS INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION...............................................................................1
Item 1. Financial Statements.....................................................................1
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..............................................................................11
Item 3. Quantitative and Qualitative Disclosures About Market Risk..............................21
Item 4. Controls and Procedures.................................................................21
PART II. OTHER INFORMATION..................................................................................22
Item 1. Legal Proceedings.......................................................................22
Item 2. Changes in Securities...................................................................22
Item 3. Defaults Upon Senior Securities.........................................................23
Item 4. Submission of Matters to a Vote of Security Holders.....................................23
Item 5. Other Information.......................................................................24
Item 6. Exhibits and Reports on Form 8-K........................................................24
(a) Exhibits..........................................................................24
(b) Reports on Form 8-K...............................................................24
SIGNATURES.......................................................................................................25
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
724 SOLUTIONS INC.
Consolidated Balance Sheets
(In thousands of U.S. dollars)
June 30, 2003 and December 31, 2002
- -------------------------------------------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------------------------------------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents (note 2) $20,896 $19,129
Short-term investments (note 2) 2,758 18,562
Restricted cash (note 2) 1,630 962
Accounts receivable - trade, net of allowance
of $25 (December 31, 2002 - $150) 2,518 2,211
Prepaid expenses and other receivables 1,091 819
- -------------------------------------------------------------------------------------------------------------------
28,893 41,683
Fixed assets 938 1,418
Goodwill 9,097 9,097
Other intangible assets 1,156 3,468
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$40,084 $55,666
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- -------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 940 $ 1,253
Accrued liabilities 7,691 9,892
Note payable - 600
Deferred revenue 652 1,217
Deferred consideration 983 1,415
- -------------------------------------------------------------------------------------------------------------------
10,266 14,377
Shareholders' equity:
Share capital (note 4):
Authorized:
Unlimited common shares
Unlimited preferred shares
Issued and outstanding:
5,983,349 common shares
(December 31, 2002 - 5,983,349) 764,508 764,508
Deferred stock-based compensation - (1,616)
Accumulated deficit (734,741) (721,560)
Cumulative translation adjustment 51 (43)
- -------------------------------------------------------------------------------------------------------------------
29,818 41,289
Contingent liabilities *
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$40,084 $55,666
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- -------------------------------------------------------------------------------------------------------------------
* See note 17 to our audited consolidated financial statements set forth in
our 2002 annual report.
The historic common share numbers have been adjusted to reflect the 10 for 1
share consolidation completed in the second quarter of 2003.
See accompanying notes to consolidated financial statements.
724 SOLUTIONS INC.
Consolidated Statements of Operations
(In thousands of U.S. dollars, except per share amounts)
- -------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Revenue:
Product $ 1,635 $ 1,572 $ 3,645 $ 4,127
Services 1,375 3,436 2,880 5,394
- -------------------------------------------------------------------------------------------------------------------
3,010 5,008 6,525 9,521
Operating expenses:
Cost of revenue 1,422 2,669 2,996 4,372
Research and development 2,555 4,106 5,505 9,858
Sales and marketing 2,165 4,342 4,357 10,718
General and administrative 1,291 1,546 2,236 3,946
Depreciation 203 1,478 562 3,160
Amortization of intangible assets 1,156 1,011 2,312 2,164
Stock-based compensation:
Cost of revenue - 54 8 200
Research and development 682 1,879 1,211 6,997
Sales and marketing 170 662 282 2,467
General and administrative - 482 115 1,793
Restructuring costs (note 5) 300 - 300 16,987
Write-down of fixed assets - - - 4,134
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9,944 18,229 19,884 66,796
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Loss from operations (6,934) (13,221) (13,359) (57,275)
Interest income, net 85 139 178 525
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Loss for the period $ (6,849) $ (13,082) $ (13,181) $ (56,750)
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- -------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per share $ (1.14) $ (2.19) $ (2.20) $ (9.60)
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Weighted average number of shares
used in computing basic and diluted
loss per share (in thousands) 5,983 5,964 5,983 5,911
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- -------------------------------------------------------------------------------------------------------------------
The historic common share numbers have been adjusted to reflect the 10 for 1
share consolidation completed in the second quarter of 2003.
See accompanying notes to consolidated financial statements.
2
724 SOLUTIONS INC.
Consolidated Statements of Shareholders' Equity
(In thousands of U.S. dollars, except number of common shares)
Six months ended June 30, 2003 and 2002
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------------
Deferred
stock-based
compensation Cumulative Total
Common shares related to stock Accumulated translation shareholders'
Number Amount options deficit adjustment equity
- -----------------------------------------------------------------------------------------------------------------------------
Balances,
December 31, 2001 5,837,576 $ 763,033 $ (19,582) $ (634,153) $ (52) $ 109,246
Loss for the period - - - (56,750) - (56,750)
Cumulative translation
adjustment - - - - (6) (6)
Deferred stock-based
compensation - (163) 163 - - -
Amortization of
deferred stock-based
compensation - - 11,457 - - 11,457
Issuance for cash on
exercise of options 25,919 144 - - - 144
Issuance of common
shares 101,169 1,415 - - - 1,415
- -----------------------------------------------------------------------------------------------------------------------------
Balances,
June 30, 2002 5,964,664 $ 764,429 $ (7,962) $ (690,903) $ (58) $ 65,506
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
Balances,
December 31, 2002 5,983,349 $ 764,508 $ (1,616) $ (721,560) $ (43) $ 41,289
Loss for the period - - - (13,181) - (13,181)
Cumulative translation
adjustment - - - - 94 94
Amortization of
deferred stock-based
compensation - - 1,616 - - 1,616
- -----------------------------------------------------------------------------------------------------------------------------
Balances,
June 30, 2003 5,983,349 $ 764,508 $ - $ (734,741) $ 51 $ 29,818
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
The historic common share numbers have been adjusted to reflect the 10 for 1
share consolidation completed in the second quarter of 2003.
See accompanying notes to consolidated financial statements.
