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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
Commission file number 0-28572
OPTIMAL GROUP INC.
(Exact name of registrant as specified in its charter)
CANADA 98-0160833
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
3400 de Maisonneuve Blvd. W., 12th floor, Montreal, Quebec, Canada H3Z 3B8
(514) 738-8885
(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 |X| No |_|
At August 6, 2004, the registrant had 22,201,531 Class "A" shares (without
nominal or par value) outstanding.
-1-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Financial Statements of
(Unaudited)
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Six-month periods ended June 30, 2004 and 2003
(expressed in US dollars)
-2-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Financial Statements
(Unaudited)
Six-month periods ended June 30, 2004 and 2003
(expressed in US dollars)
Financial Statements
Consolidated Balance Sheets.......................................... 4
Consolidated Statements of Operations................................ 5
Consolidated Statements of Deficit................................... 6
Consolidated Statements of Cash Flows................................ 7
Notes to Consolidated Financial Statements........................... 8
-3-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Balance Sheets
(Unaudited)
June 30, 2004 and December 31, 2003
(expressed in US dollars)
===============================================================================================================
June 30, December 31,
2004 2003
- ---------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 2,772,713 $ 4,211,964
Short-term investments 161,540,386 74,301,582
Cash and short-term investments - held as reserves (note 4) 23,033,572 --
Accounts receivable, net of allowance for doubtful accounts
of $94,889 ($134,977 at December 31, 2003) 6,403,909 4,793,435
Service parts inventory 2,058,353 4,215,694
Income taxes receivable and refundable investment tax credits 1,554,750 922,130
Future income taxes 169,111 331,829
Prepaid expenses and deposits 1,648,799 795,931
Current assets related to discontinued operations (note 3 (c)) -- 25,291,718
----------------------------------------------------------------------------------------------------------
199,181,593 114,864,283
Note receivable 1,550,176 --
Other receivable (note 5) 3,122,613 --
Property and equipment 4,369,332 1,931,331
Goodwill and other intangible assets (note 6) 56,939,879 10,517,416
Deferred compensation cost (note 3 (b)) 2,374,486 --
Non-refundable investment tax credits 3,364,825 --
Future income taxes 6,403,115 2,278,016
Long-term assets related to discontinued operations (note 3 (c)) -- 5,951,279
- ---------------------------------------------------------------------------------------------------------------
$ 277,306,019 $ 135,542,325
===============================================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
Bank indebtedness (note 7) $ 10,356,442 $ 10,726,076
Customer reserves and security deposits (note 4) 63,292,345 --
Accounts payable and accrued liabilities 22,771,441 5,569,250
Deferred revenue 3,849,228 1,302,146
Current portion of obligations under capital leases 358,357 --
Future income taxes 133,806 133,806
Current liabilities related to discontinued operations (note 3 (c)) -- 4,388,826
----------------------------------------------------------------------------------------------------------
100,761,619 22,120,104
Future income taxes 3,674,120 129,583
Deferred revenue 318,168 --
Obligations under capital leases 270,224 --
Shareholders' equity:
Share capital (note 8) 183,547,829 122,102,244
Additional paid-in capital 7,515,887 5,282
Deficit (17,169,821) (7,330,417)
Cumulative translation adjustment (1,612,007) (1,484,471)
----------------------------------------------------------------------------------------------------------
172,281,888 113,292,638
Contingencies (note 9)
Subsequent event (note 16)
- ---------------------------------------------------------------------------------------------------------------
$ 277,306,019 $ 135,542,325
===============================================================================================================
See accompanying notes to unaudited consolidated financial statements.
-4-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Statements of Operations
(Unaudited)
Periods ended June 30, 2004 and 2003
(expressed in US dollars)
=====================================================================================================================
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------
Revenues $ 24,041,660 $ 2,093,825 $ 34,322,086 $ 4,196,779
Expenses:
Transaction processing and
service costs 14,049,474 1,381,705 21,372,410 2,804,005
Selling, general and administrative 9,054,974 2,624,279 14,331,120 4,606,127
Research and development 458,237 -- 458,237 --
Operating leases 1,120,576 199,081 1,854,304 320,925
----------------------------------------------------------------------------------------------------------------
24,683,261 4,205,065 38,016,071 7,731,057
Investment income 375,201 242,740 560,472 511,162
- ---------------------------------------------------------------------------------------------------------------------
Loss before undernoted items (266,400) (1,868,500) (3,133,513) (3,023,116)
Restructuring costs (note 10) 1,324,648 -- 1,324,648 108,900
Inventory write-downs (note 10) 2,429,989 -- 2,930,536 --
Stock-based compensation
(notes 3 (b) and 10) 1,933,713 -- 1,933,713 --
Amortization of intangibles 659,372 39,318 841,494 78,641
Amortization of property and equipment 609,295 118,040 790,585 222,189
Foreign exchange 89,964 19,376 (61,550) 173,132
- ---------------------------------------------------------------------------------------------------------------------
7,046,981 176,734 7,759,426 582,862
- ---------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (7,313,381) (2,045,234) (10,892,939) (3,605,978)
(Provision for) recovery of
income taxes (note 11) (308,283) 1,073,000 19,717 2,879,000
- ---------------------------------------------------------------------------------------------------------------------
Loss from continuing operations (7,621,664) (972,234) (10,873,222) (726,978)
Loss from discontinued operations
(note 3 (c)) (3,188,760) (245,089) (3,130,527) (471,253)
Gain on disposal of net assets from
discontinued operations, net of
income taxes of $2,342,000 (note 3 (c)) 4,164,345 -- 4,164,345 --
- ---------------------------------------------------------------------------------------------------------------------
Net loss $ (6,646,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
=====================================================================================================================
Weighted average number of shares:
Basic 21,702,051 14,936,235 18,337,833 14,936,235
Plus impact of stock options -- 426 506 213
- ---------------------------------------------------------------------------------------------------------------------
Diluted 21,702,051 14,936,661 18,338,399 14,936,448
=====================================================================================================================
Earnings per share :
Continuing operations:
Basic $ (0.35) $ (0.07) $ (0.59) $ (0.05)
Diluted (0.35) (0.07) (0.59) (0.05)
Discontinued operations:
Basic 0.04 (0.01) 0.05 (0.03)
Diluted 0.04 (0.01) 0.05 (0.03)
Total:
Basic (0.31) (0.08) (0.54) (0.08)
Diluted (0.31) (0.08) (0.54) (0.08)
=====================================================================================================================
See accompanying notes to unaudited consolidated financial statements.
-5-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Statements of Deficit
(Unaudited)
Periods ended June 30, 2004 and 2003
(expressed in US dollars)
=======================================================================================================
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------
Deficit, beginning of period $(10,523,742) $ (1,142,933) $ (7,330,417) $ (1,162,025)
Net loss (6,646,079) (1,217,323) (9,839,404) (1,198,231)
- -------------------------------------------------------------------------------------------------------
Deficit, end of period $(17,169,821) $ (2,360,256) $(17,169,821) $ (2,360,256)
=======================================================================================================
See accompanying notes to unaudited consolidated financial statements.
-6-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Consolidated Statements of Cash Flows
(Unaudited)
Periods ended June 30, 2004 and 2003
(expressed in US dollars)
============================================================================================================================
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Loss from continuing operations $ (7,621,664) $ (972,234) $(10,873,222) $ (726,978)
Adjustments for:
Amortization 1,268,667 157,358 1,632,079 300,831
Stock-based compensation 1,933,713 -- 1,933,713 --
Inventory write-downs 2,429,989 -- 2,930,536 --
Future income taxes 282,283 (313,000) (45,717) (1,699,000)
Changes in operating assets and liabilities:
Accounts receivable 742,190 874,118 1,100,837 622,866
Service parts inventory 89,762 (93,401) (27,467) (131,126)
Income taxes and credits receivable (44,023) (828,689) (44,023) (1,597,419)
Prepaid expenses and deposits (45,753) (196,992) (313,459) (542,310)
Accounts payable and
accrued liabilities 503,885 (399,733) 165,068 (350,310)
Customer reserves and
security deposits (9,966,565) -- (9,966,565) --
Deferred revenue (373,335) 33,548 (69,684) 102,368
-----------------------------------------------------------------------------------------------------------------------
(10,800,851) (1,739,025) (13,577,904) (4,021,078)
Cash flows from investing activities:
Additions to property and equipment (1,248,921) (226,402) (1,550,439) (248,575)
(Increase) decrease in short-term
investments (27,950,846) 2,386,103 (20,137,639) 1,908,816
Proceeds from note receivable 147,465 -- 147,465 --
Proceeds from sale of business, before
repayment of purchase price
adjustment in July 2004 35,000,000 -- 35,000,000 --
Proceeds from disposal of EBS
(note 3 (d)) 3,974,495 -- 3,974,495 --
Acquisition costs (note 3 (b)) (1,027,843) -- (1,377,828) --
Acquisition of Systech (note 3 (a)) (464,556) -- (3,464,556) --
-----------------------------------------------------------------------------------------------------------------------
8,429,794 2,159,701 12,591,498 1,660,241
Cash flows from financing activities:
Bank indebtedness (106,445) -- (369,634) --
Proceeds from issuance of share capita l32,000 -- 32,000 --
Repayment of obligation under
capital lease (103,482) -- (103,482) --
-----------------------------------------------------------------------------------------------------------------------
(177,927) -- (441,116) --
- ----------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash during the
period (2,548,984) 420,676 (1,427,522) (2,360,837)
Net increase (decrease) in cash
from discontinued operations (1,705,514) 340,823 106,441 (2,895,119)
Effect of foreign exchange (118,170) -- (118,170) --
Cash, beginning of period 7,145,381 3,597,893 4,211,964 9,615,348
- ----------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 2,772,713 $ 4,359,392 $ 2,772,713 $ 4,359,392
============================================================================================================================
Supplemental cash flow disclosure (note 12)
See accompanying notes to unaudited consolidated financial statements.
-7-
OPTIMAL GROUP INC.
(formerly Optimal Robotics Corp.)
Notes to Consolidated Financial Statements
(Unaudited)
Six-month periods ended June 30, 2004 and 2003
(expressed in US dollars)
================================================================================
1. Interim financial information:
These consolidated financial statements have been prepared by management
in accordance with Canadian generally accepted accounting principles. The
unaudited balance sheet as at June 30, 2004 and the unaudited statements
of operations, deficit and cash flows for the three and six-month periods
ended June 30, 2004 and 2003 reflect all adjustments which, in the opinion
of management, are necessary to present a fair statement of the results of
the interim periods presented. The results of operations and cash flows
for any quarter are not necessarily indicative of the results or cash
flows for an entire year. These interim consolidated financial statements
follow the same accounting policies and methods of their application as
described in note 2 of the annual audited consolidated financial
statements for the year ended December 31, 2003, except as described in
note 2 below. The interim consolidated financial statements do not include
all disclosures required for annual financial statements and should be
read in conjunction with the most recent annual audited consolidated
financial statements of Optimal Group Inc. (formerly Optimal Robotics
Corp.) (the "Company") as at and for the year ended December 31, 2003.
All amounts in the attached notes are unaudited unless specifically
identified.
2. Significant accounting policies and new accounting standards:
(a) Discontinued operations:
As a result of the sale of the U-Scan(R) self-checkout business
referred to in note 3 (c), the results of discontinued operations
are included in the net loss but recorded separately for current and
prior periods. The balance sheet presents the current and long-term
assets and liabilities related to the discontinued operations for
the current and prior periods.
(b) Revenue recognition:
As a result of the business acquisitions and disposals referred to
in note 3, the Company is engaged in payment services, and, in
addition, provides hardware maintenance and repair outsourcing
services throughout North America.
Revenues from payment services are recognized at the time services
are rendered. Revenues for set-up fees are deferred and recognized
over the expected term of the customer relationship.
Revenues from repair services are recognized at the time the
services are rendered. Revenues from maintenance contracts are
deferred and amortized ratably over the term of the contract.
-8-
2. Significant accounting policies and new accounting standards (continued):
(c) Amortization:
Intangibles are being amortized using the straight-line method over
the following periods:
=====================================================================================================
Customer contracts and customer relationships 42 - 72 months
Acquired technology 60 months
Customer list 44 months
Deferred compensation cost Vesting period for periods
ranging up to 36 months
=====================================================================================================
Amortization of property and equipment is provided for over the
estimated useful lives of the assets using the straight-line method
at the following annual rates:
=====================================================================================================
Computer equipment and software 33 - 50%
Equipment 10 - 20%
Leasehold improvements Lease term
=====================================================================================================
(d) Stock-based compensation:
Effective January 1, 2003, the Company adopted the fair value-based
method to account for stock-based compensation and other stock-based
payments. Under the fair value-based method, compensation cost is
measured at fair value at the date of grant and is expensed over the
award's vesting period.
-9-
2. Significant accounting policies and new accounting standards (continued):
(d) Stock-based compensation (continued):
In accordance with the standard, the following disclosure is
required to report the pro forma net earnings (loss) and earnings
(loss) per share as if the fair value-based method had been used to
account for employee stock options granted during fiscal 2002:
===================================================================================================================
Three months ended June 30, Six months ended June 30,
-------------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Net loss, as reported $ (6,646,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
Add:
Total stock-based employee
compensation expense
determined under fair
value-based method for all
awards granted in fiscal 2002,
net of related taxes of nil -- (270,752) -- (732,673)
-------------------------------------------------------------------------------------------------------------------
Pro forma net loss $ (6,646,079) $ (1,488,075) $ (9,839,404) $ (1,930,904)
===================================================================================================================
===================================================================================================================
Three months ended June 30, Six months ended June 30,
-------------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Loss per share:
Basic:
As reported $ (0.31) $ (0.08) $ (0.54) $ (0.08)
Pro forma (0.31) (0.10) (0.54) (0.13)
Diluted:
As reported (0.31) (0.08) (0.54) (0.08)
Pro forma (0.31) (0.10) (0.54) (0.13)
===================================================================================================================
There were no stock options granted in the three and six-month
periods ended June 30, 2003. The pro forma adjustment for fiscal
2003 relates to the amortization of compensation cost for stock
options granted during fiscal 2002 over the vesting periods.
