U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-28690
SHOPNET.COM, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 13-3871821
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
112 West 34th Street, Suite 902, New York, New York 10120
(Address of Principal Executive Offices)
(212) 967-8303
(Issuer's Telephone Number, Including Area Code)
14 East 60th Street, Suite 402, New York, NY 10022
(Former Name, Former Address, and Former Fiscal Year,
if Changed Since Last Report)
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares of each of the issuer's classes of common equity
outstanding as of the latest practicable date: Common Stock, par value $.001 par
value: 8,067,462 shares outstanding as of February 13, 2003.
SHOPNET.COM, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page
Number
--------
Item 1. FINANCIAL STATEMENTS
Consolidated balance sheets as of December 31, 2002 (Unaudited) and June 30, 2002 3
Consolidated statements of operations and comprehensive income (Unaudited) for the six months and
three months ended December 31, 2002 and December 31, 2001 4
Consolidated statements of stockholders' equity for the six months ended December 31,
2002(Unaudited) 5
Consolidated statements of cash flows for the six months ended December 31, 2002 and December 31,
2001 (Unaudited) 6
Notes to consolidated financial statements (Unaudited) 7
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 19
Item 3. CONTROLS AND PROCEDURES 31
PART II. OTHER INFORMATION 32
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31, 2002 and June 30, 2002
Dec. 31 June 30,
ASSETS 2002 2002
----------- -----------
(Unaudited) (Audited)
Current assets:
Cash .................................................................................... $ 11,624 $ 3,309
Accounts receivable, net ................................................................ 85,928 19,109
Other receivables ....................................................................... -- 88,118
Inventory ............................................................................... 3,954,116 230,049
Prepaid expenses ........................................................................ 348,963 298,968
Advances to officer ..................................................................... 40,000 40,000
----------- -----------
Total current assets ...................................................... 4,440,631 679,553
----------- -----------
Property and equipment, net ............................................................. 83,668 70,044
Film production and distribution costs, net ............................................. 1,204,728 1,204,728
Costs in excess of net assets of business acquired ...................................... 727,261 727,261
Investments in movie ventures ........................................................... 246,399 246,399
Deferred tax asset-non-current .......................................................... 224,240 224,240
Other assets ............................................................................ 27,306 27,078
----------- -----------
2,513,602 2,499,750
----------- -----------
Total assets .............................................................. $ 6,954,233 $ 3,179,303
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Due to factor ........................................................................... $ 3,398,122 $ 690,595
Loan payable ............................................................................ 50,000 --
Accounts payable ........................................................................ 1,835,963 280,003
Accrued expenses ........................................................................ 5,916 4,782
Capital lease obligations ............................................................... 16,544 3,938
Other taxes payable ..................................................................... 1,723 2,214
Deferred tax liability .................................................................. 5,938 5,188
----------- -----------
Total current liabilities ................................................. 5,314,206 986,720
----------- -----------
Total liabilities ......................................................... 5,314,206 986,720
----------- -----------
Commitments and contingencies
Stockholders' equity
Common stock- $.001 par value, 20,000,000 shares authorized, 8,067,462 shares issued and
outstanding at December 31, 2002 and 7,472,224 shares issued and outstanding at June
30, 2002 .............................................................................. 8,067 7,472
Capital in excess of par value .......................................................... 6,653,257 6,638,852
Accumulated deficit ..................................................................... (5,021,297) (4,453,741)
----------- -----------
Total stockholders' equity ................................................ 1,640,027 2,192,583
----------- -----------
Total liabilities and stockholders' equity .............................................. $ 6,954,233 $ 3,179,303
=========== ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
-3-
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Statement of Operations and Comprehensive Income (Loss)
(Unaudited)
Six Months Ended Three Months Ended
-------------------------------------- -----------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net sales .......................................... $ 750,678 $ 1,700,705 $ 730,871 $ 1,335,592
Cost of sales ...................................... 247,239 1,098,622 145,792 693,300
----------- ----------- ----------- -----------
Gross profit ....................................... 503,439 602,083 585,079 642,292
----------- ----------- ----------- -----------
Expenses:
Selling, general, and administrative ............... 981,746 979,147 515,479 508,318
Amortization of costs in excess of net assets of
business acquired .............................. -- 35,476 -- 17,738
----------- ----------- ----------- -----------
Total expenses ..................................... 981,746 1,014,623 515,479 526,056
----------- ----------- ----------- -----------