3
724 SOLUTIONS INC.
Consolidated Statements of Cash Flows
(In thousands of U.S. dollars)
- -------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Loss for the period $ (6,849) $ (13,082) $ (13,181) $ (56,750)
Items not affecting cash:
Depreciation and amortization 1,359 2,489 2,874 5,324
Stock-based compensation 852 3,077 1,616 11,457
Other non-cash expenses 104 (56) 43 82
Write-down of fixed assets - - - 4,134
Change in operating assets and liabilities:
Accounts receivable 358 3,602 (307) 5,613
Prepaid expenses and other receivables 16 (389) (272) (94)
Accrued interest on short-term
investments - 179 - 157
Accounts payable (34) (714) (314) (1,137)
Accrued liabilities (472) (3,700) (2,201) 5,566
Deferred consideration (374) - (374) -
Deferred revenue (648) 172 (565) 641
- -------------------------------------------------------------------------------------------------------------------
Net cash flows used in operating activities (5,688) (8,422) (12,681) (25,007)
Cash flows from financing activities:
Principal repayment of notes payable - (802) (600) (1,334)
Issuance of common shares - 18 - 144
- -------------------------------------------------------------------------------------------------------------------
Net cash flows used in
financing activities - (784) (600) (1,190)
Cash flows from investing activities:
Purchase of fixed assets (18) (137) (88) (338)
Sale of short-term investments, net 3,100 11,269 15,804 14,944
Restricted cash 257 (2,946) (668) (2,946)
Purchase of intangible and other assets - (457) - (457)
- -------------------------------------------------------------------------------------------------------------------
Net cash flows from investing activities 3,339 7,729 15,048 11,203
Foreign exchange loss on cash held
in foreign currency - (58) - (58)
- -------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and
cash equivalents (2,349) (1,535) 1,767 (15,052)
Cash and cash equivalents, beginning
of period 23,245 46,762 19,129 60,279
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Cash and cash equivalents, end of period $ 20,896 $ 45,227 $ 20,896 $ 45,227
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Supplemental disclosure of non-cash
investing and financing activities:
Interest received $ 81 $ 365 $ 232 $ 847
Interest paid - 72 7 164
Common shares issued upon
settlement of contingent
consideration - - - 1,415
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
1. BASIS OF PRESENTATION:
The accompanying consolidated financial statements include the accounts of
724 Solutions Inc. and its wholly owned subsidiaries (collectively referred
to as the "Company"). Intercompany transactions and balances are eliminated
on consolidation.
The consolidated financial statements are stated in U.S. dollars, except as
otherwise noted. They have been prepared in accordance with Canadian
generally accepted accounting principles, which conform, in all material
respects, with U.S. generally accepted accounting principles. The interim
financial statements follow the same accounting policies and methods of
application as the most recent annual financial statements. For further
information, reference should be made to the audited annual consolidated
financial statements for the year ended December 31, 2002 that are included
in the Company's Annual Report filed with the Canadian Securities
Administrators on March 31, 2003 and with the Securities and Exchange
Commission on Form 10-K filed on March 31, 2003.
The information furnished for the three and six months ended June 30, 2003
and June 30, 2002 reflect, in the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the results of the interim periods presented. Interim
results are not necessarily indicative of results for a full year.
2. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:
All short-term investments are classified as held-to-maturity because the
Company has the positive intent and ability to hold the securities to
maturity. Held-to-maturity securities are stated at amortized cost,
adjusted for amortization of premiums and accretion discounts to maturity.
The Company owns no short-term investments that are considered to be
trading securities or available-for-sale securities.
The components of cash and cash equivalents and short-term investments are
as follows:
- ------------------------------------------------------------------------------------------------------------------------
June 30, 2003 December 31, 2002
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents:
Cash $ 20,896 $ 6,375
Cash equivalents:
Government treasury bills - 1,554
Corporate bonds - 11,200
- ------------------------------------------------------------------------------------------------------------------------
$ 20,896 $ 19,129
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Short-term investments:
Held-to-maturity:
Government treasury bills 2,474 4,681
Term deposits 284 4,681
Corporate bond - 13,881
- ------------------------------------------------------------------------------------------------------------------------
$ 2,758 $ 18,562
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
The Company has entered into letters of credit in the aggregate amount of
$1,630,000 (December 31, 2002 - $962,000). See note 7(c) for further details.
5
3. SEGMENTED INFORMATION:
The Company operates in a single reportable operating segment, that is, the
design and delivery of an Internet infrastructure platform and related
applications that enable financial institutions, mobile network operators
and other customers to deliver information and services to a range of
Internet-enabled devices. The single reportable operating segment derives
its revenue from the sale of software and related services. Information
about the Company's geographical revenue and assets is set forth below:
- -------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Net revenue by geographic
location:
North America $ 2,416 $ 4,641 $ 5,513 $ 7,924
Europe 552 157 850 927
Asia Pacific 42 210 162 670
- -------------------------------------------------------------------------------------------------------------------
$ 3,010 $ 5,008 $ 6,525 $ 9,521
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
For the six months ended June 30, 2003, three customers accounted for 48%,
16% and 10% of revenue. For the six months ended June 30, 2002, two
customers accounted for 24% and 21% of revenue.
For the six months ended June 30, 2003, two customers accounted for 51% and
18% of accounts receivable. For the six months ended June 30, 2002, three
customers accounted for 18% and 14% and 12% of accounts receivable.
- -------------------------------------------------------------------------------------------------------------------
June 30, 2003 December 31, 2002
- -------------------------------------------------------------------------------------------------------------------
Goodwill Goodwill
and other and other
Fixed intangible Fixed intangible
assets assets assets assets
- -------------------------------------------------------------------------------------------------------------------
North America $ 475 $ 10,253 $ 596 $ 12,565
Europe 463 - 797 -
Asia Pacific - - 25 -
- -------------------------------------------------------------------------------------------------------------------
$ 938 $ 10,253 $ 1,418 $ 12,565
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
6
4. SHARE CAPITAL:
(a) Reverse stock split
On April 24, 2003 the Company's shareholders approved a ten for one
reverse stock split of the Company's common shares. As a result, the
historic number of shares, historic loss per share and the weighted
average number of shares used in compiling basic and diluted loss per
share have been restated for all periods presented to reflect the
reverse stock split.
(b) Stock options
At June 30, 2003 and December 31, 2002, there were options outstanding
to acquire 675,069 and 748,408 common shares of the Company,
respectively.
The following table summarizes the Company's options as of June 30,
2003.
- -----------------------------------------------------------------------------------------------------------------------------
Weighted average
remaining
Weighted average contractual life Number of options Weighted average
Exercise price ranges Number of options exercise price (years) exerciseable exercise price
- -----------------------------------------------------------------------------------------------------------------------------
$ - $ 5.00 237,489 $ 3.63 8.5 41,088 3.11
5.01 10.00 251,772 5.69 9.1 71,233 6.22
10.01 20.00 45,941 17.37 6.3 42,956 17.73
20.01 50.00 20,894 36.72 6.6 20,407 36.96
50.01 100.00 54,618 88.70 7.1 39,835 95.66
100.01 600.00 64,356 242.38 7.5 26,905 290.18
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
675,069 $36.00 8.3 242,423 $ 56.53
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
(c) Loss per share
The Company has excluded from the calculation of diluted earnings per
share all common shares potentially issuable upon the exercise of
stock options and other potentially convertible instruments that
could dilute basic earnings per share in the future, because to do so
would have been anti-dilutive.