-10-
2. Significant accounting policies and new accounting standards (continued):
(e) Foreign exchange:
The accounts of Terra Payments Inc. ("Terra"), acquired on April 6,
2004 and considered a self-sustaining enterprise, have been
translated using the current-rate method. Under this method, assets
and liabilities are translated into US dollars at the exchange rate
in effect at the balance sheet date. Revenues and expenses are
translated at the average rates prevailing during the period.
Resulting unrealized gains or losses are accumulated and reported as
a "cumulative translation adjustment" in shareholders' equity.
All other subsidiaries are integrated subsidiaries and are accounted
for under the temporal method. Under this method, monetary assets
and liabilities are translated at the exchange rate in effect at the
balance sheet date. Non-monetary assets and liabilities are
translated at historical rates. Revenues and expenses are translated
at average rates for the period. Exchange gains or losses arising
from translation from these transactions are included in the
statement of operations.
(f) Asset retirement obligations:
On January 1, 2004, the Company adopted the new recommendations of
the Canadian Institute of Chartered Accountants relating to asset
retirement obligations. This standard was established for the
recognition, measurement and disclosure of liabilities for asset
retirement obligations and the associated retirement cost. The
standard applies to legal obligations associated with the retirement
of a tangible long-lived asset that results from acquisition,
development or normal operations. The standard requires an entity to
record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred and when a
reasonable estimate of fair value can be made. An entity is
subsequently required to allocate the asset retirement cost to
expense using a systematic and rational method over its estimated
life. The adoption of this standard did not have an impact on the
Company's financial statements.
3. Business acquisitions and disposals:
(a) Systech Retail Systems:
On February 27, 2004, the Company acquired the hardware service
division of Systech Retail Systems ("Systech"). The Company believes
that the combination of this division with Optimal's existing
service organization will contribute positively to the Company's
financial results in 2004.
The net assets acquired for cash were approximately $3.5 million.
The acquisition is accounted for by the Company using the purchase
method and the results of Systech are consolidated with those of the
Company from the date of acquisition.
-11-
3. Business acquisitions and disposals (continued):
(a) Systech Retail Systems (continued):
The following table summarizes the estimated fair value of the
assets acquired and liabilities assumed at the date of acquisition.
The Company is in the process of finalizing its valuation of the net
assets acquired, including goodwill and other intangible assets;
thus, the allocation of the purchase price is subject to refinement.
====================================================================
Assets acquired:
Accounts receivable $ 1,428,411
Inventories 745,728
Property and equipment 273,706
Prepaid expenses and deposits 64,536
Customer contracts and customer relationships 612,332
Goodwill 4,364,411
---------------------------------------------------------------
7,489,124
Liabilities assumed:
Accounts payable and accrued liabilities 1,533,571
Deferred revenue 2,490,997
---------------------------------------------------------------
4,024,568
--------------------------------------------------------------------
Net assets acquired for cash $ 3,464,556
====================================================================
During the period ended June 30, 2004, the Company adjusted the fair
value of inventories acquired at the date of acquisition to $745,728
from $3,620,125 for service parts that could not be used by the
Company, increased accrued liabilities assumed by $475,078 for
accrued vacation due to Systech employees at the date of acquisition
and recorded a value of $612,332 as the estimated fair value of the
customer contracts and customer relationships.
(b) Terra Payments Inc.:
Effective April 6, 2004, the Company completed a Combination
Agreement with Terra Payments Inc. ("Terra"), a Canadian
publicly-traded company that offers proprietary technology and
services to businesses to accept credit card, electronic check and
direct debit payments. Terra processes credit card payments
primarily for non-face-to-face transactions, including
mail-order/telephone order, licensed online gaming and other online
merchants, as well as for retail point-of-sale merchants. Terra also
processes checks and direct debits online and by telephone. The
Company believes that this transaction will provide a platform for
enhanced growth and profitability.
-12-
3. Business acquisitions and disposals (continued):
(b) Terra Payments Inc. (continued):
The agreement provided for a stock-for-stock merger in which 0.4532
of the Company's common shares were exchanged for each share of
Terra. The total purchase price of $65,993,820 was paid through the
issuance of 7,242,168 Class A shares by the Company, the acquisition
of outstanding options and warrants issued by Terra and estimated
transaction costs of the Company.
The acquisition is accounted for by the Company using the purchase
method. The following table presents the estimated fair value of the
assets and liabilities of Terra on April 6, 2004. The Company is in
the process of finalizing its valuation of the net assets acquired,
including goodwill and other intangible assets; thus, the allocation
of the purchase price is subject to refinement.
===========================================================================
Assets acquired:
Short-term investments $ 66,579,709
Cash and short-term investments - held as reserves 23,555,028
Accounts receivable 1,282,900
Refundable investment tax credits receivable 588,597
Prepaid expenses and deposits 474,873
Property and equipment 1,466,194
Investment in ebs Electronic Billing Systems AG 3,974,495
Note receivable 1,697,640
Other assets 3,122,490
Non-refundable investment tax credits 3,330,343
Future income taxes 6,750,092
Customer contracts and customer relationships 5,456,000
Acquired technology 4,520,000
Non-deductible goodwill 32,249,461
----------------------------------------------------------------------
155,047,822
Liabilities assumed:
Accounts payable and accrued liabilities 10,697,312
Deferred revenue 443,937
Customer reserves and security deposits 73,258,910
Future income taxes 3,921,780
Obligations under capital leases 732,063
----------------------------------------------------------------------
89,054,002
---------------------------------------------------------------------------
Net assets acquired $ 65,993,820
===========================================================================
-13-
3. Business acquisitions and disposals (continued):
(b) Terra Payments Inc. (continued):
========================================================================================
Consideration:
7,242,168 common shares $ 61,413,585
Transaction costs 1,377,828
Options and warrants 5,877,330
Less: options and warrants considered deferred compensation (2,674,923)
----------------------------------------------------------------------------------------
Total purchase price $ 65,993,820
========================================================================================
The per share value of the shares issued as consideration for the
business acquisition was $8.48, which was determined using the
Company's average closing share price on NASDAQ over a reasonable
period before and after the date the terms of the business
combination were agreed to and announced.
The Company assumed 1,587,058 stock options and warrants having a
fair value of $5,877,330, or a weighted average of $3.70 per share,
relating to the Terra outstanding stock options and warrants. This
also represents 0.4532 stock option or warrant of the Company for
each stock option or warrant of Terra. The fair value of the vested
stock options and warrants of $3,202,407 is included in the purchase
consideration. The remaining $2,674,923 representing the fair value
of the unvested stock options, is recorded as deferred compensation
cost and is being amortized over the vesting periods. For the three
and six months ended June 30, 2004, an amount of $300,437 was
amortized as stock-based compensation in the consolidated statements
of operations.
The fair values were determined using the Black-Scholes option
pricing model using the following weighted average assumptions:
========================================================================================
Expected volatility 70%
Expected life 2.9 years
Risk-free interest rate 2%
Dividend rate 0%
========================================================================================
-14-
3. Business acquisitions and disposals (continued):
(c) Sale of U-Scan(R) self-checkout business:
Effective April 8, 2004, the Company sold its U-Scan(R)
self-checkout business to Fujitsu Transaction Solutions Inc.
("Fujitsu"), including all related tangible assets, intellectual
property rights, and obligations, for $35,000,000 in cash plus the
assumption of liabilities. Fujitsu funded the payment of a
termination fee owed by the Company to NCR Corporation as a result
of the termination of their offer to purchase the self-checkout
business. Included in accounts payable and accrued liabilities at
June 30, 2004 is an amount of $4,806,240 owing to Fujitsu due to
purchase price adjustments mainly attributed to there being less net
assets sold to Fujitsu as the Company collected a large portion of
the accounts receivable and realized the cash thereon in advance of
the sale. Thus, the net proceeds realized on the sale to Fujitsu
were $30,193,760.
The sale of the U-Scan(R) self-checkout business is consistent with
the Company's strategy to reposition the business as a payments and
services leader. As a result of weak capital spending environment
for retail technology and a significantly more competitive landscape
in the self-checkout business, which negatively impacted sales,
gross margins and overall financial results, the Company decided to
exit this business and focus on building a payments and services
business.
-15-
3. Business acquisitions and disposals (continued):
(c) Sale of U-Scan(R) self-checkout business (continued):
The following table summarizes the book value of the assets and
liabilities at April 8, 2004 and December 31, 2003 relating to the
business sold by the Company:
================================================================================================
April 8, December 31,
2004 2003
------------------------------------------------------------------------------------------------
Current assets:
Accounts receivable $ 8,193,454 $ 6,289,527
Inventories 17,915,397 18,722,431
Prepaid expenses and deposits 169,347 279,760
-------------------------------------------------------------------------------------------
26,278,198 25,291,718
Long-term assets:
Property and equipment 3,936,821 4,358,857
Intangible assets 3,500,444 1,592,422
-------------------------------------------------------------------------------------------
7,437,265 5,951,279
Current liabilities:
Accounts payable accrued liabilities 2,896,110 2,830,850
Deferred revenue 7,131,938 1,557,976
-------------------------------------------------------------------------------------------
10,028,048 4,388,826
------------------------------------------------------------------------------------------------
Net assets relating to U-Scan(R) self-checkout business 23,687,415 26,854,171
Proceeds from sale 30,193,760 N/A
------------------------------------------------------------------------------------------------
Gain on sale of net assets of U-Scan(R) self-checkout business
before income taxes 6,506,345 N/A
Income taxes 2,342,000 N/A
------------------------------------------------------------------------------------------------
Net gain on sale of net assets of U-Scan(R) self-checkout
business $ 4,164,345 $ N/A
================================================================================================
-16-
3. Business acquisitions and disposals (continued):
(c) Sale of U-Scan(R) self-checkout business (continued):
The results of operations of this business for the three and six
months ended June 30, 2004 and 2003 were as follows:
========================================================================================================
Three months ended June 30, Six months ended June 30,
--------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------
Systems and hardware service
revenue $ 734,783 $ 14,485,661 $ 10,870,032 $ 28,682,933
Cost of sales 1,037,814 10,283,699 6,929,014 19,545,480
--------------------------------------------------------------------------------------------------------
(303,031) 4,201,962 3,941,018 9,137,453
Expenses:
Selling, general and
administrative 2,830,738 3,565,655 5,968,133 7,727,352
Amortization 54,991 542,231 664,195 1,030,992
Operating leases -- 209,697 237,363 504,010
Research and development -- 293,468 201,854 522,752
Restructuring costs -- -- -- 138,600
---------------------------------------------------------------------------------------------------
2,885,729 4,611,051 7,071,545 9,923,706
--------------------------------------------------------------------------------------------------------
Loss before income taxes (3,188,760) (409,089) (3,130,527) (786,253)
Income taxes recovery -- 164,000 -- 315,000
--------------------------------------------------------------------------------------------------------
Net loss from discontinued
operations $ (3,188,760) $ (245,089) $ (3,130,527) $ (471,253)
========================================================================================================
The results of operations include management assumptions and
adjustments related to cost allocations which are inherently
subjective.
(d) Disposition of ebs Electronic Billing Systems AG:
In May 2004, the Company sold its investment in ebs Electronic
Billing Systems AG ("EBS") to EBS' majority shareholder for a net
cash consideration of $3,974,495, which was the fair value of the
investment recorded by the Company upon the acquisition of Terra at
April 6, 2004. Accordingly, there was no gain or loss on this
transaction.
-17-
3. Business acquisitions and disposals (continued):
(e) RBA Inc.:
On September 30, 2003, the Company acquired substantially all of the
assets and the ongoing business of RBA Inc. ("RBA"), a company that
provides hardware maintenance outsourcing services, including
debit/credit card system maintenance and computer maintenance
services, across Canada.
The net assets acquired for cash are approximately $6.0 million
(CA$8.1 million), subject to the determination of certain
post-closing adjustments, if any. The acquisition is accounted for
by the Company using the purchase method and the results of RBA are
consolidated with those of the Company from the date of acquisition.
In fiscal 2004, an adjustment of $139,327 was made to increase
goodwill attributable to the acquisition of the ongoing business of
RBA Inc. for liabilities estimated at time of the acquisition. As at
June 30, 2004, the Company is still in the process of finalizing its
valuation of the net assets acquired, including the determination of
post-closing adjustments and the allocation to goodwill and to other
intangible assets; thus, the allocation of the purchase price is
subject to final modifications.
4. Cash and short-term investments held as reserves, and customer reserves
and security deposits:
Cash and short-term investments held as reserves:
The Company has agreements with various financial institutions for the
settlement of payment transactions. Under the terms of these agreements,
the Company is required to maintain certain amounts as reserves, which may
be applied against any amounts for which the financial institutions would
be entitled to reimbursement. Any amounts charged by the financial
institutions are charged to the Company's customers.
Customer reserves and security deposits:
Customer reserves and security deposits are required from the customers to
allow the Company to recover any amounts charged by the financial
institutions under the arrangements described above. Customer reserves
relate to the short-term portion of collateral and outstanding payments
due to customers. Security deposits are held by the Company over the term
of the customer relationship, which has generally been of a long-term
nature.
5. Other receivable:
During Terra's fiscal year ended March 31, 2002, Terra was assessed a
charge of $6.8 million (CA$8.8 million) by one of its credit card
suppliers of services. This amount was withdrawn by the supplier from
Terra's bank account. The Company believes this charge is largely
unsubstantiated and is pursuing the claim through legal recourse. A
provision of $3.7 million has been made against the amount receivable.