Income (loss) before other income (expenses) and
provision for income taxes ......................... (478,307) (412,540) 69,600 116,236
----------- ----------- ----------- -----------
Other income (expenses):
Equity in earnings (loss) of affiliate ............. -- (63) -- --
Rental income ...................................... -- 9,050 -- --
Interest and financial expense ..................... (90,185) (155,919) (66,998) (94,345)
Interest income .................................... 936 10,933 936 1,334
----------- ----------- ----------- -----------
Total other income (expense) ....................... (89,249) (135,999) (66,062) (93,011)
----------- ----------- ----------- -----------
Income (loss) before provision for income taxes
(567,556) (548,539) 3,538 23,225
Provision (benefit) for income taxes ............... -- -- -- --
----------- ----------- ----------- -----------
Net income (loss) .................................. (567,556) (548,539) 3,538 23,255
----------- ----------- ----------- -----------
Other items of comprehensive (loss) income
-- (6,350) -- --
----------- ----------- ----------- -----------
Comprehensive loss ................................. $ (567,556) $ (554,889) $ 3,538 $ 23,225
----------- ----------- ----------- -----------
Basic:
Net loss per share ................................. $ (.074) $ (.07) $ .0004 $ .003
=========== =========== =========== ===========
Weighted average number of common shares outstanding
7,670,637 7,472,224 7,869,049 7,472,224
=========== =========== =========== ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
-4-
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For The Six Months Ended December 31, 2002
(Unaudited)
Additional 5% Total
Common Stock Paid-in Accumulated Convertible Stockholders'
Shares Amount Capital Deficit Debentures equity
----------- ----------- ----------- ----------- ----------- -----------
Balances at June 30, 2002 (Audited) ....... 7,472,224 $ 7,472 $ 6,638,852 $(4,453,741) $ -- $ 2,192,583
August 28, 2002, issuance of 5% Convertible
debentures ................................ -- -- -- -- $ 15,000 15,000
Nov. 6, 2002-Conversion of debentures into
595,238 shares ............................ 595,238 595 14,405 (567,556) (15,000) (567,556)
Net loss (Unaudited)
----------- ----------- ----------- ----------- ----------- -----------
Balances at December 31, 2002 ............. $ 8,067,462 $ 8,067 $ 6,653,257 $(5,021,297) $ -- $ 1,640,027
=========== =========== =========== =========== =========== ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
-5-
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Statement of Cash Flows
For The Six Months Ended December 31, 2002 And 2001
(Unaudited)
Dec. 31, Dec. 31,
2002 2001
----------- -----------
Cash flows from operating activities:
Net loss ....................................................................... $ (567,556) $ (548,539)
Adjustments to reconcile net income to net cash used in operating activities:
Equity in loss of affiliate ............................................... -- 63
Amortization and depreciation
13,326 31,665
Decrease (increase) in:
Accounts receivable ....................................................... (66,819) (5,186)
Other receivables ......................................................... 88,118 62,734
Inventory ................................................................. (3,724,067) (2,575,203)
Prepaid expenses .......................................................... (49,995) (256,220)
Advances to officer ....................................................... (1,971) (1,971)
Other assets .............................................................. 1,743 (71)
Increase (decrease) in:
Due to factor ............................................................. 2,707,527 1,147,472
Accounts payable .......................................................... 1,555,960 1,121,032
Accrued expenses .......................................................... 1,134 57,997
Deferred liability ........................................................ 750 --
Other taxes payable ....................................................... (491) (467)
----------- -----------
Net cash used in operating activities ............................................. (42,341) (966,694)
----------- -----------
Cash flows from investing activities:
Acquisition of property and equipment .......................................... (26,950) (17,801)
----------- -----------
Net cash used in investing activities ............................................. (26,950) (17,801)
----------- -----------
Cash flows from financing activities:
Principal payments on capital leases ............................................ (5,057) (8,750)
Issuance of new capital leases .................................................. 17,663 --
Issuance of convertible debentures .............................................. 15,000 --
Loans Payable ................................................................... 50,000 --
----------- -----------
Net cash used in financing activities ............................................. 77,606 (8,750)
----------- -----------
Net decrease in cash and restricted cash .......................................... 8,315 (993,245)
Cash and restricted cash, beginning of period ..................................... 3,309 994,285
----------- -----------
Cash and restricted cash, end of period ........................................... $ 11,624 $ 1,040
=========== ===========
Supplemental disclosure of cash flow information: cash paid during the period for :
Interest .................................................................. $ 90,185 $ 155,919
=========== ===========
Income taxes .............................................................. $ -- $ --
=========== ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
-6-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 1- ORGANIZATION
Shopnet.com, Inc. ("Shopnet" or the "Company") was
incorporated in the State of Delaware on December 1, 1995 under
the name of Hollywood Productions, Inc. It was formed for the
purpose of acquiring screenplays and producing motion pictures.