(d) Pro forma disclosure for stock-based compensation and other
stock-based payments:
For companies electing not to adopt the fair value measurement for
stock-based compensation, Canadian and US GAAP requires the
disclosure of pro forma net income (loss) and net income (loss) per
share information. The Company has presented this pro forma
information as if the Company had accounted for its stock options
issued from inception on July 28, 1997 under the fair value method. A
summary of the pro forma disclosure and the impact on the
consolidated statement of operations is presented in the following
table:
7
- -------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Loss for the period $ (6,849) $ (13,082) $ (13,181) $ (56,750)
Compensation expense related
to the fair value of stock options
In excess of amounts recognized (3,704) (4,755) (8,226) (7,594)
- -------------------------------------------------------------------------------------------------------------------
Pro forma loss for the period $ (10,553) $ (17,837) $ (21,407) $ (64,344)
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Pro forma loss per share:
Basic and diluted $ (1.76) $ (2.99) $ (3.58) $ (10.89)
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
The fair value of each option granted in the period ended June 30,
2003 has been estimated at the date of grant using the Black-Scholes
option pricing model under the following assumptions: dividend yield
of zero, expected volatility of 100%, risk-free rate of return of
3.82% and an expected life of the option of five years. The fair
value of each option granted prior to January 1, 2003, has been
estimated at the date of grant using the Black-Scholes option pricing
model with the assumptions disclosed in note 9(v) of the annual
consolidated financial statements.
The Company has assumed no forfeiture rate, as adjustments for actual
forfeitures are made in the period they occur. The weighted average
grant date fair value of options issued in three months ended June
30, 2003 was $2.26 (2002 - $8.52).
5. RESTRUCTURING COSTS:
The restructuring charge recorded in the three months ended June 30, 2003
relates to the termination of twenty-six employees, the closure of one
office and the partial closure of two other offices offset by an
adjustment to the Hosting exit costs reserve.
Six months ended June 30, 2002
- -------------------------------------------------------------------------------------------------------------------
Severance Lease exit Hosting exit Write-down
costs costs of inventory Total
- -------------------------------------------------------------------------------------------------------------------
Provision,
December 31, 2001 $ 2,331 $ 6,593 $ - $ - $ 8,924
Activity during the period
ended June 30, 2002
Restructuring charges 3,691 4,801 5,747 2,748 16,987
Cash payments (5,417) (3,053) (1,892) - (10,362)
Non-cash charges - (1,781) 1,691 (2,748) (2,838)
- -------------------------------------------------------------------------------------------------------------------
Provision,
June 30, 2002 $ 605 $ 6,560 $ 5,546 $ - $ 12,711
- -------------------------------------------------------------------------------------------------------------------
8
Six months ended June 30, 2003
- -------------------------------------------------------------------------------------------------------------------
Severance Lease exit Hosting exit Write-down
costs costs of inventory Total
- -------------------------------------------------------------------------------------------------------------------
Provision,
December 31, 2002 $ 967 $ 1,528 $ 2,487 $ - $ 4,982
Activity during the period
ended June 30, 2003
Cash payments (783) (1,183) (587) - (2,553)
Restructuring charges 525 175 (400) 300
- -------------------------------------------------------------------------------------------------------------------
Provision,
June 30, 2003 $ 709 $ 520 $ 1,500 $ - $ 2,729
- -------------------------------------------------------------------------------------------------------------------
6. STATEMENT OF COMPREHENSIVE LOSS:
Comprehensive loss generally encompasses all changes in shareholders'
equity except those arising from transactions with shareholders.
- -------------------------------------------------------------------------------------------------------------------
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Loss for the period $ (6,849) $ (13,082) $ (13,181) $ (56,750)
Other comprehensive loss,
net of income taxes:
Cumulative translation adjustment 20 26 94 (6)
- -------------------------------------------------------------------------------------------------------------------
Comprehensive loss
based on U.S. GAAP $ (6,829) $ (13,056) $ (13,087) $ (56,756)
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
7. GUARANTEES:
(a) General indemnities
In the normal course of operations, the Company provides
indemnification agreements to counterparties in transactions such as
purchase contracts, service agreements, and leasing transactions.
These indemnification agreements sometimes require the Company to
compensate the counterparties for costs incurred as a result of
changes in laws and regulations (including tax legislation) or as a
result of litigation claims or statutory sanctions that may be
suffered by the counterparty as a consequence of the transaction. The
terms of these indemnification agreements will vary based upon the
contract. The nature of the indemnification agreements prevents the
Company from making a reasonable estimate of the maximum potential
amount it could be required to pay to counterparties. Historically,
the Company has not made any significant payments under such
indemnification. No amount has been accrued in the consolidated
financial statements with respect to these indemnification
agreements.
9
(b) Product warranties
Our software license agreements generally include certain provisions
for indemnifying customers against liabilities if our software
products infringe a third party's intellectual property rights. To
date, we have not incurred any material costs as a result of such
indemnifications and have not accrued any liabilities related to such
obligations in our consolidated financial statements.
Our software license agreements also generally include a warranty
that our software products will substantially operate as described in
the applicable program documentation for a specified period after
delivery. We also warrant that services we perform will be provided
in a manner consistent with industry standards and in accordance with
applicable specifications for a specified period from performance of
the service. To date, we have not incurred any material costs
associated with these warranties.
(c) Letters of credit
The Company has entered into letters of credit in the aggregate
amount of $1,630,000 to guarantee future payments under contractual
commitments (December 31, 2002 - $962,000). The commitments include
$570,000 related to insurance premiums, $871,000 related to deferred
consideration and $189,000 to secure Company credit cards. The
insurance and deferred compensation amounts will be paid by the end
of 2003 and the Company can cancel the credit card commitment at any
time. The letters of credit are secured by segregated short-term
investments and are disclosed as restricted cash on the consolidated
balance sheet.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
724 Solutions Inc. is a leading provider of next-generation IP-based network and
data services. We were incorporated in 1997, and in 1999 we introduced our
initial products and solutions for the financial services industry. In 2001, we
began offering our Actionable Alerts and Mobile Internet Gateway products to
mobile network operators (MNO's). In October 2002, our products and solutions
for the mobile network operators were brought under the umbrella of our X-treme
Mobility Suite of products. Through this family of products, 724 Solutions
delivers reliable, scalable technology and solutions that allow mobile network
operators to rapidly deploy flexible and open, next-generation IP-based network
and data services.
Financial institutions (FI's) use 724's pro-active, alerts-based solutions to
offer services across a broad range of channels, including the mobile channel,
to their consumer customers and internal enterprise users, allowing these
organizations to improve customer satisfaction and retention while at the same
time lowering their operating costs.