-18-
6. Goodwill and other intangible assets:
----------------------------------------------------------------------------------------------------
June 30,
2004
----------------------------------------------------------------------------------------------------
Gross carrying Accumulated Net book
amount amortization value
----------------------------------------------------------------------------------------------------
Goodwill $ 43,708,452 $ 141,750 $ 43,566,702
Customer contracts and customer
relationships 9,468,052 756,082 8,711,970
Acquired technology 4,520,000 226,000 4,294,000
Customer list 786,414 419,207 367,207
----------------------------------------------------------------------------------------------------
$ 58,482,918 $ 1,543,039 $ 56,939,879
====================================================================================================
====================================================================================================
December 31,
2003
----------------------------------------------------------------------------------------------------
Gross carrying Accumulated Net book
amount amortization value
----------------------------------------------------------------------------------------------------
Goodwill $ 6,955,251 $ 141,750 $ 6,813,501
Customer contracts and customer
relationships 3,399,720 141,655 3,258,065
Customer list 786,414 340,564 445,850
----------------------------------------------------------------------------------------------------
$ 11,141,385 $ 623,969 $ 10,517,416
====================================================================================================
7. Bank indebtedness:
The Company has credit facilities in the amount of approximately CA$15
million (U.S.$11.6 million), which can be utilized in the form of loans or
bankers' acceptances in Canadian dollars. At June 30, 2004, the Company
utilized US$10,356,442 of the facilities. The borrowings are due on demand
and bear interest either at the bank's prime rate or the market rate for
bankers' acceptances plus an acceptance fee of 0.75% per annum, depending
on the form of the facility utilized. The facilities are secured by a
first ranking moveable hypothec on short-term investments.
-19-
8. Share capital:
(a) Issued and outstanding share capital were as follows:
=====================================================================================================
June 30, 2004 December 31, 2003
------------------------------- -------------------------------
Number Book value Number Book value
-----------------------------------------------------------------------------------------------------
Common shares 22,183,403 $ 183,547,829 14,936,235 $ 122,102,244
=====================================================================================================
Changes in the issued and outstanding share capital were as follows:
=====================================================================================================
Book
Number value
-----------------------------------------------------------------------------------------------------
Balance, December 31, 2003 14,936,235 $ 122,102,244
Shares issued on acquisition of Terra (note 3 (b)) 7,242,168 61,413,585
Exercise of options 5,000 32,000
-----------------------------------------------------------------------------------------------------
Balance, June 30, 2004 22,183,403 $ 183,547,829
=====================================================================================================
(b) Stock options:
Details of the outstanding stock options are as follows:
=====================================================================================================
Weighted-average
exercise price
Number per share
-----------------------------------------------------------------------------------------------------
Balance, December 31, 2003 5,000 $ 6.40
Granted 4,606,926 7.10
Expired/cancelled (50,000) 7.10
Exercised (5,000) 6.40
-----------------------------------------------------------------------------------------------------
Balance, June 30, 2004 4,556,926 $ 7.10
=====================================================================================================
During the period ended June 30, 2004, the Company granted 4,606,926
stock options having an exercise price of $7.10 per share. Included
in the stock option grants are 3,484,417 stock options that have
certain performance vesting triggers tied to the market price of the
Company's shares.
-20-
8. Share capital (continued):
(b) Stock options (continued):
Under the terms of the Combination Agreement with Terra, the Company
assumed Terra's stock option plan, as such, stock options governed
by this plan will be exercisable for the Company's common shares.
The exercise price and number of options outstanding on April 6,
2004, the effective date of the acquisition of Terra, were adjusted
based on the exchange ratio of 0.4532 of the Company's common shares
for each share of Terra.
Details of the outstanding stock options under this plan are as
follows:
==================================================================================================
US dollar exercise price Canadian dollar exercise price
--------------------------------------------------------------------------------------------------
Weighted-average Weighted-average
exercise price exercise price
Number per share Number per share
--------------------------------------------------------------------------------------------------
Balance, April 6, 2004 217,451 $ 7.43 611,541 $ 16.24
Expired/cancelled -- -- (16,829) 6.04
--------------------------------------------------------------------------------------------------
Balance, June 30, 2004 217,451 $ 7.43 594,712 $ 12.10
==================================================================================================
As at April 6, 2004 and June 30, 2004, there was 758,066 warrants
outstanding with a weighted average exercise price of CA$9.43 and
expiring on December 19, 2005.
There are 6,143,984 options and warrants that could potentially
dilute basic earnings per share in the future that were not included
in the computation of diluted earnings per share because to do so
would have been antidilutive for the period ended June 30, 2004.
9. Contingencies:
(a) The Company received a legal letter from a claimant in 1999, and
again in February 2001, alleging infringement of a patent related to
the U-Scan(R) self-checkout business. In March 2003, this claimant
also sent a third demand letter alleging infringement of additional
patents. The Company believes these claims to be without merit and
intends to vigorously defend its position should this claimant
initiate a civil action. No amounts have been specified in these
claims. It is not possible at this time to make an estimate of the
amount of damages, if any, that may result and, accordingly, no
provision has been made in these financial statements with respect
to such claims.
-21-
9. Contingencies (continued):
(b) In connection with the sale of the U-Scan(R) self-checkout business
on April 8, 2004 to Fujitsu, orders were obtained from the Superior
Court of Quebec permitting the Company to submit the sale to Fujitsu
to the Company's shareholders for approval in lieu of the originally
proposed sale to NCR Corporation ("NCR"). NCR is seeking to appeal
these decisions. The Company believes that these appeals will not
prevail. NCR has also delivered a notice of dispute under its now
terminated purchase agreement alleging a breach of the
non-solicitation provisions of that agreement. The Company believes
that such allegations are without merit and intends to vigorously
defend itself in any arbitration proceedings that may ensue.
Accordingly, no provision has been made in these financial
statements with respect to such claims.
(c) The Company is contractually bound to indemnify Fujitsu for any
losses, claims, liabilities or other damages resulting from the
U-Scan(R) self-checkout business arising on or before April 8, 2004.
A reasonable estimate of the maximum potential amount the Company
could be required to pay to Fujitsu cannot be made given the nature
of the indemnification.
(d) The Company is party to litigation arising in the normal course of
operations. The Company does not expect the resolution of such
matters to have a materially adverse effect on the financial
position or results of operations of the Company.
10. Other charges:
(a) Restructuring and inventory write-downs:
Restructuring costs of $1,324,648 were recorded in the three-month
period ended June 30, 2004 as a result of efficiency initiatives
undertaken that relate principally to the services operating
segment. The restructuring costs relate primarily to workforce
reduction of approximately $0.9 million and facility closure costs
of $0.4 million. At June 30, 2004, the entire amount of costs
accrued is included in accounts payable and accrued liabilities in
the consolidated balance sheets.
Inventory write-downs of $2,429,989 were recorded in the three-month
period ended June 30, 2004 ($2,930,536 year-to-date) for service
parts inventory that were deemed to be no longer of use to the
Company in light of the realignment of its services business.
-22-
10. Other charges (continued):
(b) Stock-based compensation:
The fair value of stock options granted during the three-month
period ended June 30, 2004 was determined at the date of grant using
the Black-Scholes option pricing model and the following
weighted-average assumptions:
===================================================================================================
Volatility 69.4%
Expected life 5 years
Risk-free interest rate 3.39%
Dividend rate 0%
===================================================================================================
The weighted-average fair value of stock options granted was as
follows:
===================================================================================================
Weighted-average
grant date
Number fair value
of options per share
---------------------------------------------------------------------------------------------------
Exercise price per share equal to market price
per share 4,606,926 $ 4.25
===================================================================================================
-23-
11. Income taxes:
The income tax provision differs from the amount computed by applying the
combined Canadian federal and Quebec provincial tax rates to earnings
before income taxes. The reasons for the difference and the related tax
effects are as follows:
===========================================================================================================
Three months ended June 30, Six months ended June 30,
-----------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes $ (7,313,381) $ (2,045,234) $(10,892,939) $ (3,605,978)
===========================================================================================================
Combined Canadian federal and
Quebec provincial income taxes
at 31% (2003 - 33%) $ (2,267,148) $ (674,927) $ (3,376,811) $ (1,189,973)
Foreign exchange (1) (4,259) (174,763) 21,436 (1,418,982)
Benefits of losses not recorded 1,915,425 -- 2,699,223 --
Stock-based compensation 512,000 -- 512,000 --
Permanent differences and other 152,265 (223,310) 124,435 (270,045)
-----------------------------------------------------------------------------------------------------------
Income tax provision (recovery) $ 308,283 $ (1,073,000) $ (19,717) $ (2,879,000)
===========================================================================================================
(1) For purposes of calculating the income tax provision of the Company,
a tax liability is recognized on the foreign exchange gains which
arise on the conversion into Canadian dollars of the net monetary
assets denominated in U.S. dollars which is required for Canadian
tax purposes. As these financial statements are presented in U.S.
dollars, these foreign exchange gains do not impact earnings
(losses) before income taxes even though the income tax provision
would include a tax liability for these gains. Future fluctuations
in the foreign exchange rate between the Canadian and U.S. dollar
will change the amount of the foreign exchange gains and thus, the
provision for or recovery of income taxes thereon.
The provision for (recovery) of income taxes is composed of the following:
===========================================================================================================
Three months ended June 30, Six months ended June 30,
-----------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------
Current income taxes $ 26,000 $ (760,000) $ 26,000 $ (1,180,000)
Future income taxes 282,283 (313,000) (45,717) (1,699,000)
-----------------------------------------------------------------------------------------------------------
$ 308,283 $ (1,073,000) $ (19,717) $ (2,879,000)
===========================================================================================================
-24-
12. Supplemental cash flow disclosure:
======================================================================================================
Three months ended June 30, Six months ended June 30,
------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
------------------------------------------------------------------------------------------------------
Non-cash transactions:
Issue of shares on acquisition
of Terra $61,413,585 $ -- $61,413,585 $ --
Assumption of stock options
and warrants of Terra 5,877,330 -- 5,877,330 --
======================================================================================================
13. Segmented information:
As a result of the business acquisitions and disposals referred to in note
3, the Company now operates in two segments, namely payments, and hardware
maintenance and repair outsourcing services. Management measures the
results of operations based on segment income before income taxes adjusted
for certain non-cash and non-recurring items provided by each business
segment.
Previously, the Company also developed and sold automated transaction
products designed for use in the retail sector and provided related
hardware and software maintenance. As a result of the sale of the
U-Scan(R) self-checkout business, this segment has been reclassified as
discontinued operations.
-25-
13. Segmented information (continued):
(a) Information on the operating segments is as follows:
======================================================================================================================
Hardware
Payment maintenance and
services repair services Consolidated
---------------------------------------------------------------------------------------------------------------------
Three months ended June 30, 2004:
Revenues $ 11,895,564 $ 12,146,096 $ 24,041,660
Transaction processing/service costs 4,844,058 9,205,416 14,049,474
Amortization 854,476 414,191 1,268,667
Investment income 186,781 188,420 375,201
Stock-based compensation 1,358,703 575,010 1,933,713
Restructuring costs 76,310 1,248,338 1,324,648
Inventory write-downs -- 2,429,989 2,429,989
Loss from continuing operations before income taxes (323,115) (6,990,266) (7,313,381)
Provision for income taxes (308,283) -- (308,283)
Loss from continuing operations (631,398) (6,990,266) (7,621,664)
Three months ended June 30, 2003:
Revenues $ -- $ 2,093,825 $ 2,093,825
Transaction processing/service costs -- 1,381,705 1,381,705
Amortization -- 157,358 157,358
Investment income -- 242,740 242,740
Loss from continuing operations before income taxes -- (2,045,234) (2,045,234)
Recovery of income taxes -- 1,073,000 1,073,000
Loss from continuing operations -- (972,234) (972,234)
Six months ended June 30, 2004:
Revenues $ 11,895,564 $ 22,426,522 $ 34,322,086
Transaction processing/service costs 4,844,058 16,528,352 21,372,410
Amortization 854,476 777,603 1,632,079
Investment income 186,781 373,691 560,472
Stock-based compensation 1,358,703 575,010 1,933,713
Restructuring costs 76,310 1,248,338 1,324,648
Inventory write-downs -- 2,930,536 2,930,536
Loss from continuing operations before income taxes (323,115) (10,569,824) (10,892,939)
Provision for (recovery of) income taxes 308,283 (328,000) (19,717)
Loss from continuing operations (631,398) (10,241,824) (10,873,222)
Six months ended June 30, 2003:
Revenues $ -- $ 4,196,779 $ 4,196,779
Transaction processing/service costs -- 2,804,005 2,804,005
Amortization -- 300,830 300,830
Investment income -- 511,162 511,162
Loss from continuing operations before income taxes -- (3,605,978) (3,605,978)
Recovery of income taxes -- 2,879,000 2,879,000
Loss from continuing operations -- (726,978) (726,978)
======================================================================================================================
-26-
13. Segmented information (continued):
(a) Information on the operating segments is as follows (continued):
===================================================================================================================
Hardware
Payment maintenance and
services repair services Consolidated
-------------------------------------------------------------------------------------------------------------------
June 30, 2004:
Total assets $158,948,195 $118,357,824 $277,306,019
Total additions to property and equipment
and intangibles for the six months ended
June 30, 2004:
- at date of acquisition $ 43,691,655 $ 5,250,449 $ 48,942,104
- thereafter 571,847 978,592 1,550,439
December 31, 2003:
Total assets $ -- $104,299,328(1) $104,299,328(1)
Total additions to property and equipment
and intangibles for the year ended
December 31, 2004 $ -- $ 7,564,947 $ 7,564,947
===================================================================================================================
(1) Excluding $31,242,997 of total assets related to discontinued
operations.
(b) Geographic information is as follows:
===================================================================================================================
Property and equipment,
Revenues goodwill and intangibles
-------------------------------------------------------------- ----------------------------
Three months ended Six months ended
June 30, June 30, June 30, December 31,
2004 2003 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------------
Canada $ 7,383,275 $ -- $14,340,552 $ -- $52,949,692 $ 8,196,857
United States 9,108,937 2,093,825 12,432,086 4,196,779 8,359,519 4,251,890
Other 7,549,448 -- 7,549,448 -- -- --
-------------------------------------------------------------------------------------------------------------------
$24,041,660 $ 2,093,825 $34,322,086 $ 4,196,779 $61,309,211 $12,448,747
===================================================================================================================
Revenues are attributed to countries based on location of customer.