On May 10, 1999, the Company filed an amendment to its Articles
of Incorporation to change its name to Shopnet.com. Inc. On May
12, 1999, Shopnet incorporated a new wholly owned subsidiary,
Hollywood Productions, Inc. ("Hollywood"), to which the Company
assigned all of its film rights. Accordingly, Shopnet is
considered a holding company. During September 1996,
simultaneously with the completion of its Initial Public Offering
("IPO"), Shopnet acquired all of the capital stock of Breaking
Waves, Inc. ("Breaking Waves"). Breaking Waves designs,
manufactures, and distributes private and brand name labels of
children's swimwear nationally. As of June 30, 2002, Shopnet and
all of its subsidiaries changed their financial year end from
December 31 to June 30.
NOTE 2- INTERIM RESULTS AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements
as of December 31, 2002 and for the six month periods ended
December 31, 2002 and December 31, 2001 and for the three month
periods ended December 31, 2002 and December 31,2001 have been
prepared in accordance with generally accepted accounting
principles for interim financial information and with the
instructions to Form 10-QSB and Items 303 and 310 of Regulation
S-B. In the opinion of management, the unaudited financial
statements have been prepared on the same basis as the annual
financial statements and reflect all adjustments, which include
only normal recurring adjustments, necessary to present fairly
the financial position as of December 31, 2002 and the results of
operations and cash flows for the six month periods ended
December 31, 2002 and December 31, 2001 are not necessarily
indicative of the results to be expected for any subsequent
quarter or the entire fiscal year. The balance sheet at June 30,
2002 has been derived from the audited financial statements at
that date.
Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted pursuant to the Securities and Exchange Commission's
rules and regulations. The Company believes, however, that the
disclosures in this report are adequate to make the information
presented not misleading in any material respect. The
accompanying consolidated financial statements should be read in
conjunction with the audited financial statements of Shopnet.com,
Inc. and Subsidiaries as of June 30, 2002 and for the year then
ended and notes thereto included in the Company's report on Form
10-KSB filed on October 15, 2002.
The Company in the quarter ended December 31, 2002 has
implemented a number of initiatives which it believes will reduce
its costs of operations and alleviate in the following six months
its working capital deficiency. In particular, the Company
believes that the repayment of its indebtedness to Century (See
Note 7) and the recent reductions in interest rates will reduce
interest expense.
-7-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 2- INTERIM RESULTS AND BASIS OF PRESENTATION (continued)
In December 2001, the Company consolidated all of its
operation's in the New York metropolitan region into one new
facility (See Note 9(a) ), creating a savings through synergies
in office expense and decrease in rent and salaries. The Company
has, also, recently refocused its sales efforts, to the extent
possible, to eliminate unprofitable or low margin sales and has
had improved sales and orders for the current fiscal year.