Our customers currently include leading mobile network operators and financial
institutions. With our corporate office in Toronto, Canada, we have development
and sales offices around the world, including, Hong Kong, Germany, Switzerland,
the United Kingdom and the United States.
CRITICAL ACCOUNTING POLICIES
We periodically review our financial reporting and disclosure practices and
accounting policies to ensure that they provide accurate and transparent
information relative to the current economic and business environment. As part
of this process, we have reviewed our selection, application and communication
of critical accounting policies and financial disclosures. We have determined
that our critical accounting policies relating to our core ongoing business
activities are primarily those that relate to revenue recognition. Other
important accounting policies are described in Note 2 to our audited annual
consolidated financial statements set forth in our annual report on form 10-K,
which we encourage you to read.
REVENUE RECOGNITION
SOURCES OF REVENUE
We derive revenue from licensing our products and providing related services,
including installation, integration, training, maintenance and support, and
application hosting services. We recognize revenue from our license agreements
when all the following conditions are met:
o We have an executed license agreement with the customer;
o We have delivered the software product to the customer;
o The amount of the fees to be paid by the customer is fixed and
determinable; and
o Collection of these fees is deemed probable.
11
Typically, software license agreements are multiple element arrangements that
include related maintenance and implementation fees. Accordingly, the fee is
allocated to each element in the arrangement based on the respective vendor
specific objective evidence of value (VSOE) of each element. For contracts for
which we do not have sufficient VSOE, we use the residual method to record
revenues. Under this method, as long as we have VSOE for all undelivered
elements (typically, services and maintenance) we can record the remaining value
of the contract as license revenue after allocating full value to the
undelivered elements.
For license and services agreements that provide significant commitments to
refunds and/or penalties on the services and/or license components should the
system not perform according to documented specifications, we defer recognition
of revenue for the amount subject to refund or penalty until we achieve
contractually defined milestones or until customer acceptance has occurred, as
the case may be for such agreements.
PRODUCT REVENUE
Product revenue consists of the following:
o Fixed License Fee Arrangement - a one-time license fee for a
fixed number or copies of unlimited use of the software with a
perpetual term. We typically recognize the upfront fees in the
period the contract is executed or shortly thereafter.
o Variable License Fee Arrangement - a variable license fee based
on the numbers of users in a period. Revenue is recognized on an
ongoing basis and will vary with the number of our customers' end
users. However, over time, we believe that these fees will grow
as our customers roll out services based on our products or
solutions to substantial numbers of their customers.
o Reseller Arrangement - the reseller generally pays a
non-refundable licensing fee for our software and/or a royalty
fee based on the related number of users. We recognize revenue
associated with non-refundable license fees when we have met our
revenue recognition criteria for license agreements as outlined
above.
o Solutions Arrangement - there are two key factors that
distinguish what we consider to be a solutions sale versus a
software and services sale. Firstly, in a solutions sale, there
may initially be a higher mix of revenue for services than in a
software sale. Secondly, in a solutions sale the services include
the development and implementation of customized software code
and more complex interfaces than in a software sale, where the
contracted services are primarily installation services.
Recognition of revenue from such contracts will primarily be
based on the percentage of work completed as described below
under service revenue.
SERVICE REVENUE
IMPLEMENTATION AND CUSTOMER SERVICE FEES
Revenue from implementation and customer services includes fees for
implementation of our product offerings, consulting and training services.
Customers are charged a fee based on time and expenses. Revenue from
implementation and customer service fees is recognized as the services are
performed or
12
deferred until we achieve contractually defined milestones or until customer
acceptance has occurred, as the case may be for such contracts.
MAINTENANCE FEES
We receive revenue from maintaining and servicing our products for customers.
The maintenance fee is typically equal to a specified percentage of the
customer's license fee. If associated with the fixed fee license model, the
maintenance revenues received will be recorded as deferred revenue and
recognized on a straight-line basis over the contract period. When associated
with the variable fee license model, any maintenance payments will be recognized
on a monthly basis as earned.
HOSTING FEES
We no longer provide hosting services directly. Instead, we have arranged an
alliance with CSC, whereby CSC is our preferred hosting partner for current and
future customer deployments where hosting is or will be required. Under our
existing hosting contracts, we typically charge customers a monthly flat fee or
a monthly fee based on the number of users. The fees are recognized on a monthly
basis.
For a more detailed description of our revenue recognition policies, refer to
note 2(c) of our annual audited consolidated financial statements for the year
ended December 31, 2002.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 2002
Our consolidated financial statements have been prepared in accordance with
Canadian generally accepted accounting principles. These principles conform in
all material respects with U.S. generally accepted accounting principles.
REVENUE
PRODUCT REVENUE
In the three months ended June 30, 2003, product revenue increased to just over
$1.6 million from just under $1.6 million for the same period in 2002. In the
six months ended June 30, 2003, product revenue decreased to $3.6 million,
including $860,000 related to a contract cancellation fee in the first quarter
of 2003, from $4.1 million for the corresponding period in 2002. Due to
continuing poor economic conditions, our FI customers were reluctant to make
large upfront commitments on license fees as they had done in previous years. In
addition, our change in strategy to focus more on sales to MNO's, who typically
have a longer sales cycle, has resulted in a decrease in license revenue in 2003
compared to 2002.
13
SERVICE REVENUE
Service revenue decreased to $1.4 million and $2.9 million for the three and six
months ended June 30, 2003, respectively, compared to $3.4 million and $5.4
million in the corresponding periods in 2002. Service revenue declined in 2003
because the projects completed were generally smaller than those completed in
2002.
OPERATING EXPENSES
COST OF REVENUE
Cost of revenue (COR) consists primarily of personnel costs associated with
customer support, training, and implementations as well as amounts paid to
third-party consulting firms for those services, together with an allocation of
expenses for our facilities and administration.
Cost of revenue was $1.4 million and $3.0 million for the three and six months
ended June 30, 2003, respectively, compared to $2.7 million and $4.4 million for
the corresponding periods in 2002. COR decreased in 2003 because the number of
projects deployed was down and because we eliminated costs not essential to our
focus on our two key markets, the mobile network operator and financial
institution markets. Cost of revenue as a percentage of revenue, was 47% for the
three months ended June 30, 2003 and 46% for the six months ended June 30, 2003,
compared to 53% and 46% for the corresponding periods in 2002.
RESEARCH AND DEVELOPMENT
Research and development expenses include compensation of software development
teams working on the continuing enhancement of our products as well as our
quality assurance and testing activities. These expenses also include
independent contractors and consultants, software licensing expenses, and
allocated operating expenses.