-27-
14. Canada/U.S. reporting differences:
The consolidated financial statements of the Company are prepared in
accordance with Canadian generally accepted accounting principles
("GAAP"), which conform, in all material respects, with those generally
accepted in the United States except as described below:
(a) Consolidated statement of operations:
The reconciliation of net earnings (loss) reported in accordance
with Canadian GAAP with U.S. GAAP is as follows:
=================================================================================================================
Three months ended June 30, Six months ended June 30,
-----------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------
Net loss in accordance
with Canadian GAAP $ (6,640,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
Stock-based compensation costs (i) -- -- -- --
-----------------------------------------------------------------------------------------------------------------
Net loss in accordance
with U.S. GAAP $ (6,640,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
=================================================================================================================
Loss per share under
U.S. GAAP:
Basic $ (0.31) $ (0.08) $ (0.54) $ (0.08)
Diluted (0.31) (0.08) (0.54) (0.08)
=================================================================================================================
The weighted average number of common shares outstanding for
purposes of determining basic and diluted earnings (loss) per share
are the same amounts disclosed for Canadian GAAP purposes.
(i) Stock-based compensation:
Effective January 1, 2003, the Company adopted the fair value
recognition provisions of FASB Statement 123, Accounting for
Stock-based Compensation, prospectively to all employee awards
granted, modified or settled after January 1, 2003.
Consequently, for periods after January 1, 2003, there are no
differences between Canadian GAAP and US GAAP. However, for
awards granted prior to January 1, 2003, and because awards
under the Company's plan vest over a period of three years,
the cost related to stock-based compensation included in the
determination of net earnings is less than that which would
have been recognized if the fair value based method had been
applied to all awards since the original effective date of
Statement 123.
-28-
14. Canadian/U.S. reporting differences (continued):
(a) Consolidated statement of operations (continued):
(i) Stock-based compensation (continued):
The following table illustrates the effect on net loss and
loss per share if the fair value based method had been applied
to all outstanding and unvested awards in each period:
==========================================================================================================
Three months ended June 30, Six months ended June 30,
----------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
----------------------------------------------------------------------------------------------------------
Reported net loss in accordance
with US GAAP $ (6,646,079) $ (1,217,323) $ (9,839,404) $ (1,198,231)
Add: Stock-based employee
compensation expense
determined under the
intrinsic value method
included in reported net
earnings, net of related
taxes of nil -- -- -- --
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related taxes of nil -- (4,131,275) -- (9,256,295)
----------------------------------------------------------------------------------------------------------
Pro forma net loss $ (6,646,079) $ (5,348,598) $ (9,839,404) $(10,454,526)
==========================================================================================================
-29-
14. Canadian/U.S. reporting differences (continued):
(a) Consolidated statement of operations (continued):
(i) Stock-based compensation (continued):
========================================================================================
Three months ended June 30, Six months ended June 30,
----------------------------------------------------------------------------------------
2004 2003 2004 2003
----------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic:
As reported $ (0.31) $ (0.08) $ (0.54) $ (0.08)
Pro forma (0.31) (0.36) (0.54) (0.70)
Diluted:
As reported (0.31) (0.08) (0.54) (0.08)
Pro forma (0.31) (0.36) (0.54) (0.70)
========================================================================================
(b) Consolidated balance sheets:
==========================================================================================================
June 30, 2004 December 31, 2003
--------------------------------- ---------------------------------
Canadian US Canadian US
GAAP GAAP GAAP GAAP
----------------------------------------------------------------------------------------------------------
Shareholders' equity:
Share capital $ 183,547,829 $ 226,004,392 $ 122,102,244 $ 164,558,807
Additional paid-in
capital 7,515,887 37,372,614 5,282 29,862,009
Deficit (17,169,821) (87,949,349) (7,330,417) (78,109,945)
Cumulative translation
adjustment (1,612,007) -- (1,484,471) --
Accumulated other
comprehensive loss -- (3,145,769) -- (3,018,233)
----------------------------------------------------------------------------------------------------------
$ 172,281,888 $ 172,281,888 $ 113,292,638 $ 113,292,638
==========================================================================================================
(c) Supplementary information:
Under US GAAP, stock-based compensation would be presented as part
of "selling, general and administrative" expenses on the statement
of operations instead of as a separate line item.
-30-
14. Canadian/U.S. reporting differences (continued):
(c) Supplementary information (continued):
The following unaudited pro forma financial information reflects the
consolidated results of operations as if the acquisitions of Terra
and RBA had taken place January 1, 2003. The pro forma financial
information is not necessarily indicative of the results of
operations as it would have been had the transactions been reflected
on the assumed date.
=================================================================================================
Three months ended June 30, Six months ended June 30,
-------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------
Revenues $ 37,183,289 $ 20,128,756 $ 47,463,715 $ 39,256,391
Net loss (7,000,003) (1,554,723) (10,190,328) (1,579,032)
Diluted loss per share $ (0.32) $ (0.10) $ (0.56) $ (0.11)
=================================================================================================
15. Comparative figures:
Certain of the comparative figures have been reclassified in order to
conform with the current period's presentation.
16. Subsequent event:
On July 1, 2004, the Company acquired National Processing Services LLC
("NPS"), a registered VISA(R) and Mastercard(R) independent sales
organization, for a cash consideration of $15 million. The Company
believes that this acquisition will diversify its payment services
portfolio and contribute positively to the Company's financial results.
The acquisition will be accounted for by the Company using the purchase
method and the results of NPS will be consolidated with those of the
Company from the date of acquisition.
-31-
16. Subsequent event (continued):
The following table summarizes the estimated fair value of the assets
acquired and liabilities assumed at date of acquisition. The Company is in
the process of finalizing its valuation of the net assets acquired,
including goodwill and other intangible assets; thus, the allocation of
the purchase price is subject to refinement.
==========================================================================
Assets acquired:
Accounts receivable $ 474,471
Inventories 37,000
Property and equipment 21,306
Prepaid expenses and deposits 12,083
Goodwill and other intangible assets 14,560,102
----------------------------------------------------------------------
15,104,962
Liabilities assumed:
Accounts payable and accrued liabilities 104,962
--------------------------------------------------------------------------
Net assets acquired for cash $ 15,000,000
==========================================================================
-32-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial condition and results of
operations of our company should be read in conjunction with our audited
consolidated financial statements for the year ended December 31, 2003, and the
factors set forth below under "Forward-Looking Statements". All dollar amounts
are expressed in U.S. dollars and, other than those expressed in millions of
dollars, have been rounded to the nearest thousand. Our accounting policies are
in accordance with Canadian generally accepted accounting principals ("GAAP").
These differ in some respects from GAAP in the United States ("US GAAP"). Our
results are reconciled to US GAAP; see note 14 to our interim consolidated
financial statements.
Overview
We have recently completed a number of business acquisitions and disposals
in pursuit of our strategy to reposition our business activities with the goal
of enhancing long-term financial results. We believe these transactions will
realign us into a strong payments and services company with a more balanced and
stable business mix. We plan to grow our core businesses on a strategic basis,
both organically and through acquisition. Furthermore, by leveraging our strong
balance sheet, we intend to take advantage of strategic and transactional
opportunities that may arise, with a focused approach on potential acquisitions.
As a result of these transactions, we currently operate in two segments;
payments, through Optimal Payments, and hardware maintenance and repair
outsourcing services, through Optimal Services Group.
For additional information relating to our Company, readers may review the
documentation filed by us with the U.S. Securities and Exchange Commission
(including the Annual Report on Form 10-K) available at www.sec.gov and with the
securities regulatory authorities of British Columbia, Alberta, Ontario and
Quebec available at www.sedar.com.
Optimal Payments
Optimal Payments is a growing presence in the payments processing industry
and provides technology and services that businesses require to accept credit
card, electronic check and direct debit payments. Optimal Payments processes
credit card payments for card-not-present and card-present (or, "swipe")
transactions, including Internet businesses, mail-order/telephone-order ("MOTO")
merchants, and retail point-of-sale merchants. Optimal Payments also processes
checks and direct debits online and by telephone. Optimal Payments has
approximately 110 employees and is headquartered in Montreal with operations
throughout North America and in the United Kingdom. Optimal Payments currently
has approximately 7,500 customers (merchants) using its credit card and
electronic check products.
Optimal Payments generates revenues primarily from fees charged to
merchants for processing services, as well as from fees charged to consumers who
utilize our FirePay(R) Personal Account stored-value offering. Fees charged to
merchants typically include a discount rate, based upon a percentage of the
dollar amounts processed, and a variety of fixed transaction or service fees.
Merchant fees charged are based upon the merchant's volume and risk profile.
Fees charged to consumers are based on fixed transaction amounts. Revenue is
recognized primarily at the time the transaction or service is performed. To the
extent that we retain responsibility to a bank or other acquiring processing
supplier for chargebacks against our merchant accounts, and therefore the
associated credit risk with regard to such merchants, we record revenue gross of
the amounts paid to the acquiring processing supplier. See note 2(b) to our
interim consolidated financial statements.
We retain a portion of amounts owed to each merchant based on processing
volume for a period of six months to cover potential merchant credit losses that
can arise as a result of, among other things,
-33-
disputes between cardholders and merchants or association fines related to
chargeback activity. The aggregate withheld amount is referred to as "reserves"
and our liability to refund our customers is included in the line item "Customer
reserves and security deposits" in the balance sheet contained in the
consolidated financial statements included in this report. If disputes are not
resolved in the merchant's favour, the transaction is charged back to us and the
purchase price is refunded to the merchant's customer. If we are unable to
collect from the merchant, we bear the credit risk for the full amount of the
transaction. As a result, our acquiring processing suppliers require us to
maintain certain amounts with them as reserves. Amounts withheld by our
acquiring processing suppliers are included in cash and short-term investments
on our balance sheet as "held as reserve". For merchants who continue to use our
services, we withhold and refund reserves on a rolling basis so that as new
transactions are processed, we withhold a portion as the reserve, while at the
same time refunding the reserves for which the six-month period has expired.
Optimal Services Group
Optimal Services Group ("OSG") offers its customers a single-source
solution for many of their computer maintenance and technology support
requirements, including hardware maintenance services, software support,
end-user/help desk services, network support and other technology support
services. OSG also provides multi-vendor parts repair, refurbishment and
inventory management services as part of its logistics services portfolio. OSG
delivers services through an extensive service organization located throughout
the United States and Canada. OSG has approximately 800 employees located
throughout the United States and Canada.
OSG's primary source of revenue is contracted computer maintenance and
technology support services. These contracts typically have a stipulated monthly
fee over a fixed initial term, and continue thereafter unless canceled by either
party. In addition, we enter into per-incident contracts with customers.
Per-incident contracts can cover a range of bundled services for computer
maintenance or support services or can be for a specific service. Another form
of per-incident service revenues is time and material billings for services
provided on an as needed basis, principally for maintenance and repair.
We also derive revenue from the repair of hardware and components at our
logistics services and depot repair facilities. Pricing of these services is
based on various factors, including equipment failure rates, cost of parts and
labor expenses. We customize our contracts to the individual customer based
generally on the nature of the customer's requirements, the term of the contract
and the services which are provided. Revenue is recognized upon the completion
of services performed on a per-incident basis and ratably for contracts based on
monthly fees.
Recent developments
On July 1, 2004, Optimal Payments completed the acquisition of National
Processing Services LLC ("NPS"), a Detroit, Michigan-based registered Visa(R)
and MasterCard(R) independent sales organization for $15 million in cash. The
portfolios acquired in this transaction include approximately 4,500 merchants,
processing in excess of $1 billion in annual credit and debit card volume. As a
result of this acquisition, we anticipate that Optimal Payments' customers will
process approximately $2 billion in annual electronic check and credit card
volume. The acquisition will be accounted for using the purchase method of
accounting and the financial results will be consolidated from the date of the
acquisition in our third quarter. See note 16 to our interim consolidated
financial statements for details of the transaction.
On May 6, 2004, we disposed of Optimal Payments' investment in ebs
Electronic Billing Systems AG ("ebs Billing"). The shares in ebs Billing were
sold to ebs Billing's majority shareholder EBS Holding AG for a net cash
consideration of $4.0 million. The investment in ebs Billing was no longer
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considered strategic to Optimal Payments; however Optimal Payments intends to
continue its business relations with ebs Billing for the mutual providing of
payment processing services.
On April 8, 2004, we completed the sale of our U-Scan(R) self-checkout
business to Fujitsu Transaction Solutions, Inc. ("Fujitsu") for $35.0 million
plus the assumption of certain liabilities. Included in accounts payable and
accrued liabilities as at June 30, 2004 is an amount of $4.8 million owing to
Fujitsu as we collected a large portion of the accounts receivable and realized
the cash thereon in advance of the sale. Thus, the net proceeds realized on the
sale to Fujitsu was $30.2 million. The U-Scan(R) self-checkout business has been
accounted for as discontinued operations in this second quarter of 2004 and
comparative figures have been reclassified accordingly. See note 3(c) to our
interim consolidated financial statements.
On April 6, 2004, the corporation's name was changed from Optimal Robotics
Corp. to Optimal Group Inc.
On April 6, 2004, we completed the amalgamation of a wholly-owned
subsidiary with Terra Payments Inc. ("Terra Payments"). The amalgamated company
is a wholly-owned subsidiary of Optimal Group Inc. and will continue its
business under the name of Optimal Payments Inc. We believe that this
acquisition will provide us with a superior platform for enhanced growth and
financial results. The acquisition is accounted for using the purchase method
and the financial results have been consolidated from the date of the
acquisition. See note 3(b) to our interim consolidated financial statements.
On February 27, 2004, we acquired the hardware service division of Systech
Retail Systems ("Systech") at a net cost of approximately $3.5 million. We
believe that the combination of the Systech hardware service division with our
existing service organization will contribute positively to our financial
results in 2004. The acquisition is accounted for using the purchase method and
the financial results have been consolidated from the date of the acquisition.
See note 3(a) to our interim consolidated financial statements.
Critical accounting policies and estimates
The accompanying interim consolidated financial statements have been prepared in
accordance with Canadian GAAP. In the preparation of financial statements we are
required to make numerous estimates and assumptions. Actual results could differ
from those estimates and assumptions, impacting our reported results of
operations and financial position. Our significant accounting policies are more
fully described in Note 2 of our annual audited consolidated financial
statements included in our Form 10-K Annual Report for the year ended December
31, 2003. The critical accounting policies described here are those that are
most important to the depiction of our financial condition and results of
operations and their application requires our most subjective judgment in making
estimates about the effect of matters that are inherently uncertain.