NOTE 3- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) Recently adopted accounting principles - Film accounting
Pursuant to SFAS no. 139, the Company adopted Statement of
Position ("SOP") 00-2, "Accounting by Producers or Distributors
of Films" during the six months ended December 31, 2002. SOP 00-2
established new film accounting standards, including changes in
revenue recognition and accounting for advertising, development
and overhead costs. Specifically, SOP 00-2 requires advertising
costs for theatrical and television products to be expensed as
incurred. This compares to the Company's previous policy of first
capitalizing these costs and then expensing them over the related
revenue streams. In addition, SOP 00-2 requires development costs
for abandoned projects and certain indirect overhead costs to be
charged to film costs, which was required under the previous
accounting rules, SOP 00-2 also in other areas, such as revenue
recognition, generally are consistent with the Company's existing
accounting policies. SOP 00-2 was adopted as of July 1, 2002, and
had no effect on the Company's consolidated results of
operations, financial position or cash flows.
b) Recently issued accounting pronouncements
The Company does not believe that any recently issued but
not yet effective accounting standards, have a material effect on
the Company's consolidated financial position, results of
operations or cash flows except for the effect of adoptions of
SFAS No. 142, " Goodwill and Other Intangible assets". It
addresses how intangible assets that are acquired individually or
with a group of other assets (but not those acquired in a
business combination) should be accounted for in financial
statements upon their acquisition. SFAS 142 also addresses how
goodwill and other intangible assets should be accounted for
after they have been initially recognized in the financial
statements. The Company adopted the provisions of this new
standard beginning with the first quarter of 2002.
c) Earnings per share:
Basic earnings (loss) per share is computed by dividing net
income (loss) income attributable to common shares, by the
weighted average number of common shares outstanding during each
period. Diluted earnings (loss) per share is similar to basic
earnings (loss) share, except that the weighted average number of
common shares is outstanding is increased to reflect the dilutive
effect of potential common shares, such as the conversion of the
5% convertible debentures, as if they had been issued.
-8-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 4- ACQUISITION OF BREAKING WAVES, INC.
Pursuant to a stock purchase agreement dated May 31, 1996
(the "Agreement"), on September 24, 1996, the Company issued
110,000 shares of common stock in exchange for all of the issued
and outstanding capital stock of Breaking Waves. The transaction
was accounted for using the purchase method of accounting. As a
result of the transaction, excess of cost over net assets
acquired totaling $1,064,283 was recorded and was being amortized
over the useful lives of the related assets which was fifteen
years.
Effective for the year ended June 30, 2002, the Company
adopted FAS 142 "Goodwill and Other Intangible Assets". Under FAS
142, goodwill and indefinite lived intangible assets are no
longer amortized but are reviewed annually for impairment.
Goodwill is tested for impairment at the reporting level. Under
FAS 142, the fair value of a reporting unit is compared to its
carrying amount, including goodwill. If the book value (carrying
amount) is below the fair value assessment, there will be no
impairment or loss. If the fair value is below the book value
(carrying amount), the Company needs to perform a second test to
determine the gap between the impaired fair value of goodwill and
its carrying amount.
The Company had determine that no impairment existed as of
December 31, 2002. Accordingly, the book value was not further
written down.
NOTE 5- INVESTMENTS IN MOVIE VENTURES
a) Battle Studies
Pursuant to a co-production agreement dated April 17, 1998
with North Folk Films, Inc., the Company invested through
December 31, 2002, $217,500 for a 50% interest in a new entity,
Battle Studies Productions, LLC ("Battle Studies") a limited
liability company. Battle Studies is accounted for as a joint
venture in order to co-produce motion pictures and to finance the
costs of production and distribution of such motion pictures. The
joint venture retains all rights to the motion pictures, the
screenplays, and all ancillary rights attached thereto.
b) The Girl
Pursuant to an agreement dated July 1, 1999 with Artistic
License Films Inc., Hollywood invested through December 31, 2002
$35,000 for a 22.533% interest in a new entity, The Girl, LLC
("The Girl") a limited liability company. In return for its
participation in The Girl, Hollywood is entitled to receive a
non-contested, non-dilutable 22.533% ownership interest in The
Girl, a recoupment of its investment on no less favorable terms
than any other investor and 22.533% of 100% of any contingent
compensation which shall be actually received by The Girl. The
Girl retains all rights to the motion pictures, the screenplays,
and all ancillary rights attached thereto.