Research and development (R&D) decreased to $2.6 million and $5.5 million for
the three and six months ended June 30, 2003, respectively, compared to $4.1
million and $9.9 million for the corresponding periods in 2002. The decrease is
a result of our restructuring initiatives that have reduced our R&D headcount as
we developed a more streamlined, integrated and focused product road map and
reduced duplication in the R&D process. We continue to evaluate our R&D
expenditure needs based on our new product architecture and services and the
current market environment. R&D expense, as a percentage of revenue, was 85% and
84% for the three months and the six months ended June 30, 2003, respectively,
compared to 82% and 104% for the same periods in 2002.
SALES AND MARKETING
Sales and marketing expenses include compensation of sales and marketing
personnel, public relations and advertising, trade shows, marketing materials
and allocated operating expenses.
Sales and marketing (S&M) expenses were $2.2 and $4.4 million for the three and
six months ended June 30, 2003, respectively, compared to $4.3 million and $10.7
million for the corresponding periods in 2002. The decrease is a result of the
reduction in the number of sales and marketing personnel and reduced spending on
discretionary marketing programs. We continue to monitor our sales and marketing
14
expenditures to ensure that they remain aligned with our targeted opportunities
as well as prevailing market conditions.
GENERAL AND ADMINISTRATIVE
General and administrative (G&A) expenses include salaries and benefits for
corporate personnel and other general and administrative expenses such as
facilities, travel and professional consulting costs. Our corporate staff
includes several of our executive officers and our business development,
financial planning and control, legal, human resources and corporate
administration staff.
G&A expenses decreased to $1.3 million and $2.2 million for the three and six
months ended June 30, 2003, respectively, compared to $1.5 million and $3.9
million for the corresponding periods in 2002. The decrease in G&A expenses
reflected our restructuring initiatives to reduce complexity in our business and
to make our infrastructure efficient for the support of our business in the
current market environment.
DEPRECIATION AND AMORTIZATION
Depreciation expense was $203,000 and $562,000 in the three and six months ended
June 30, 2003, respectively, compared to $1.5 million and $3.2 million in the
corresponding periods in 2002. The decrease is a result of the decommissioning
of our redundant fixed assets and reductions in our capital expenditure budgets
as part of our restructuring initiatives.
Amortization expense was $1.2 million and $2.3 million for the three and six
months ended June 30, 2003, respectively, compared to $1.0 million and $2.2
million in the corresponding periods in 2002. The amortization expense in 2003
and 2002 represents the amortization of acquired technology, which is being
amortized over a period of two to five years. At June 30, 2003, the carrying
value of goodwill was $9.1 million and the carrying value of acquired technology
was $1.2 million.
STOCK-BASED COMPENSATION
Stock-based compensation decreased to $852,000 and $1.6 million for the three
and six months ended June 30, 2003, respectively, compared to $3.1 million and
$11.5 million in the corresponding periods in 2002. The 2002 six month expense
included significant charges related to the immediate recognition of deferred
stock-based compensation associated with employees who were terminated as part
of our restructuring plan as well as the immediate recognition of the
unamortized portion of the deferred stock compensation for those employees who
tendered their options as part of our stock option exchange initiative in
January 2002. In addition, the deferred stock compensation associated with the
Tantau acquisition was higher in 2002 as it was fully amortized by the end of
January 2003. As of June 30, 2003, there is no remaining Deferred Stock-based
Compensation to be amortized.
RESTRUCTURING COSTS
With the downturn in general economic conditions, in the second quarter of 2001
we began to identify areas to reduce costs by eliminating duplicate resources
and positions, narrowing our product offerings and streamlining our operating
processes. We have continued to evaluate our costs and will do so on an ongoing
basis.
15
In the three months ended June 30, 2003 we recorded a net restructuring charge
of $300,000. There was no charge in the first quarter of 2003. In the three and
six month periods ended June 30, 2002, restructuring charges were nil and $17
million, respectively, reflecting a charge made in the first quarter of 2002.
Additionally, in the three and six month periods ended June 30, 2002, we
recorded charges related to the decommissioning of redundant fixed assets of nil
and $4.1 million, respectively, again reflecting a charge made in the first
quarter of 2002. There were no fixed assets write-downs for the three or six
months ended June 30, 2003.
The $300,000 net charge in the second quarter of 2003 includes $525,000 related
to severance costs, $175,000 related to lease exit costs, offset by a $400,000
adjustment to reduce our estimated obligation under our hosting provision.
Included in our "Accrued Liabilities" as at June 30, 2003 is approximately $2.7
million in restructuring reserves. This includes severance costs of $709,000,
lease exit costs of $520,000 and hosting exit costs of $1.5 million. See note 5
to our consolidated financial statements for the three and six months ended June
30, 2003 for further details.
INTEREST INCOME
Interest income decreased to $85,000 and $178,000 for the three and six months
ended June 30, 2003, respectively, compared to $139,000 and $525,000 in the
corresponding periods in 2002. Interest was derived from cash and cash
equivalent balances and short-term investments. Interest income is net of
interest expense relating to our note payable. The note was fully repaid by the
end of the first quarter of 2003. Interest income decreased in the three and six
months ended June 30, 2003 compared to the same periods in 2002 due to declining
interest rates and because we have reduced holdings of cash and cash equivalent
balances and short-term investments.
NET LOSS
Our net loss decreased to $6.8 million and $13.2 million for the three and six
months ended June 30, 2003, respectively, compared to $13.1 million and $56.8
million in the corresponding periods in 2002. Our net loss decreased due to the
significant restructuring charges and write down of intangible assets recorded
in the first quarter of 2002 and the substantial reduction in our operating
expenses resulting from our restructuring initiatives.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities decreased to $5.7 million and $12.6
million for the three and six months ended June 30, 2003, respectively, compared
to $8.4 million and $25.0 million for the corresponding periods in 2002, as we
have significantly reduced our workforce and expense structure as a result of
our restructuring efforts. Net cash used in operating activities for the three
months ended June 30, 2003 consisted of our net loss of $6.8 million and a cash
outflow of $1.2 million related to working capital account changes, offset by
non-cash items, specifically depreciation and amortization of $1.4 million and
stock-based compensation expense of $852,000.
As at June 30, 2003, we had commitments to make $580,000 in minimum lease
payments up to 2005, primarily related to our facilities and equipment rentals.
As a result of our restructuring initiatives, we have vacated some of our
premises and we have been successful in reducing our total future lease
commitments with our landlords.