Service Parts Inventory
Periodic revisions to obsolescence provisions are required, based upon the
evaluation of several factors, including changes in usage levels and technology
changes. Changes in these estimates are reflected immediately in income.
Merchant Losses
When a consumer pays a merchant for goods or services using a credit card and
the consumer disputes the charge, the amount of the disputed item gets charged
back to us and the credit card associations may levy fees against us. In
addition, if our chargeback rate becomes excessive, credit card associations can
also
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require us to pay fines In turn, we attempt to recover from the merchant the
amount charged back and the amount of such fines. However, we may not always be
successful in doing so, for reasons which could include merchant insolvency. We
evaluate the risk associated with each merchant and estimate our potential loss
for chargebacks based primarily on historical experience and other relevant
factors.
Goodwill and Other Intangibles
Effective January 1, 2002, we adopted the new recommendations of the Canadian
Institute of Chartered Accountants, Handbook Section 3062, with respect to the
accounting for goodwill and other intangible assets with indefinite lives which
are not amortized but rather evaluated under an impairment approach. Other
intangible assets with finite lives continue to be amortized over their
estimated useful lives. In our assessment of impairment, we are required to
determine the fair value of the businesses acquired from which the goodwill and
intangibles originated. For intangibles with finite lives, we make estimates of
future cash flows to be generated from the related assets.
Other Receivable
During Terra Payments' fiscal year ended March 31, 2002, Terra Payments was
assessed a charge of $6.8 million from one of its credit card suppliers of
services. We believe this charge is largely unsubstantiated and are pursuing a
claim through legal recourse. We have recorded a provision of $3.7 million
against the amount receivable based on our estimate of the value.
Income Taxes
We provide for income taxes using the asset and liability method of tax
allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities using
substantively enacted income tax rates expected to be in effect for the year in
which the differences are expected to reverse. We establish a valuation
allowance against future income tax assets if, based on available information,
it is more likely than not that some or all of the future income tax assets will
not be realized.
New accounting policy
Asset Retirement Obligations
This standard was established for the recognition, measurement and
disclosure of liabilities for asset retirement obligations and the associated
retirement cost. The standard applies to legal obligations associated with the
retirement of tangible long-lived assets that result from acquisition,
development or normal operations. The standard requires an entity to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred and when a reasonable estimate of fair value can be made.
The entity is subsequently required to allocate the asset retirement cost to
expense using a systematic and rational method over the estimated life of the
asset. The standard is effective for fiscal years beginning on or after January
1, 2004. The adoption of this standard did not have an impact on our financial
statements.
Financial Condition
As at June 30, 2004, cash, cash equivalents and short-term investments
totaled $187.3 million (including $23.0 million held as reserves), compared to
$78.5 million as at December 31, 2003. The increase in cash and short-term
investments is primarily due to the acquisition of Terra Payments, which
resulted in the consolidation of its cash balance with the Optimal Group cash
balance, as well as the
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proceeds on the disposal of the U-Scan self-checkout business and the investment
in ebs Billing. As already described, a significant portion of cash and
short-term investments have a corresponding liability as these amounts are
derived from reserves and security deposits which are due to merchants (see
Overview - Optimal Payments). As at June 30, 2004, our cash position, net of
bank indebtedness and customer reserves and security deposits, was as follows:
$000s
-----
Cash and cash equivalents 2,773
Short-term investments 161,540
Cash and short-term investments - held as reserves 23,034
--------
187,347
--------
Less:
Bank indebtedness (10,356)
Customer reserves and security deposits (63,292)
--------
Net 113,699
========
Our portfolio of liquid and investment grade short-term investments
consists of U.S.- and Canadian-dollar denominated discounted notes and bonds.
Working capital as at June 30, 2004 was $98.4 million (December 31, 2003 -
$92.7 million).
Service parts inventory decreased by $2.1 million or 51% from $4.2 million
as at December 31, 2003 to $2.1 million at June 30, 2004. This decrease is
mainly attributable to inventory write-downs recorded in the current period.
These write-downs were recorded for service parts inventory which were deemed to
be no longer of use to us in light of the realignment of our services business.
Service parts inventory as at June 30, 2004 pertain exclusively to the hardware
maintenance and repair outsourcing services business segment and are comprised
primarily of items to be consumed in the servicing of customers' hardware.
Goodwill and other intangible assets increased by $46.4, from $10.5
million as at December 31, 2003 to $56.9 million as at June 30, 2004. This
increase resulted primarily from the acquisition of Terra Payments and the
acquisition of Systech (see note 3 to our interim consolidated financial
statements).
Bank indebtedness decreased by $0.3 million or 3% from $10.7 million as at
December 31, 2003 to $10.4 million as at June 30, 2004. The bank indebtedness
was incurred on September 30, 2003 in connection with the acquisition of
substantially all of the assets of RBA Inc. ("RBA"), a company that provides
hardware maintenance outsourcing services. Due to the low-interest rate
environment coupled with the rapid decline of the U.S. dollar in relation to the
value of the Canadian dollar, we made a determination that it would be
advantageous for us to utilize a portion of our bank operating credit facility
to finance the RBA acquisition. The decrease is due to foreign exchange
fluctuations as the indebtedness is denominated in Canadian dollars.
Customer reserves and security deposits as at June 30, 2004 were $63.3
million compared to nil as at December 31, 2003. Customer reserves and security
deposits pertain exclusively to the payments business segment, acquired in April
2004.
We have no long-term debt. Shareholders' equity as at June 30, 2004 was
$172.3 million as compared to $113.3 million as at December 31, 2003. The
increase is attributable primarily to the issuance of share capital resulting
from the Terra Payments acquisition (see note 3(b) to our interim consolidated
financial statements).
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Results of Operations
(Current and comparative figures have been reclassified to reflect the
disposition of the U-Scan(R) self-checkout business which has been accounted for
as discontinued operations.)
Six-month period ended June 30, 2004 compared to the six-month period ended June
30, 2003
Revenues from continuing operations increased by $30.1 million, from $4.2
million in the six-month period ended June 30, 2003 to $34.3 million in the
six-month period ended June 30, 2004. The increase in revenues is due primarily
to the following business acquisitions which were completed subsequent to June
30, 2003:
o On September 30, 2003, we acquired substantially all the
assets of RBA;
o On February 27, 2004, we acquired the hardware service
division of Systech Retail Systems; and
o On April 6, 2004, Terra Payments amalgamated with a
wholly-owned subsidiary of ours.
Revenues for the six-month period ended June 30, 2004 include revenues from the
payments business segment from the transaction date of April 6, 2004 amounting
to $11.9 million or approximately 35% of total revenues and revenues from the
hardware maintenance and repair outsourcing services business segment of $22.4
million or approximately 65% of total revenues. For the six-month period ended
June 30, 2003, $4.2 million or 100% of total revenues was attributed to the
hardware maintenance and repair outsourcing services business segment.
Transaction processing and service costs increased by $18.6 million, from
$2.8 million in the six-month period ended June 30, 2003 to $21.4 million in the
six-month period ended June 30, 2004. The increase in transaction processing and
service costs is due primarily to the business acquisitions as described above.
Transaction processing costs attributable to the payments business segment were
$4.8 million or 23% of total transaction processing and service costs. Service
costs attributable to the hardware maintenance and repair outsourcing services
business segment accounted for $16.5 million or 77% of total transaction
processing and service costs. Transaction processing and service costs include
direct costs of providing the respective services such as interchange for the
payments business segment and direct labour, freight charges, consumables and
fleet costs for the hardware maintenance and repair outsourcing services
business segment.
Selling, general and administrative expenses increased by $9.7 million,
from $4.6 million in the six-month period ended June 30, 2003 to $14.3 million
in the six-month period ended June 30, 2004. The increase in selling, general
and administrative expenses is due primarily to the business acquisitions as
described above.
Research and development expenses increased by $0.5 million from nil in
the six-month period ended June 30, 2003. Research and development expenses
pertain exclusively to the payments business segment and are comprised primarily
of personnel-related expenditures associated with the development of new
solutions and the enhancement of existing offerings.
Operating lease expenses increased by $1.6 million, from $0.3 million in
the six-month period ended June 30, 2003 to $1.9 million in the six-month period
ended June 30, 2004. The increase in operating lease expenses is due primarily
to the business acquisitions as described above.
Operating earnings (loss), defined as earnings (loss) before restructuring
costs, inventory write-downs, stock-based compensation, amortization of
intangibles and property and equipment, foreign
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exchange, income taxes, discontinued operations and disposals of net assets, was
a loss of $3.1 million for the six-month period ended June 30, 2004 compared to
a loss of $3.0 million for the six-month period ended June 30, 2003. Operating
earnings (loss) is presented on the face of the Consolidated Statements of
Operations as "Loss before undernoted items". Management believes operating
earnings (loss) is a relevant measure of our performance. Operating earnings
(loss) is not a measure of performance under Canadian GAAP or U.S. GAAP and
should not be considered in isolation or as a substitute for net earnings
prepared in accordance with Canadian GAAP or U.S. GAAP and therefore may not be
comparable to similar measures presented by other companies.
Restructuring costs of $1.3 million were recorded in the three-month
period ended June 30, 2004 as a result of efficiency initiatives undertaken
relating exclusively to the hardware maintenance and repair outsourcing services
business segment. The restructuring costs relate primarily to workforce
reduction costs of $0.9 million and facility closure costs of $0.4 million.
Inventory write-downs of $2.4 million were recorded in the period. These
write-downs were recorded for service parts inventory which was deemed to be no
longer of use to us in light of the realignment of our services business.
Stock-based compensation is attributable to the accounting for the fair value of
stock options granted in fiscal 2004. Total stock-based compensation related to
stock options granted in 2004 was $19.6 million of which $1.6 million was
amortized in the period. Furthermore, as a result of the Terra Payments
acquisition, deferred compensation of $2.7 million was recorded on the balance
sheet as deferred compensation relating to the unvested Terra Payments stock
options that we assumed (see note 3(b) to our interim consolidated financial
statements) of which $0.3 million was amortized in the period.
Amortization of intangibles increased by $0.7 million, from $0.1 million
in the six-month period ended June 30, 2003 to $0.8 million in the six-month
period ended June 30, 2004. The increase in amortization is due primarily to the
intangible assets acquired from the various business acquisitions as described
above.
Amortization of property and equipment increased by $0.6 million, from
$0.2 million in the six-month period ended June 30, 2003 to $0.8 million in the
six-month period ended June 30, 2004. The increase in amortization is due
primarily to the business acquisitions as described above.
Recovery of income taxes was $nil in the six-month period ended June 30,
2004 compared to $2.9 million for the six-month period ended June 30, 2003. The
decrease was due to the non-recognition of income tax benefits incurred in
fiscal 2004 and non-deductible stock-based compensation (see Note 11 to our
interim consolidated financial statements).
Loss from discontinued operations of $3.1 million relates exclusively to
the operations of the U-Scan(R) self-checkout business as described above (see
Recent developments above and note 3(c) to our interim consolidated financial
statements).
The gain on disposal of net assets from discontinued operations of $4.2
million, net of income taxes of $2.3 million, relates to the sale of the
U-Scan(R) self-checkout business in April 2004 as described above (see Recent
developments above and note 3(c) to our interim consolidated financial
statements).
Our net loss was $9.8 million for the six-month period ended June 30, 2004
compared to a net loss of $1.2 million in the six-month period ended June 30,
2003. On a per share basis, including discontinued operations, we lost $0.54 for
the six-month period ended June 30, 2004 compared to a loss of $0.08 (basic and
diluted basis) for the comparable period in fiscal 2003.
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Three-month period ended June 30, 2004 compared to the three-month period ended
June 30, 2003
Revenues from continuing operations increased by $21.9 million, from $2.1
million in the three-month period ended June 30, 2003 to $24.0 million in the
three-month period ended June 30, 2004. The increase in revenues is due
primarily to the following business acquisitions which were completed subsequent
to June 30, 2003:
o On September 30, 2003, we acquired substantially all the
assets of RBA;
o On February 27, 2004, we acquired the hardware service
division of Systech Retail Systems; and
o On April 6, 2004, Terra Payments amalgamated with a
wholly-owned subsidiary of ours.
Revenues for the three-month period ended June 30, 2004 include revenues
from the payments business segment from the transaction date of April 6, 2004
amounting to $11.9 million or 49% of total revenues and revenues from the
hardware maintenance and repair outsourcing services business segment of $12.1
million or 51% of total revenues. For the three-month period ended June 30,
2003, $2.1 million or 100% of total revenues was attributed to the hardware
maintenance and repair outsourcing services business segment.
Transaction processing and service costs increased by $12.6 million, from
$1.4 million in the three-month period ended June 30, 2003 to $14.0 million in
the three-month period ended June 30, 2004. The increase in transaction
processing and service costs is due primarily to the business acquisitions as
described above. Transaction processing costs attributable to the payments
business segment were $4.8 million or 34% of total transaction processing and
service costs. Service costs attributable to the hardware maintenance and repair
outsourcing services business segment accounted for $9.2 million or 66% of total
transaction processing and service costs. Transaction processing and service
costs include the direct costs of providing such services, including interchange
for the payments business segment and direct labour, freight charges,
consumables and fleet costs for the hardware maintenance and repair outsourcing
services business segment.
Selling, general and administrative expenses increased by $6.5 million,
from $2.6 million in the three-month period ended June 30, 2003 to $9.1 million
in the three-month period ended June 30, 2004. The increase in selling, general
and administrative expenses is due primarily to the business acquisitions as
described above.
Research and development expenses increased by $0.5 million in the period
from nil in the three-month period ended June 30, 2003. Research and development
expenses pertain exclusively to the payments business segment and are comprised
primarily of personnel-related expenditures associated with the development of
new solutions and the enhancement of existing offerings.
Operating lease expenses increased by $0.9 million, from $0.2 million in
the three-month period ended June 30, 2003 to $1.1 million in the three-month
period ended June 30, 2004. The increase in operating lease expenses is due
primarily to the business acquisitions as described above.