The Company accounts for the investments in Battle Studies
and The Girl under the equity method. For the six months ended
December 31, 2002 and 2001, the Company recorded no equity losses
from these investments.
-9-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 6- MARKETABLE SECURITIES- AFFILIATE
Breaking Waves owned 1,270,000 unregistered common shares of
Play Co. Toys & Entertainment Corp. ("Play Co."), a toy retailer
and a publicly traded company whose Chairman of the Board was
also the President of Shopnet and Breaking Waves.
Breaking Waves' ownership percentage was approximately 1.5%
of Play Co. The investment in Play Co. was accounted for under
the requirements of SFAS No. 115, "Accounting for Certain
investments in Debt and Equity Securities." Under SFAS 115, the
securities were considered available for sale and therefore the
carrying value was based on the fair market value of the
securities at December 31, 2002 and 2001 which amounted to $0 as
of both dates.
The change in the fair market value of the securities during
the periods are recorded as an unrealized gain or loss as a
component of comprehensive income. The Company pledged such
shares as collateral for a standby letter of credit in connection
with Breaking Waves entering into a new factoring agreement with
Century Business Credit Corporation ("Century") and were
therefore considered non-current (See Note 7).
On March 28, 2001 Play Co. filed for protection under
Chapter Eleven of the United States Code with the United States
Bankruptcy Court for the Southern District of New York. The
filing was converted into a Chapter Seven filing on August 28,
2001.
NOTE 7- DUE TO FACTOR
Century Business Credit Corporation
On or about September 12, 2000, Breaking Waves entered into
a factoring and revolving inventory loan and security agreement
("factoring agreement") with Century Business Credit Corporation
("Century") to sell its interest in all present and future
receivables without recourse. Breaking Waves submits all sales
offers to Century for credit approval prior to shipment, and pays
a factoring commission of .75% of receivables sold.
Century retains from the amount payable to Breaking Waves a
reserve for possible obligations such as customer disputes and
possible credit losses on unapproved receivables. Breaking Waves
may take advances of up to 85% of eligible receivables and up to
50% of the value of finished goods in inventory, with interest
payable monthly at the rate of 1 3/4% over prime.
Pursuant to the terms of a Reimbursement and Compensation
Agreement, a trust ("Trust"), the beneficiary of which is a
relative of the Company's President and Chief Executive Officer
("CEO") and a relative of a principal stockholder, pledged assets
as collateral for securing a $250,000 letter of credit to replace
a portion of a letter of credit previously pledged by the
Company.
Accordingly, on December 20, 2000 the original agreement
with the factor was amended to allow such replacement of
collateral. Breaking Waves' Loan and Security Agreement with
Century dated December 20, 2000 requires the provision of one or
more letters of credit in the aggregate amount of $1,150,000 to
partially secure the line of credit. On September 15, 2001,
Century required the Company to increase the amount of
collateralized standby letters of credit by $300,000 raising such
amount to $1,450,000.
-10-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 7- DUE TO FACTOR
Century Business Credit Corporation
On May 3, 2001, the Agreement with the Trust was amended so
that the letter of credit secured by the Trust was increased to
$400,000. As a condition of the amendment, the Company entered
into a guarantee agreement with Gal Capital Corp., whose
President is a relative of the Company's President and CEO and a
principal stockholder of the Company to act as guarantor of the
obligation to the Trust up to $400,000 in exchange for a fee of
$42,500 which the Company paid on May 3, 2001. The amended letter
of credit expired on September 1, 2001 and was subsequently
amended on September 15, 2001.
On September 15, 2001, the Amended and Restated
Reimbursement and Compensation Agreement was entered into and
further amended the agreement with the Trust, so that the letter
of credit secured by the Trust was increased to $750,000. The
amended letter of credit expired on September 1, 2002 but can be
extended year to year at the Company's option for a period of ten
years. On September 1, 2002, the letter of credit was extended.