16
Cash used in financing activities was nil and $600,000 for the three and six
month periods ending June 30, 2003, respectively, compared to $784,000 and $1.2
million in the corresponding periods in 2002. The $600,000 represents the final
two payments of our note payable that was repaid by the end of the first quarter
of 2003. There have been no common shares issuances in 2003. In the six months
ended June 30, 2002, principal payments on the note totaled $1.3 million and we
had a cash source of $144,000 resulting from the exercise of options
Excluding the sale (purchase) of short-term investments, and restricted cash
changes, cash used in investing activities was $18,000 and $88,000 for the three
and six month periods ending June 30, 2003, respectively, compared to $594,000
and $795,000 in the corresponding periods in 2002. We have significantly reduced
our capital assets budget.
Total cash used, excluding the sale (purchase) of short-term investments, and
restricted cash changes, was $5.7 million and $13.4 million for the three and
six month periods ending June 30, 2003, respectively, compared to $9.9 million
and $27.1 million in the corresponding periods in 2002. This was mainly due to
our significantly lower operating costs.
Due to the operational savings resulting from our restructuring, we expect that
cash from the sales of our products and our existing cash and cash equivalents
and short-term investments will be sufficient to cover our cash requirements,
including planned capital expenditures, for at least the next 12 months. We may
require additional financing if we expand our operations at a faster rate than
currently expected, or if we seek to effect one or more significant
acquisitions.
RECENT ACCOUNTING PRINCIPLES
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement No. 123 to require prominent disclosure of the pro forma impact of
fair value accounting for stock options in both annual and interim financial
statements. Certain of the disclosure modifications are required for fiscal
years ending after December 15, 2002 and are included in the notes to these
consolidated financial statements.
Effective January 1, 2003, the Company adopted the initial recognition and
measurement provisions of FASB interpretation No. 45 "Guarantees, Including
Indirect Guarantees of Indebtedness of Others," which apply on a prospective
basis to certain guarantees issued or modified after December 31, 2002. FIN 45
requires that a liability be recognized for the estimated fair value of the
guarantee at its inception. The Company has entered into agreements that contain
features which meet the definition of a guarantee under FIN 45 as described in
note 7. Historically, the Company has not made significant payments related to
these guarantees. The adoption of FIN 45 did not have a material impact on the
business, results of operations and financial condition of the Company.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51." This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The Interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in
17
variable interest entities obtained after January 31, 2003. The Interpretation
requires certain disclosures in financial statements issued after January 31,
2003 if it is reasonably possible that the Company will consolidate or disclose
information about variable interest entities when the Interpretation becomes
effective. The application of this Interpretation will not have a material
effect on the Company's financial statements.
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this report which are not historical facts are
forward-looking statements within the meaning of Section 21E of the U.S.
Securities Exchange Act of 1934, as amended. A forward-looking statement may
contain words such as "anticipate that," "believes," "continue to," "estimates,"
"expects to," "hopes," "intends," "plans," "to be," "will be," "will continue to
be," or similar words. These forward-looking statements include the statements
herein regarding: future developments in the financial services and mobile
network industries; our estimated cost reductions; our future ability to fund
our operations and become profitable; our development of new products and
relationships; our plans to operate in the mobile network operator and financial
institutions markets; the rate at which consumers will adopt wireless
applications; our ability to increase our customer base; the services that we or
our customers will introduce and the benefits that end users will receive from
these services; the impact of entering new markets; our plans to use or not to
use certain types of technologies in the future; our future cost of revenue,
gross margins and net losses; our future restructuring, research and
development, sales and marketing, general and administrative, stock-based
compensation, depreciation and amortization expenses; our future interest
income; the value of our goodwill and other intangible assets; our future
capital expenditures and capital requirements; and the anticipated impact of
changes in applicable accounting rules.
The accuracy of these statements may be impacted by a number of business risks
and uncertainties that could cause actual results to differ materially from
those projected or anticipated. These risks include the risks described in our
SEC filings, including our annual report on Form 10-K. These risks are also
described in our filings with the Canadian Securities Administrators, including
our prospectuses, material change reports, Annual Information Form and
Management Information Circular. We encourage you to carefully review these
risks in order to evaluate an investment in our securities. Some of the key
risks that could cause actual results to differ materially from those projected
or anticipated also include the risks discussed below. We do not undertake any
obligation to update this forward-looking information, except as required under
applicable law.
GENERAL INDUSTRY, ECONOMIC AND MARKET CONDITIONS
Our future revenues and operating results are dependent to a large extent upon
general economic conditions, conditions in the wireless market and within that
market our primary target markets of mobile network operators and financial
institutions. As economic activity slowed in these markets beginning in 2001,
our customers began deferring their spending on our products and our revenues
began to decline. Our sales cycle has lengthened significantly as potential
customers have reduced their spending commitments, including their willingness
to make investments in new wireless services. Moreover, adoption of wireless
services has not proceeded as rapidly as we previously anticipated. For example,
in 2002, Bank of Montreal and Wells Fargo, two of our initial customers, ceased
offering their wireless banking and/or brokerage services. If general economic
conditions continue to be adverse, if the economies in which our target
customers are located enter into a recession, or if demand for our solutions
does not expand, our ability to increase our customer base may be limited, and
our revenue may decrease further.
18
ENTERING NEW MARKETS
We have made mobile network operators an important focus of our activities. In
order to encourage these potential customers to adopt and implement our
solutions, we may incur higher costs than we have in the past, and we may not be
able to attract a large number of these customers. Mobile network operators may
not be successful in rolling out our services, and subscribers to these services
may not seek to use them. Any developments of this kind could limit our ability
to sell our solutions to companies in this industry, may increase our expenses
and may damage our reputation.
INTERNATIONAL MARKETS
In December 2000, we first recognized revenues from sales in international
markets. We had expected that sales in these regions would be a major factor in
our growth, particularly since the use of wireless networks and wireless devices
have generally proceeded more rapidly there. However, some key countries in
these regions have experienced decreasing economic activity, and our sales to
these regions declined beginning in the third quarter of 2001. This trend did
not reverse in 2002 nor in the first half of 2003 and it may not reverse in
subsequent quarters in 2003 and thereafter, resulting in us not being able to
increase our customer base, and accordingly, limited growth from these markets.
LIQUIDITY
In order to help ensure that we would have sufficient capital to take advantage
of our core business opportunities, we have taken significant actions since the
second quarter of 2001 to reduce our operating expenses. However, most of our
operating expenses, such as employee compensation and lease payments for
facilities and equipment, are relatively stable, and these expense levels are
based in part on our expectations regarding future revenues. As a result, any
sustained shortfall in our revenues relative to our expectations would
negatively impact our operating results. Accordingly, if the cost-cutting
actions that we have taken are insufficient, we may not have sufficient capital
to fund our operations, and additional capital may not be available on
acceptable terms, if at all. Any of these outcomes could adversely impact our
ability to respond to competitive pressures or could prevent us from conducting
all or a portion of our planned operations. We may need to undertake additional
measures to reduce our operating expenses in the future.