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Operating earnings (loss), defined as earnings (loss) before restructuring
costs, inventory write-downs, stock-based compensation, amortization of
intangibles and property and equipment, foreign exchange, income taxes,
discontinued operations and disposals of net assets, was a loss of $0.3 million
for the three-month period ended June 30, 2004 compared to a loss of $1.9
million for the three-month period ended June 30, 2003. Operating earnings
(loss) is presented on the face of the Consolidated Statement of Operations as
"Loss before undernoted items". Management believes operating earnings (loss) is
a relevant measure of our performance. Operating earnings (loss) is not a
measure of performance under Canadian GAAP or U.S. GAAP and should not be
considered in isolation or as a substitute for net earnings prepared in
accordance with Canadian GAAP or U.S. GAAP and therefore may not be comparable
to similar measures presented by other companies.
Restructuring costs of $1.3 million were recorded in the three-month
period ended June 30, 2004 as a result of efficiency initiatives undertaken
relating exclusively to the hardware maintenance and repair outsourcing services
business segment. The restructuring costs relate primarily to workforce
reduction costs of $0.9 million and facility closure costs of $0.4 million.
Inventory write-downs of $2.4 million were recorded in the period. These
write-downs were recorded for service parts inventory which was deemed to be no
longer of use to us in light of the realignment of our services business.
Stock-based compensation is attributable to the accounting for the fair
value of stock options granted in fiscal 2004, while no stock options were
granted in fiscal 2003. Total stock-based compensation related to stock options
granted in 2004 was $19.6 million of which $1.6 million was amortized in the
period. Furthermore, as a result of the Terra Payments acquisition, deferred
compensation of $2.7 million was recorded on the balance sheet as deferred
compensation relating to the unvested Terra Payments stock options that we
assumed (see note 3(b) to our interim consolidated financial statements) of
which $0.3 million was amortized in the period.
Amortization of intangibles increased by $0.7 million, from nil in the
three-month period ended June 30, 2003. The increase in amortization is due
primarily to the intangible assets acquired from the various business
acquisitions as described above.
Amortization of property and equipment increased by $0.5 million, from
$0.1 million in the three-month period ended June 30, 2003 to $0.6 million in
the six-month period ended June 30, 2004. The increase in amortization is due
primarily to the business acquisitions as described above.
Provision for income taxes was $0.3 for the three-month period ended June
30, 2004 compared to a recovery of income taxes of $1.1 million for the
three-month period ended June 30, 2003. The decrease was due primarily to the
non-recognition of income tax benefits incurred in the period and non-deductible
stock-based compensation (see Note 11 to our interim consolidated financial
statements).
Loss from discontinued operations of $3.2 million relates exclusively to
the operations of the U-Scan(R) self-checkout business as described above (see
Recent developments above and note 3(c) to our interim consolidated financial
statements).
The gain on disposal of net assets from discontinued operations of $4.2
million, net of income taxes of $2.3 million, relates to the sale of the
U-Scan(R) self-checkout business in April 2004 as described above (see Recent
developments above and note 3(c) to our interim consolidated financial
statements).
Our net loss was $6.6 million in the quarter compared to a net loss of
$1.2 million in the second quarter of fiscal 2003. On a per share basis,
including discontinued operations, we lost $0.31 in the
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second quarter of fiscal 2004 compared to a loss of $0.08 (basic and diluted
basis) in the second quarter of fiscal 2003.
Liquidity and Capital Resources
As at June 30, 2004, we had cash, cash equivalents and short-term
investments of $187.3 million (including $23.0 million held as reserves)
(December 31, 2003 - $78.5 million), and working capital of $98.4 million
(December 31, 2003 - $92.7 million). As described above, a significant portion
of cash, cash equivalents and short-term investments have a corresponding
liability as these amounts are derived from reserves and security deposits which
are due to merchants (see Overview - Optimal Payments). As at June 30, 2004, our
cash position net of bank indebtedness and customer reserves and security
deposits was $113.7 million (see Financial Condition above).
Operating activities used $13.5 million of cash and cash equivalents in
the six-month period ended June 30, 2004, compared to the use of cash of $4.0
million during the six-month period ended June 30, 2003. The increase in the use
of cash was due primarily to an increase in customer reserves and security
deposits of $9.9 million due to the timing of payments to merchants.
In the six-month period ended June 30, 2004, we invested $1.6 million
(2003- $0.2 million) to purchase property, equipment and intangible assets,
which related principally to leasehold improvements, computer equipment and
software and patents costs. As well during the six-month period ended June 30,
2004, short-term investments increased by $20.1 million, compared to a decrease
of $1.9 million in the six-month period ended June 30, 2003.
As a result of the business acquisitions, we used $3.5 million for
acquisitions and $1.4 million for acquisition costs. Furthermore, during the
six-month period ended June 30, 2004, we received proceeds of $4.0 million on
the disposal of our investment in ebs Billing.
We believe that our cash and short-term investments will be adequate to
meet our needs for at least the next 12 months.
Forward-Looking Statements
This Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the "1933
Act"), and Section 21E of the Securities Exchange Act of 1934, as amended, which
are intended to be covered by the safe harbors created thereby. Words such as
"expects", "intends", "anticipates", "plans", "believes", "seeks", "estimates",
or variations of such words and similar expressions are intended to identify
such forward-looking statements. Investors are cautioned that all
forward-looking statements involve risk and uncertainty. Although we believe
that the assumptions underlying the forward-looking statements contained herein
are reasonable, any of the assumptions could be inaccurate, and therefore, there
can be no assurance that the forward-looking statements included in this Form
10-Q will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation of our company or
any other person that the objectives and plans of our company will be achieved.
The following factors are not intended to represent a complete list of the
general or specific factors that may affect us. It should be recognized that
other factors, including general economic factors and business strategies, may
be significant, presently or in the future, and the factors discussed below may
affect us to a greater extent than indicated. These risks factors are discussed
in the context of the business as it exists at the date of this Form 10-Q.
Except to the extent set forth below, risk factors related to the self-checkout
business, which we no longer operate have ceased to be relevant to us. Risks
related to our
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operations, including both the service and payments businesses are presented
below under "RISKS RELATED TO OUR OPERATIONS". Risks related specifically to our
service business are presented below under "RISKS RELATED TO SERVICE BUSINESS"
and risks related specifically to the payments business are presented below
under "RISKS RELATED TO PAYMENT BUSINESS". All forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by the cautionary statements set forth herein. Except as required
by law, we undertake no obligation to update any forward-looking statement,
whether as a result of new information, future events or otherwise.
RISKS RELATED TO OUR OPERATIONS
OUR ABILITY TO RETAIN KEY PERSONNEL IS IMPORTANT TO OUR GROWTH AND
PROSPECTS. Our ability to complete the integration of acquisitions and to grow
our business is particularly dependent upon the services of a few key personnel,
the loss of any of whom could adversely affect our business and overall results
of operations. The loss of key personnel or damage to their reputations could
adversely affect our relationships with our strategic service providers, which
would adversely affect our business.
WE MAY BE UNABLE TO FIND SUITABLE ACQUISITION CANDIDATES AND MAY NOT BE
ABLE TO SUCCESSFULLY INTEGRATE BUSINESSES THAT MAY BE ACQUIRED INTO OUR
OPERATIONS. As part of our recent history and future growth strategy, we have
acquired, and intend to continue to acquire, other businesses. In the future, we
may continue to seek acquisition candidates and, from time to time, engage in
exploratory discussions with suitable candidates. There can be no assurance,
however, that we will be able to identify and acquire targeted businesses or, to
the extent required, obtain financing for such acquisitions on satisfactory
terms. The process of integrating acquired businesses into our operations may
involve unforeseen difficulties and may require a disproportionate amount of
resources and management attention. In connection with future acquisitions, we
may incur significant charges to earnings. Acquisitions involve a number of
special risks, including the time and expense associated with identifying and
evaluating acquisitions, the diversion of management's attention from day-to-day
operations, the difficulty in integrating widely dispersed operations with
distinct corporate cultures, the potential loss of key employees of the acquired
company, the difficulty of incorporating acquired technologies successfully, the
potential impairment of relationships with employees, clients and strategic
partners and the inability to maintain uniform standards, controls, procedures
and policies. In addition, customer satisfaction or performance problems at a
single acquired firm could have a material adverse effect on our reputation.
Future acquisitions may be financed through the issuance of common shares, which
may dilute the ownership of our shareholders, or through the incurrence of
indebtedness. Furthermore, there can be no assurance that competition for
acquisition candidates will not escalate, thereby increasing the costs of making
acquisitions or making suitable acquisitions unattainable.
RISKS RELATED TO SERVICES BUSINESS
The services business is subject to a number of risks, which, should they
materialize, can have a material adverse effect on our business, revenues,
operating results and financial condition, including those set forth below:
OUR CONTRACTS FOR SERVICES MAY NOT BE RENEWED OR MAY BE REDUCED. As is
customary in the hardware services industry, we can experience reductions in our
contract-based revenue, as customers may eliminate certain equipment or services
from coverage under their contracts. We believe that the principal reasons for
the loss of contract-based revenue are the replacement of the equipment being
serviced with new equipment covered under a manufacturer's warranty, the
discontinuance of the use of equipment being serviced for a customer due to
obsolescence or a customer's
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determination (based on cost, quality and scope of services) to utilize a
competitor's services or to move technical support services in house. There can
be no assurance that we will be able to offset the reduction of contract-based
revenue and maintain revenue growth through new contracts in the future. Any
failure to enter into new contracts, add additional services and equipment to
existing contracts or consummate acquisitions could have a material adverse
effect on our results.
OUR BUSINESS IS AFFECTED BY COMPUTER INDUSTRY TRENDS. Our future success
is dependent upon (i) the continuation of a number of trends in the computer
industry, including the migration by information technology end-users to
multi-vendor and multi-system computing environments, the overall increase in
the sophistication and interdependency of computing technology, and a focus by
information technology managers on cost efficient management and (ii) our
ability to diversify our services to meet the needs of clients with respect to
these trends. We believe that these trends have resulted in a movement by both
end-users and original equipment manufacturers (each, an "OEM") towards
outsourcing and an increased demand for support service providers that have the
ability to provide a broad range of multi-vendor support services. There can be
no assurance that these trends will continue in the future
WE OPERATE IN A MARKET SUBJECT TO RAPID TECHNOLOGICAL CHANGE. Rapid
technological change and compressed product life cycles are prevalent in the
computer industry, which may lead to the development of improved or lower cost
technologies, higher quality hardware with significantly reduced failure rates
and maintenance needs, or customer decisions to replace rather than continue to
repair and maintain aging hardware, which could result in a reduced need for our
services in the future. Moreover, such rapid technological changes could
adversely affect our ability to predict equipment failure rates and, therefore,
to establish prices that provide adequate financial results. Similarly, new
computer systems could be built based upon proprietary, as opposed to open,
systems that cannot be serviced by us.
OUR PER INCIDENT REVENUES ARE VARIABLE. Per incident revenues, which
consist primarily of revenues from services performed for customers on an as
requested basis (e.g., projects, help desk services, parts repair, installations
and moves, installation and de-installation of computer equipment), are subject
to monthly variation due to the nature of per incident revenue transactions. It
is difficult for us to estimate the impact or amount of future per incident
revenues because per incident revenues are dependent on customer demand, which
fluctuates based upon various factors such as competition and customers' use of
internal employees. We may not be able to generate significant amounts of per
incident revenue in the future.
WE OPERATE IN A HIGHLY COMPETITIVE MARKET AND THERE IS NO ASSURANCE THAT
WE WILL BE ABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT OR FUTURE COMPETITORS.
Competition among hardware support service providers, both OEM's and independent
service organizations, is intense. We believe that a significant portion of
industry hardware maintenance services is currently serviced by OEM service
organizations. The remainder of the technology support services market is
serviced by a small number of larger, independent companies, such as ourselves,
offering a broader range of service capabilities, as well as numerous small
companies focusing on narrower areas of expertise or serving limited geographic
areas.
In many instances, OEM service organizations have greater resources than
us, and, because of their access to the OEM's engineering data, may be able to
respond more quickly to servicing equipment that incorporates new or emerging
technologies. Moreover, some OEM's do not make available to end-users or
independent service organizations the technical information, repairable parts,
diagnostics, information that relates to engineering changes and other support
items required to service their products, and design and sell their products in
a manner so as to make it virtually impossible for a third party to perform
maintenance services without potentially infringing upon certain proprietary
rights of the OEM. In
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addition, OEM's are sometimes able to develop proprietary remote diagnostic or
monitoring systems, which we may not be able to offer. Therefore, OEM service
organizations sometimes have a cost and timing advantage over us because we must
first develop or acquire from another party the required support items before we
can provide services for that equipment. An OEM's cost advantage, the
unavailability of required support items or various proprietary rights of the
OEM may preclude us from servicing certain products. Furthermore, OEM's usually
provide warranty coverage for new equipment for specified periods, during which
it is not economically feasible for us to compete for the provision of
maintenance services. To the extent that OEM's choose, for marketing reasons or
otherwise, to expand their warranty periods or terms, our business may be
adversely affected.
WE RELY ON SINGLE SUPPLIERS FOR SOME OF OUR INVENTORY. Spare parts
purchases are made from OEM's and other vendors. We, from time to time, will
have only a single supplier for a particular part, which, in some cases, may be
the OEM for such spare part. Should a supplier be unwilling or unable to supply
any part or component in a timely manner, our business could be adversely
affected.
WE MAY NOT BE ABLE TO ACCURATELY PREDICT OUR INVENTORY REQUIREMENTS. In
order to service our customers, we are required to maintain a high level of
spare parts for extended periods of time. Any decrease in the demand for our
maintenance services could result in a substantial portion of our spare parts
becoming excess, obsolete or otherwise unusable. In addition, rapid changes in
technology could render significant portions of our spare parts obsolete,
thereby giving rise to write-offs and a reduction in financial results. Our
inability to manage our spare parts or the need to write them off in the future
could have a material adverse effect on our business, financial results and
results of operations.