Breaking Waves agreed to reimburse the Trust for any and all
losses, fees, charges and expenses to the Trust in the event the
letter of credit is called by Century and / or the issuing bank
demands reimbursement from the Trust. Breaking Waves' obligations
are guaranteed by the Company in addition to being secured by a
first security interest in all of the assets of the Company and a
subordinate security interest in all of the assets of Breaking
Waves.
In December 2002, Breaking Waves entered into a
Reimbursement and Compensation Agreement with TERE, S.A., a Swiss
entity. As a consequence of Century being unwilling to grant
credit to Breaking Waves unless it received one or more letters
of credit satisfactory to it as well as cash collateral to
partially secure the line of credit in such amounts as it deems
appropriate, the Trust reduced the letter of Credit secured by it
to $500,000. TERE, S.A. agreed to loan Breaking Waves the sum of
$250,000 represented by a promissory note. The funds were
deposited as cash collateral with Century to replace the reduced
portion of the letter of credit secured by the Trust.
All obligations under this agreement are guaranteed by the
Company and are secured by a security interest in all of the
Company's assets.
As compensation, Breaking Waves paid all interest received
from or credited to it by Century on the sums deposited pursuant
to the Cash Collateral Agreement when received.
The term of the loan is for ten years.
ARC has agreed to pay to TERE, interest at the rate of 8%
per annum on quarterly basis.
On September 15, 2001, the Company entered into a
Reimbursement Agreement with relatives of a principal stockholder
who is related to the President and CEO of the Company ("RAYA")
who pledged assets as collateral for securing a $300,000 letter
of credit as additional collateral to secure Breaking Waves' Loan
and Security Agreement with Century. Absent any default, the
letter of credit will remain in effect for ten years. The
Agreement is guaranteed by Shopnet under a separate Security
Agreement dated September 15, 2001.
-11-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 7- DUE TO FACTOR
Century Business Credit Corporation (continued)
In exchange for the letters of credit, the Trust and RAYA
will proportionately, based on the total outstanding letters of
credit, receive a fee of one and one quarter percent (1-1/4%) of
net sales of Breaking Waves through June 30, 2002 and thereafter
one and three quarters percent (1-3/4%) of net sales through
September 30, 2011. In October 2001, the Trust and RAYA received
advance payments to be applied towards future fees of $24,500 and
$12,250, respectively. All future payments are payable forty five
days after the close of each fiscal quarter. The fees are
effective October 1, 2001.
In September 2001, the Company and Breaking Waves retained
Arc Financial Corp. ("ARC"), a British Virgin Island company, for
a ten year term to provide financial consulting services.
Pursuant to the terms of a consulting services. Pursuant to
the terms of a consulting agreement ("ARC Consulting Agreement"),
ARC was retained to assist the Company in the acquisition of
financing to acquire inventory and for other corporate purposes
("Financing"), as well as consult with the Company with regard to
its ongoing operations, promote sales of Breaking Waves' products
and improving production.
Pursuant to the terms of the ARC Consulting Agreement, the
Company and Breaking Waves agreed to compensate ARC (i) an annual
fee of $20,000 ("Base Fee") and (ii) a percentage of annual net
sales in the amount of 1-1/4% through June 30, 2002 and 1-3/4% of
net sales for each year of the term thereafter through September
30, 2011 ("ARC Percentage Fee"), payable 45 days after the
closing of each fiscal quarter.
In October 2001, ARC received (I) a lump sum payment of
$209,000 reflecting full advance payment of the Base Fee and (ii)
$36,750 reflecting advance payment of the Arc Percentage Fee. The
agreement with Arc expires September 30, 2011. The Company and
Breaking Waves are entitled to terminate the ARC Consulting
Agreement any time after September 30, 2006, in which event all
prepaid fees are forfeited.
The following table summarizes the percentage due each
party, as noted above, as a percentage of net sales for the three
months ended December 31, 2002:
% of
Net Sales Amount
---------------
RAYA 0.58 $ 4,353
ZAT 1.16 8,708
ARC 1.75 13,137
--------------- --------------
3.49 $ 26,198
=============== ==============
Interest expense related to the factor agreement totaled
$63,702 and $102,883 for the six months ended December 31, 2002
and 2001, respectively. Century has a secured interest in
Breaking Waves' inventory as collateral for the advances. As of
December 31, 2002, the net advances to Breaking Waves from
Century amounted to $3,398,122.