INVESTMENTS IN OTHER COMPANIES
For year ended December 31, 2001 we realized a loss of $4.6 million on sales of
our long-term investments and recorded a loss provision of $10.0 million against
these investments as they have experienced a significant other than temporary
decline in their value. In addition, in the third quarter of 2002, we recorded
an additional loss provision of $5.3 million. Because of the continuing
volatility in the financial markets, as well as other factors, we expect to
limit the extent to which we make equity investments in other non-core companies
during the next few fiscal quarters, and possibly longer. As a result, we may
not take advantage of investment opportunities that could provide significant
financial benefits to our company, or that could provide us with the opportunity
to build relationships with other companies in our industry and target markets.
INVESTMENTS IN NEW TECHNOLOGIES
During fiscal 2001, we made significant investments in new technology assets to
help expedite customer adoption of our solutions, including interactive voice
response technology, technologies relating to short messaging services and
technology to allow mobile applications to be executed with real-time
interaction. In accordance with our accounting policy, we review the carrying
value of these assets, considering key factors such as our estimate of customer
demand for these assets and the assets' fit with our product strategy. For the
year ended December 31, 2002, we recorded a charge of $2.7 million relating to
our decision not to use these assets that we purchased to resell to our
customers. In the future, if there are any circumstances in which there is a
decline in the carrying value of these assets or if we decide not to pursue
19
these technologies if we determine that customer demand for them is not
substantial, we may need to record additional charges.
RECEIVABLES
A significant portion of our receivables are derived from companies in foreign
countries. Due to varying economic conditions and business practices in these
countries, our collections cycle from these customers may be longer than our
past experience. As adverse economic conditions persist, there is a greater risk
that our customers will have difficulties in paying us in accordance with the
terms of their contracts, and our risk of bad debt may increase substantially in
future fiscal periods.
HOSTING SERVICES
In January 2002, we formalized our plan to transfer the management of our
application hosting services to Computer Sciences Corporation ("CSC"). We will
continue to be dependent on CSC to provide secure hosting services for our
software products. If CSC becomes unable to deliver these services, or other
circumstances occur that affect CSC or its computer systems, our hosting
services may be substantially impaired. If any of these circumstances occur and
cause us to fail to deliver our hosting services, we may lose customers, our
reputation may suffer, and our ability to attract new customers may be damaged.
EMPLOYEES
Our ability to execute our business successfully depends in large part upon our
ability to have a sufficient number of qualified employees to achieve our goals.
However, if our workforce is not properly sized to meet our operating needs, our
ability to achieve and maintain profitability is likely to suffer. As indicated
in this report, we have substantially reduced the number of our employees. This
means that we use a smaller number of employees to conduct some of the
operations that were previously performed by a larger workforce, which could
cause disruption of our business. In addition, the morale of our current
employees may have been adversely affected by previous workforce reductions,
reducing their performance. Our ability to attract potential new employees in
the future may suffer if our reputation suffers as a result of these staffing
reductions.
GROSS MARGINS
We believe that certain factors in the current market may contribute to the risk
that our gross margins will decrease in future fiscal quarters. We may have to
lower our prices, in order to accommodate our customers. In addition, due to the
downturn in the economy, many of our customers are reluctant to make a
commitment to pay a large upfront license fee, which could also cause our
revenues to decrease. With a greater percentage of our revenues coming from
services, if we are not successful in reducing our costs of sales, and our
customers continue to purchase licenses on an as-needed basis, we will
experience a decrease in our gross margins.
LITIGATION
The Company and certain of its present and former officers and directors were
named as defendants in a series of purported class actions relating to our
initial public offering. Litigation may be time consuming, expensive, and
distracting from the conduct of our business, and the outcome of litigation may
be difficult to predict. The adverse resolution of any of these proceedings
could have a material adverse effect on our business, results of operations, and
financial condition.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
IMPACT OF INTEREST RATE EXPOSURE
As of June 30, 2003, we had approximately $25.3 million in cash, cash
equivalents, short-term investments and restricted cash, of which $4.4 million
consisted of short-term investments. A significant portion of the cash earns
interest at variable rates. In addition, although our short-term investments are
fixed-rate instruments, the average term is short. Accordingly, our interest
income is effectively sensitive to changes in the level of prevailing interest
rates. This is partially mitigated by the fact that we generally do not
liquidate our short-term investments before their maturity dates.
IMPACT OF FOREIGN EXCHANGE RATE EXPOSURE
Our functional currency is the U.S. dollar. In the past, the majority of our
non-US dollar denominated expenses were incurred in Canadian dollars. As a
result of our recent restructuring efforts, in the foreseeable future the
majority of our non-US dollar denominated expenses will be incurred in Euros.
Changes in the value of these currencies relative to the U.S. dollar may result
in currency gains and losses, which could affect our operating results. In the
three months ended June 30, 2003, we incurred realized and unrealized foreign
currency losses relating to the translation of our non-US denominated monetary
assets and liabilities of approximately $250,000 as the U.S. dollar declined
significantly against Canadian and European currencies.
ITEM 4. CONTROLS AND PROCEDURES
During the 90-day period prior to the filing date of this report, management,
including the Company's Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness and operation of the Company's disclosure controls
and procedures. The Chief Executive Officer and Chief Financial Officer
concluded that, as of June 30, 2003, the disclosure controls and procedures were
effective, in all material respects, to ensure that information required to be
disclosed in the reports the Company files and submits under the Exchange Act is
recorded, processed, summarized and reported as and when required. There have
been no significant changes in the Company's internal controls or in other
factors, which could significantly affect internal controls subsequent to the
date the Company carried out its evaluation. There were no significant
deficiencies or material weaknesses identified in the evaluation and therefore,
no corrective actions were taken.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been named in several class actions filed in federal court
in the Southern District of New York between approximately June 13, 2001 and
June 28, 2001 (collectively the "IPO Allocation Litigation"). The IPO Allocation
Litigation was filed on behalf of purported classes of plaintiffs who acquired
the Company's common shares during certain periods. These lawsuits have since
been consolidated into a single action and an amended complaint was filed on or
about April 19, 2002. Similar actions have or since been filed against over 300
other issuers that have had initial public offerings since 1998 and all are
included in a single coordinated proceeding in the Southern District of New
York.