WE MAY BE SUBJECT TO UNFORESEEN DIFFICULTIES IN MANAGING CUSTOMERS'
EQUIPMENT. In some instances, we manage equipment on behalf of our customers. In
these cases, we are required to adhere to specific service level agreements. Any
negative variation from the contractual service level agreement could result in
us having to reimburse the customer for the variance. As well, we could have to
provide discounts to the customer for a negative variation in the specified
service level.
WE MAY FAIL TO PRICE FIXED FEE CONTRACTS ACCURATELY. Under some of our
contracts, the customer pays a fixed fee for customized bundled services that
are priced by us based on our best estimates of various factors, including
estimated future equipment failure rates, cost of spare parts and labor
expenses. There can be no assurance that we will be able to estimate these
factors with sufficient accuracy in order to price these fixed fee contracts on
terms favorable to us. Our failure to price these fixed fee contracts accurately
could have a material adverse effect on our financial results.
RISKS RELATED TO PAYMENTS BUSINESS
The payments business is subject to a number of risks, which, should they
materialize, can have a material adverse effect on our business, revenues,
operating results and financial condition, including those set forth below:
OUR PAYMENTS BUSINESS IS AT RISK OF LOSS DUE TO FRAUD AND DISPUTES. We
face risks of loss due to fraud and disputes between consumers and merchants,
including the unauthorized use of credit card and bank account information and
identity theft, merchant fraud, disputes over the quality of goods and services,
breaches of system security, employee fraud and use of our system for illegal or
improper purposes.
When a consumer pays a merchant for goods or services using a credit card
and the cardholder disputes the charge, the amount of the disputed item gets
charged back to us and the credit card
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associations may levy fees against us. Chargebacks may arise from the
unauthorized use of a cardholder's card number or from a cardholder's claim that
a merchant failed to perform. Chargebacks may also arise when a consumer pays a
merchant for goods or services using a check and the financial institution
returns the check. In addition, if our chargeback rate becomes excessive, credit
card associations can also require us to pay fines and have done so in the past.
There is no assurance that we will not be required to pay fines in the future
and the amount of such fines may be material.
In turn, we attempt to recover from the merchant the amount charged back
and the amount of such fines, however, we may not always be successful in doing
so, for reasons which could include merchant insolvency. We have taken measures
to detect and reduce the risk of fraud, but cannot be assured of their total
effectiveness.
WE MAY NOT BE ABLE TO SAFEGUARD AGAINST SECURITY AND PRIVACY BREACHES IN
OUR ELECTRONIC TRANSACTIONS. Any inability on our part to protect the security
and privacy of our electronic transactions could have a material adverse effect
on our profitability. A security or privacy breach could:
o expose us to additional liability and to potentially costly
litigation;
o increase expenses relating to resolution of these breaches;
o deter customers from using our products; and
o decrease market acceptance of electronic commerce transactions
generally.
We cannot assure that the use of applications designed for data security
and integrity will address changing technologies or the security and privacy
concerns of existing and potential customers.
OUR PAYMENT SYSTEM MIGHT BE USED FOR ILLEGAL OR IMPROPER PURPOSES. Despite
measures that have been taken to detect and prevent identity theft, unauthorized
uses of credit cards and similar misconduct, our payment systems remain
susceptible to potentially illegal or improper uses. These may include illegal
online gaming, fraudulent sales of goods or services, illicit sales of
prescription medications or controlled substances, software and other
intellectual property piracy, money laundering, bank fraud, child pornography
trafficking, prohibited sales of alcoholic beverages and tobacco products and
online securities fraud. Despite measures that we have taken to detect and
lessen the risk of this kind of conduct, we cannot be assured that these
measures will succeed.
WE MUST COMPLY CREDIT CARD AND CHECK CLEARING ASSOCIATION RULES AND
PRACTICES WHICH COULD IMPOSE ADDITIONAL COSTS AND BURDENS ON OUR PAYMENTS
BUSINESS. As a registered party, we must comply with the operating rules of the
Visa(R) and MasterCard(R) credit card associations and the National Automated
Clearing House Association for checks. The associations' members set these
rules. The associations could adopt operating rules with which we might find it
difficult or even impossible to comply.
Furthermore, in cases of fraud or disputes between consumers and
merchants, we face chargebacks when credit card cardholders dispute items for
which they have been billed. If our chargebacks become excessive, our processing
suppliers could fine us or terminate our ability to accept credit cards for
payments. The termination of our relationship with credit card associations or
acquiring banks would limit our ability to provide transaction-processing
services.
WE MAY NOT BE ABLE TO DEVELOP NEW PRODUCTS THAT ARE ACCEPTED BY OUR
CUSTOMERS. The success of our electronic payments operations depends upon
acceptance of our technology. There can be no assurance that we will not
experience difficulties that could delay or prevent the successful development,
introduction and marketing of new products and enhancements, or that our
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new products and enhancements will be introduced in a timely fashion or will
adequately meet the requirements of the marketplace and achieve market
acceptance.
THE FAILURE OF OUR SYSTEMS, THE SYSTEMS OF THIRD PARTIES OR THE INTERNET
COULD NEGATIVELY IMPACT OUR BUSINESS SYSTEMS OR OUR REPUTATION. Fires, floods,
earthquakes, power losses, telecommunications failures, break-ins, security
breaches and similar events could damage our systems. Computer viruses,
disgruntled or rogue employees, electronic break-ins or other similar disruptive
problems, including those beyond our control, could also adversely affect our
systems. Our business and reputation could be adversely affected if such systems
were affected by any of these occurrences. Our existing or future insurance
policies may not adequately compensate us for any losses that may occur due to
any failures or interruptions in our systems.
In particular, depending on volume growth, we may need to expand and
upgrade our technology, transaction-processing systems and network
infrastructure. We could experience periodic temporary capacity constraints,
which may cause unanticipated system disruptions, slower response times and
lower levels of customer service. We may be unable to accurately project the
rate or timing of increases, if any, in the use of our services or to expand and
upgrade our systems and infrastructure to accommodate these increases in a
timely manner.
Our success in our online business will depend, in large part, on other
companies maintaining the Internet infrastructure. In particular, we will rely
on the ability of Internet service providers ("ISPs"), telecommunication and
other companies to maintain a reliable network backbone that provides adequate
speed, data capacity and the infrastructure or complementary products and
services necessary to establish and maintain the Internet as a viable commercial
medium.
Users of electronic payment services are highly concerned about the
security of transmissions over public networks. Individuals could possibly
circumvent the measures that we take to protect customer transaction data. To
the extent that our activities involve the storage and transmission of
proprietary information, such as credit card or bank account numbers, security
breaches could damage our reputation and expose us to a risk of loss or
litigation and possible liability.
THE LEGAL STATUS OF INTERNET GAMING IS UNCERTAIN AND FUTURE REGULATION MAY
MAKE IT COSTLY OR IMPOSSIBLE TO CONTINUE PROCESSING FOR GAMING MERCHANTS. As
electronic commerce in general and most of the products and services that we
offer are relatively new, the manner in which existing provincial, federal and
foreign government regulations may be applied is uncertain and difficult to
predict. Due to the relatively recent development of Internet gaming, there are
few laws or regulations that deal directly with the payment processing of this
application and there is uncertainty as to the legal status of Internet gaming.
While some jurisdictions have taken the position that Internet gaming is legal
and have adopted or are in the process of reviewing legislation to regulate
Internet gaming in such jurisdictions, other jurisdictions have taken the
opposite view and enacted legislation to attempt to restrict or prohibit
Internet gaming. For example, in the United States for the past several years
there have been conflicting efforts to clarify the status of Internet gaming. In
the summer of 2003, the United States House of Representatives passed
legislation that would prohibit the acceptance of a credit card, electronic
funds transfer or any other bank instrument in connection with unlawful Internet
gaming. The bill left the definition of "unlawful" gaming essentially unchanged,
however. A contrasting bill, currently pending before the House Judiciary
Committee, would establish a commission to recommend regulations to provide for
Internet gaming. A prohibitory bill similar to the legislation that passed the
House has been introduced in the United States Senate and is pending there. Both
the Senate prohibitory bill and the House regulatory bill have received hearings
but no further action yet has been taken. Should such a bill pass and become
law, it is likely that regulations would come into effect anywhere from six to
nine months after such passage which would make the funding of online gaming
accounts by U.S. residents unlawful. This would have a significant negative
impact on us. As a
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result, we have taken the initiative and continue to invest in the
diversification of our revenue base towards the continued diminishing of our
reliance on online gaming payments emanating from U.S. residents. Since we
derive a substantial portion of our revenue from processing transactions for
licensed online gaming, we may be exposed to governmental investigations and/or
lawsuits initiated by the public in jurisdictions where gaming is restricted or
prohibited. Any adverse findings or rulings rendered against us in such
jurisdictions could have a material adverse effect on our business, revenues,
operating results and financial condition. This uncertainty could affect us
indirectly through the effect experienced by our clients and on their revenues
and directly in the event that we are restricted from conducting our activities,
such as if the banks through which we settle our clients' transactions terminate
their agreements with us or significantly increase the costs to us for their
services, or certain credit card issuing banks continue to reject Internet
gaming transactions.
WE FACE UNCERTAINTIES WITH REGARD TO LAWSUITS, REGULATIONS AND SIMILAR
MATTERS. There is a risk that criminal and civil proceedings, including class
actions brought by or on behalf of public entities or private individuals, could
be initiated against us, ISPs, credit card processors and others involved in the
Internet gaming industry. Any future legal proceedings against us relating to
Internet gaming could involve substantial litigation expense, penalties, fines,
injunctions or other prohibitions being invoked against us or our licensees or
others and the diversion of the attention of key executives. The outcome of any
litigation cannot be predicted.
INCREASING GOVERNMENT REGULATION OF INTERNET COMMERCE COULD MAKE IT MORE
COSTLY OR DIFFICULT TO CONTINUE OUR BUSINESS. As electronic commerce over the
Internet develops, it may be the subject of increasing government regulation and
there is a risk that well-established financial institutions and credit card
companies will be able to influence the development of regulations in a manner
which prioritizes their interests to our detriment. In addition, much of the
current legislation relating to commercial transactions pre-dates and may be
incompatible with Internet electronic commerce. There can be no assurance that
regulators will not choose to enact or enforce legislation in a manner that
would restrict our operations and other aspects of the electronic commerce
market. Moreover, it may take years to determine the extent to which existing
laws relating to issues such as intellectual property ownership and
infringement, libel and personal privacy are applicable to the Internet.
Existing legislation in Canada, the United States and abroad regulate
communications or commerce specifically; however, the application of such laws
in the context of the Internet and electronic commerce is uncertain. Laws and
regulations that address issues such as user privacy, pricing, online content
regulation, taxation and the characteristics and quality of online products and
services are under consideration by federal, provincial, state, local and
foreign governments and agencies.
In Canada, the Personal Information Protection and Electronic Documents
Act was passed into law by the federal government effective January 1, 2001.
Currently, this law regulates the inter-provincial collection, use and
disclosure of personal information. This law is in addition to several
provincial laws covering the same subject matter within a province currently in
force or being considered.
In the United States, several telecommunication companies have petitioned
the Federal Communications Commission to regulate ISPs and online service
providers. The Federal Trade Commission and government agencies in certain
states of the United States have been investigating certain Internet companies
regarding their use of personal information. We could incur additional expenses
if any new regulations regarding the use of personal information are introduced
affecting the way in which we do business or if these agencies choose to
investigate our privacy practices.
Any new laws or regulations relating to the Internet, or particular
applications or interpretations of existing laws, could decrease the growth in
the use of the Internet, decrease the demand for our electronic
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commerce services, or increase the costs associated with providing such services
or transmitting data over the Internet and generally stunt the development of
the Internet and our growth.
WE RELY ON STRATEGIC RELATIONSHIPS AND SUPPLIERS. We have established and
will continue to establish relationships with strategic partners and suppliers
to help supply, promote and distribute our products and services. We are
dependent upon maintaining as well as creating these relationships with
strategic partners and suppliers, especially strategic banking relationships.
The credit card companies and financial institutions on whom we rely in order to
process our electronic transactions have adopted guidelines for the processing
of transactions, including gaming transactions. We believe that our operations
comply in all material respects with these guidelines. However, credit card
companies and financial institutions could nonetheless decide in the future to
refuse to process transactions for us or to process online gaming transactions
generally. Any such decision, when made by a particular credit card company or
financial institution, could be implemented with little or no advance notice to
us. Should we not be able to conclude alternative arrangements with other credit
card companies or financial institutions within the delays imposed by any such
termination, or at all, our ability to carry out payment transactions would be
impaired and we may not then be able to continue to carry on our business.
IT MAY BE COSTLY AND/OR TIME-CONSUMING TO ENFORCE OUR RIGHTS WITH RESPECT
TO ASSETS HELD IN FOREIGN JURISDICTIONS. Certain of our suppliers' processing
agreements require us to maintain cash reserves with such supplier. In some
instances, these suppliers are located in overseas jurisdictions including the
Caribbean and Europe. Should the processing supplier not release our reserves
based upon the contractual requirements, we would be required to take legal
action within that foreign jurisdiction. Any delay or inability in obtaining the
funds held as reserve and the corresponding resources required to pursue the
funds could negatively impact our financial condition and results of operations.
OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY IS KEY TO OUR FUTURE
GROWTH. We rely primarily upon a combination of copyright, trademark and trade
secret laws, non-disclosure and release of interest in intellectual property
agreements and license agreements to establish and protect proprietary rights in
our products and technology. The source codes for our products and technology
are protected both as trade secrets and as unpublished, unregistered copyrighted
works; however, we currently have no patents for our products and technology.
Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use our products or technology without authorization or to
develop similar technology independently. Policing unauthorized use of our
products and services is and will continue to be difficult, particularly in the
global environment in which we operate, and the laws of other jurisdictions may
afford us little or no effective protection of our intellectual property. The
global nature of the Internet will make it difficult to control the ultimate
destinations of our products or services. We rely in part on "on-screen"
licenses, which are not manually signed by end-users and, therefore, may be
unenforceable under some laws. There is no assurance that any steps taken by us
will prevent others from misappropriating our technology. We may engage in
litigation related to our intellectual property; however, such litigation,
whether successful or unsuccessful, could result in substantial costs and
diversion of resources.