The amended complaint in the IPO Allocation Litigation names as defendants,
in addition to the Company, some or all of the current or former directors and
officers of the Company (the "Individual Defendants") and certain underwriters
of the Company's initial public offering of securities (the "Underwriter
Defendants"). In general, the amended complaint alleges that the Underwriter
Defendants: (1) allocated shares of the Company's offering of equity securities
to certain of their customers, in exchange for which these customers agreed to
pay the Underwriter Defendants extra commissions on transactions in other
securities; and (2) allocated shares of the Company's initial public offering to
certain of the Underwriter Defendants' customers, in exchange for which the
customers agreed to purchase additional common shares of the Company in the
after-market at certain pre-determined prices. The amended complaint also
alleges that the Company and the Individual Defendants failed to disclose these
facts and that the Company and the Individual Defendants were aware of, or
disregarded, the Underwriter Defendants' conduct. In October 2002, the
Individual Defendants were dismissed from the IPO Allocation Litigation without
prejudice.
In July 2003, a committee of the Company's Board of Directors conditionally
approved a proposed partial settlement with the plaintiffs in this matter. The
settlement would provide, among other things, a release of the Company and of
the Individual Defendants for the conduct alleged in the action to be wrongful
in the amended complaint. The Company would agree to undertake other
responsibilities under the partial settlement, including agreeing to assign
away, not assert, or release certain potential claims the Company may have
against its underwriters. Any direct financial impact of the proposed settlement
is expected to be borne by the Company's insurers. The committee agreed to
approve the settlement subject to a number of conditions, including the
participation of a substantial number of other issuer defendants in the proposed
settlement, the consent of the Company's insurers to the settlement, and the
completion of acceptable final settlement documentation. Furthermore, the
settlement is subject to a hearing on fairness and approval by the Court
overseeing the IPO Allocation Litigation.
If the proposed settlement is not consummated, the Company intends to
continue to vigorously defend itself and the Individual Defendants against these
claims. However, due to the inherent uncertainties of litigation, and because
the IPO Litigation is at a preliminary stage, we cannot accurately predict the
ultimate outcome IPO Allocation Litigation.
ITEM 2. CHANGES IN SECURITIES
RIGHTS PLAN. On January 22, 2003, the Company's Board of Directors
authorized the Company to adopt a shareholder rights plan. On February 10, 2003,
the Company and Computershare Trust Company of Canada, as Rights Agent, entered
into a Shareholders Rights Plan Agreement (the "Rights Plan") and one right
(each, a "Right") was issued under the Rights Plan and attached to each
outstanding common
22
share of the Company. The Rights Plan was ratified by the Company's shareholders
at the annual shareholders' meeting held in April on April 24, 2003 (the "Annual
Meeting"). A Right only becomes exercisable upon the occurrence of a Flip-In
Event, which is a transaction in which a person becomes an Acquiring Person and
which otherwise does not meet the requirements of a Permitted Bid or certain
other limited exceptions (as such terms are defined in the Rights Plan).
When exercised, a Right entitles each shareholder who is not then
attempting to acquire control of the Company to purchase additional common
shares at a substantial discount to market value. Any such purchase would cause
substantial dilution to the person or group of persons attempting to acquire
control of the Company, other than by way of a Permitted Bid. The Rights will
expire on the termination of the Rights Plan, unless redeemed before such time.
The Rights Plan has been filed with the Securities and Exchange Commission
on the Company's Form 8-K, dated January 22, 2003.
CONSOLIDATION. At the Annual Meeting, the Company's shareholders approved a
ten (old) for one (new) reverse stock split. The Company's common shares began
trading on a consolidated basis on the Nasdaq SmallCap Market and the Toronto
Stock Exchange on April 28, 2003. In June 2003, the Company's common shares
ceased trading on the Nasdaq SmallCap Market, and began trading on the Nasdaq
National Market.
CONTINUANCE. At the Annual Meeting, the Company's shareholders approved
continuance (the "Continuance") of the Company under the Canada Business
Corporations Act (the "CBCA"). As a result, the Company continued its corporate
existence governed by the laws of the CBCA rather than the Ontario Business
Corporations Act. The Company believes that the Continuance will not materially
affect the share capital in the Company in any way.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Registrant's Annual and Special Meeting of Shareholders (the "Meeting")
was held on April 24, 2003. The following matters were submitted to the
Registrant's shareholders for their vote, and the results of the vote taken at
the Meeting were as follows:
1. Each of the Registrant's directors standing for election was
elected for a one year term:
(a) Gregory H. Wolfond: 21,069,848 votes for; 504,291 votes withheld; 0 broker held non-voted shares;
(b) John J. Sims: 21,270,343 votes for; 303,796 votes withheld; 0 broker held non-voted shares;
(c) Barry J. Reiter: 21,082,475 votes for; 491,664 votes withheld; 0 broker held non-voted shares;
(d) Lloyd F. Darlington: 21,004,717 votes for; 569,422 votes withheld; 0 broker held non-voted shares;
(e) James D. Dixon: 20,821,401 votes for; 752,738 votes withheld; 0 broker held non-voted shares;
(f) J. Ian Giffen: 21,065,135 votes for; 509,004 votes withheld; 0 broker held non-voted shares; and
(g) Joseph Aragona: 21,000,285 votes for; 573,854 votes withheld; 0 broker held non-voted shares
2. The appointment of KPMG LLP, as the Registrant's independent
auditors for fiscal 2003:
21,428,425 votes for; 94,543 votes against; 50,171 abstentions;
and 1,000 broker held non-voted shares.
23
3. A resolution in the form authorizing the continuance of the
Registrant under the Canada Business Corporations Act (the
"Continuance"):
21,197,324 votes for; 124,810 votes against; 252,005 abstentions;
and 0 broker held non-voted shares.
4. A resolution repealing the previous by-laws of the Registrant and
enacting new by-laws effective upon the Continuance:
21,164,204 votes for; 151,441 votes against; 258,494 abstentions;
and 0 broker held non-voted shares.
5. A resolution authorizing the consolidation of the issued and
outstanding common shares of the Registrant on a ten (10) old for
one (1) new common share basis:
20,835,536 votes for; 730,130 votes against; 8,473 abstentions;
and 0 broker held non-voted shares.
6. A resolution ratifying, confirming and approving the Registrant's
shareholder rights plan:
19,731,626 votes for; 1,769,217 votes against; 73,296
abstentions; and 0 broker held non-voted shares.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The following exhibits are filed with this Report:
No. Description
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act 2002
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act 2002
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act 2002
32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act 2002
(b) Reports on Form 8-K:
During the period covered by this Report, the Company filed two
report on Form 8-K:
April 4, 2003: reporting the Company's estimated revenues for
the three months ended March 31, 2003.
April 24, 2003: reporting the Company's results of operations
for the three months ended March 31, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURES TITLES DATE
---------- ------ -----
/s/ John J. Sims Chief Executive Officer (principal August 8, 2003
- ----------------- executive officer)
John J. Sims
/s/ Glenn Barrett Chief Financial Officer (principal August 8, 2003
- ------------------ financial and accounting officer)
Glenn Barrett
25