In addition, there is no assurance that our products and services are not
within the scope of intellectual property rights held by others, either now or
in the future. If any claims are asserted, we may seek to obtain a license under
a third party's intellectual property rights. There can be no assurance that
such a license would be available on reasonable terms or at all. We may also
decide to defend against a claim of infringement; but litigation, even if
successful, is costly and may have a material adverse effect on us regardless of
the eventual outcome.
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WE OPERATE IN A COMPETITIVE MARKET FOR OUR PRODUCTS AND SERVICES.
Potential competitors to our electronic commerce solutions include credit card
companies, banks, payment processors and other entities, any of which may have
greater financial resources, an entrenched position in the market or greater
brand recognition. These potential competitors may be able to require that their
own technology, rather than the technology of others, including our own, be used
in connection with their payment mechanisms. Furthermore, the barriers to entry
into most Internet markets, including the electronic commerce segments, are
relatively low, making them accessible to a wide number of entities. Therefore,
competition is likely to intensify as our market develops and matures, which
could result in price reductions, reduced margins or loss of market share.
Furthermore, there can be no assurance that we will be able to identify,
develop, manufacture, market or support new products or offer new services
successfully, that such new products or services will gain market acceptance, or
that we will be able to respond effectively to technological changes or product
announcements by competitors. Any failure by us to anticipate or respond
adequately to technological developments and customer requirements or any
significant delays in product developments or introductions could result in a
loss of market share or revenues.
There can be no assurance that our competitors will not develop
technologies and products that are as or more effective and efficient than our
products or that our technologies and products will not be rendered obsolete by
such developments. As well, there can be no assurance that other companies with
greater financial and technological resources will not develop electronic
commerce technologies for the Internet with similar or better capabilities than
our products or that we will be able to compete successfully against existing
competitors or future entrants into the market. Products developed by
competitors may achieve greater market acceptance than our products.
OUR BUSINESS SYSTEMS ARE BASED ON SOPHISTICATED TECHONOLGY WHICH MAY BE
NEGATIVELY AFFECTED BY TECHNOLOGICAL DEFECTS AND PRODUCT DEVELOPMENT DELAYS.
Products and services based on sophisticated technology and computing systems
often encounter development delays, and the underlying technology may contain
undetected errors or failures when introduced or when the volume of services
provided increases. We may experience delays in the development of our products,
or the technology and computing systems underlying our services, such as our
transaction processing services. In addition, despite testing, it is possible
that our technology may nevertheless contain errors, and this could delay
product launches and innovations and damage customer relations.
WE RELY UPON ENCRYPTION TECHNOLOGY TO CONDUCT SECURE ELECTRONIC COMMERCE
TRANSACTIONS. A significant barrier to electronic commerce and communication is
the secure transmission of confidential information over public networks. Our
electronic commerce software uses encryption and authentication technology to
provide the security and authentication necessary to effect secure transmission
of confidential information. Despite the fact that we strive to make use of
proven applications for premium data security and integrity to process
electronic transactions, there can be no assurance that use of these
applications will be sufficient to address changing market conditions or the
security and privacy concerns of existing and potential clients. A security or
privacy breach may cause our clients to lose confidence in our services, deter
clients from using our services, harm our reputation, expose us to liability,
increase our expenses from potential remediation costs and decrease market
acceptance and growth of our product offerings.
OUR ABILITY TO PROCESS ELECTRONIC TRANSACTIONS DEPENDS ON BANK PROCESSING
AND CREDIT CARD SYSTEMS. These systems and operations are vulnerable to damage
or interruption from human error, natural disasters, telecommunication failures,
break-ins, sabotage, computer viruses, intentional acts of vandalism and similar
events. In order to prepare for certain types of system problems, we have
developed and are testing a formal disaster recovery plan. Any
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system failure, including network, software or hardware failure, that causes a
delay or interruption in our electronic payment services could result in reduced
use, reduced revenue and harm to our reputation, brand and relations with
merchants and end-users.
Delayed response times and interruptions in service associated with our
electronic transaction processing, including delays or interruptions relating to
high volumes of traffic or technological problems, may result in a loss of
merchants and end-users using our electronic payment software for transaction
processing.
WE ARE SUBJECT TO EXCHANGE RATE FLUCTUATIONS BETWEEN THE U.S. AND CANADIAN
DOLLARS. The majority of our revenues are generated in U.S. dollars and a
significant portion of our expenses is incurred in Canadian dollars. Any
fluctuation in the value of the Canadian dollar relative to the U.S. dollar may
result in variations in our revenues and earnings. We have not implemented a
currency hedging program.
WE MAY BE SUBJECT TO LIABILITY OR BUSINESS INTERRUPTION AS A RESULT OF
UNAUTHORIZED DISCLOSURE OF MERCHANT AND CARDHOLDER DATA THAT WE STORE. We
collect and store sensitive data about merchants and cardholders, including
names, addresses, social security numbers, drivers' license numbers, checking
and savings account numbers and payment history records, such as account
closures and returned checks. In addition, we maintain a database of cardholder
data relating to specific transactions, including payment card numbers and
cardholder addresses, in order to process the transactions and for fraud
prevention and other internal processes. If a person penetrates our network
security or otherwise misappropriates sensitive merchant or cardholder data, we
could be subject to liability or business interruption.
Although we require that our agreements with service providers who have
access to merchant and customer data include confidentiality obligations that
restrict these parties from using or disclosing any customer or merchant data
except as necessary to perform their services under the applicable agreements,
there can be no assurance that these contractual measures will prevent the
unauthorized disclosure of merchant or customer data. In addition, our
agreements with financial institutions require us to take certain protective
measures to ensure the confidentiality of merchant and consumer data. Any
failure to adequately take these protective measures could result in protracted
or costly litigation.
OUR BUSINESS IS SUBJECT TO FLUCTUATIONS IN GENERAL BUSINESS CONDITIONS.
General economic conditions have caused some of the merchants we serve to
experience difficulty in supporting their current operations and implementing
their business plans. If these merchants make fewer sales of their products and
services, we will have fewer transactions to process, resulting in lower
revenues.
In addition, in a recessionary environment, the merchants we serve could
be subject to a higher rate of insolvency, which could adversely affect us
financially. We bear credit risk for chargebacks related to billing disputes
between credit card holders and bankrupt merchants. If a merchant seeks relief
under bankruptcy laws or is otherwise unable or unwilling to pay, we may be
liable for the full transaction amount of a chargeback.
RISKS RELATED TO OUR OPERATION OF THE U-SCAN(R)SELF-CHECKOUT BUSINESS
WE MAY BE SUBJECT TO ADDITIONAL LITIGATION STEMMING FROM OUR OPERATION OF THE
U-SCAN(R) SELF-CHECKOUT BUSINESS. We recently settled an action alleging that
the U-Scan(R) self-checkout systems that we marketed infringed upon the
claimant's patent. A second party has sent demand letters to us alleging a
different patent infringement (see Part II - Other Information; Item 1 - Legal
Proceedings). We may in the future be subject to other litigation, which relates
to our having
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carried on the self-checkout business. Litigation may be time consuming,
expensive and distracting from the conduct of our current businesses, and the
outcome of litigation is difficult to predict. The adverse resolution of any
specific lawsuit could have a material adverse effect on our business, results
of operations and financial condition.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes to the disclosures of market risk, as
contained in our Annual Report on Form 10-K for the year ended December 31,
2003.
Item 4. Controls and Procedures
As of June 30, 2004 (the "Evaluation Date"), under the supervision and
with the participation of our management, including our Chief Executive Officer
and our Chief Financial Officer, we evaluated the effectiveness of the design
and operation of our disclosure controls and procedures, as defined in Rule
13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"). Based upon this evaluation, our Chief Executive Officer
and our Chief Financial Officer concluded that, as of the Evaluation Date, our
disclosure controls and procedures were adequate to ensure that information
required to be disclosed by us in the reports filed or submitted by us under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms.
Additionally, there have been no changes in our internal control over
financial reporting that have materially affected, or are reasonably likely to
materially affect our internal control during our most recent fiscal quarter.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We received a demand letter in 1999, and again in February 2001 from the
same party, alleging a patent infringement related to the U-Scan(R)
self-checkout business that we were operating at that time. In March 2003, this
party sent a third demand letter to us alleging infringement of additional
patents. Although, after consultation with counsel, we believe that this
claimant should not prevail if a lawsuit is brought to assert its claims and
that the assertion of these claims will not have a material adverse effect on
our business or prospects, no assurance can be given that a court will not find
that the U-Scan(R) self-checkout system infringes upon such claimant's rights.
We sold our self-checkout business on April 8, 2004, and no longer market or
sell the U-Scan(R) self-checkout system.
In connection with the sale of our U-Scan(R) self-checkout business on
April 8, 2004 to Fujitsu Transaction Solutions Inc., orders were obtained from
the Superior Court of Quebec permitting us to submit the sale to Fujitsu to our
shareholders for approval in lieu of the originally proposed sale to NCR
Corporation. NCR is seeking to appeal these decisions. Although we believe that
these appeals should not prevail, no assurance can be given that the Court of
Appeal of Quebec will not overturn the Superior Court's decisions. Should NCR
succeed in its appeal, it could result in a material adverse consequence to us.
NCR has also delivered a notice of dispute under its now terminated purchase
agreement alleging a breach by us of the non-solicitation provisions of that
agreement. We believe that such allegations are without merit and intend to
vigorously defend ourselves in any arbitration proceedings that may ensue.
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We believe that, even if NCR were successful in any such arbitration
proceedings, it would not result in any material adverse consequence to us.
We are also party to litigation arising in the normal course of
operations. We do not expect the resolution of such matters to have a materially
adverse effect on our financial position or results of operations.
Item 2. Changes in Securities
As discussed in the Current Report on Form 8-K, as amended, filed April
21, 2004, we authorized for issuance 9,059,589 Class "A" Shares (of which
7,242,168 shares were issued during the most recent fiscal quarter and the
remaining shares were reserved for issuance on the exercise of outstanding
options and warrants) to shareholders of Terra Payments Inc. in connection with
a business combination transaction. These shares were issued pursuant to the
exemption contained in Section 802 of the Securities Act of 1933, as amended.
Item 3. Defaults Upon Senior Securities
The registrant has nothing to report under this item.
Item 4. Submission of Matters to a Vote of Security Holders
We held our annual and special meeting of shareholders on April 6, 2004. The
following resolutions were adopted:
- ------------------------------------------------------------------------------------------------
Votes
Resolution Votes For Against Withheld Spoiled Non-Voted
- ------------------------------------------------------------------------------------------------
Election of Henry 10,628,406 N/A 229,987 1,459,419 1,295,136
M. Karp as
Director(1)
- ------------------------------------------------------------------------------------------------
Election of Leon 10,628,406 N/A 229,987 1,459,419 1,295,136
P. Garfinkle as
Director(1)
- ------------------------------------------------------------------------------------------------
Appointment of 11,843,116 N/A 433,438 41,258 1,295,136
KPMG LLP as
Auditors
- ------------------------------------------------------------------------------------------------
Combination with 6,281,934 349,063 N/A 13,494 6,968,457
Terra Payments
Inc.
- ------------------------------------------------------------------------------------------------
Change of name to 6,551,585 81,956 N/A 10,950 6,968,457
Optimal Group Inc.
- ------------------------------------------------------------------------------------------------
Increase in the 11,334,374 964,801 N/A 18,637 1,295,136
number of directors
from nine (9) to
thirteen (13)
- ------------------------------------------------------------------------------------------------
Sale of U-Scan(R) 6,278,461 348,689 N/A 17,341 6,968,457
self-checkout
business
- ------------------------------------------------------------------------------------------------
(1) Henry M. Karp and Leon P. Garfinkle were elected to hold office until the
close of the 2007 annual meeting of shareholders.
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The following directors did not stand for election and continue in office for
the following respective periods:
Holden L. Ostrin, James S. Gertler and Sydney Sweibel, each to hold office until
the close of the 2005 annual meeting of shareholders; and Neil S. Wechsler,
Thomas D. Murphy and Jonathan J. Ginns, to hold office until the close of the
2006 annual meeting of shareholders.
Item 5. Other Information
Reporting Status
We were a foreign private issuer under the rules and regulations of the
Commission as of June 30, 2004. As in the past, we intend to voluntarily file
annual reports on Form 10-K and quarterly reports on Form 10-Q.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Exhibit
------ -------
10.20 Asset Purchase Agreement among Fujitsu Transaction Solutions Inc.,
Optimal Robotics Corp. and Optimal Robotics Inc.
10.21 Amendment to Asset Purchase Agreement among Fujitsu Transaction
Solutions Inc., Optimal Robotics Corp. and Optimal Robotics Inc.
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
32.1 Certification pursuant to Section 1350, Chapter 63 of Title 18,
United States Code, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification pursuant to Section 1350, Chapter 63 of Title 18,
United States Code, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed for the three-month period ended
June 30, 2004.
1. Form 8-K filed with the Commission on April 5, 2004 (Item 9)
2. Form 8-K filed with the Commission on April 6, 2004 (Item 9)
3. Form 8-K filed with the Commission on April 7, 2004 (Item 9)
4. Form 8-K filed with the Commission on April 9, 2004 (Item 9)
5. Form 8-K filed with the Commission on April 21, 2004 (Items 2 and 7)
6. Form 8-K filed with the Commission on April 23, 2004 (Items 2 and 7)
7. Form 8-K filed with the Commission on May 7, 2004 (Item 9)
8. Form 8-K filed with the Commission on May 12, 2004 (Items 2 and 7)
9. Form 8-K/A filed with the Commission on June 18, 2004 (Items 2 and
7)
10. Form 8-K filed with the Commission on June 21, 2004 (Item 9)
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OPTIMAL GROUP INC.
Dated: August 9, 2004 By: /s/ Holden L. Ostrin
----------------------------------
Holden L. Ostrin
Co-Chairman
By: /s/ Gary S. Wechsler
----------------------------------
Gary S. Wechsler
Treasurer and Chief Financial
Officer
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