-12-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 8- NOTE PAYABLE
On November 8, 2002, the Company borrowed the sum of $50,000
in the form of a promissory note from Amigal Salit, Ltd., an
unrelated party. The note which is non-interest bearing is due on
or before August 15, 2003.
On the same date, the Company entered into an agreement with
ARC Financial Corporation, whereby the Company using the proceeds
received from Amigal Salit, Ltd., agreed to pay $50,000 as an
advance against fees to be owed by Breaking Waves to ARC
Financial Corporation in connection with Breaking Waves
obligation to pay certain fees to ARC as part of a consulting
agreement as described in Note 7 (b) herein. The consulting fees
being paid in advance under this agreement are those fees which
would become due and payable for the periods ending December 31,
2002 and March 31, 2003.
NOTE 9- COMMITMENTS AND CONTINGENCIES
a) Lease commitments
Shopnet and Breaking Waves jointly share their
administrative offices under a lease agreement signed July 2001
by Breaking Waves. Shopnet is provided office space by Breaking
Waves on a rent-free basis. The lease agreement expires on
September 30, 2007. Annual rent under this lease is $84,915
through December 31, 2004 and $97,560 for the remainder of the
lease period. Additionally, Breaking Waves leases an offsite
office for one of its designers on a month to month basis with
annual payments approximating $11,000.
The approximate annual future minimum rentals under
non-cancelable operating lease signed by Breaking Waves are as
follows:
For the fiscal year ended June 30:
2003 $ 63,686
2004 84,915
2005 90,338
2006 95,760
2007 95,760
Thereafter 23,940
--------
$454,399
========
Rent expense for the six months ended December 31, 2002 and
2001 amounted to $53,188 and $68,127, respectively.
b) Significant vendors and customers
Breaking Waves purchases 100% of its inventory from three
vendors, two in Indonesia (74%) and the other in the Republic of
Korea (26%). Breaking Waves believes other sources and vendors
are available and that it is not dependent exclusively on these
vendors. For the three months ended December 31, 2002 Breaking
Waves had three customers, which comprised approximately 40%, of
net sales. For the six months ended December 31, 2001, Breaking
Waves had 2 customers which compromised 85% of net sales.
-13-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 9- COMMITMENTS AND CONTINGENCIES
c) Seasonality
Breaking Waves' business is considered seasonal with a large
portion of its revenues and profits being derived between
December and April. Each year from April through October,
Breaking Waves engages in the process of designing and
manufacturing the following season's swimwear lines, during which
time it incurs the majority of its production costs with limited
revenues and also engages in the sale of product at negative
gross margins to remove slow moving items and decrease its
carrying cost.
d) License agreements
During June 2000, Breaking Waves entered into a license
agreement with an effective date of November 1, 2001 with Gottex
Models Ltd., as Israeli corporation and Gottex Models (USA)
Corp., a New York corporation for the use of the trademark
"Gottex" in the United States of America for children's swimwear.
The agreement calls for a royalty fee of 7% of net sales with
guaranteed minimum annual royalties of $70,000 to $140,000 over
the life of the agreement. Breaking Waves recorded royalties
under the agreement totaling $86,680 and $42,611 for the six
months ended December 31, 2002 and 2001, respectively.
e) Co-production and property purchase agreements
Pursuant to co-production and property purchase agreements
dated March 15, 1996, as amended, the Company acquired the rights
to co-produce a motion picture and to finance the costs of
production and distribution of such motion picture with the
co-production. The Company retains all rights to the motion
picture with the co-producer agreeing to finance $100,000 of the
cost of production. The Company retains all rights to the motion
picture, the screenplay, and all ancillary rights attached
thereto. The motion picture was completed during the latter part
of 1996 and, accordingly, the Company commenced the marketing and
distribution process.
As of December 31, 2002, the Company invested $1,971,956 for
the co-production and distribution of such motion pictures
whereas the co-producers have invested $100,000. For the six
months ended December 31, 2002 and 2001, the Company derived no
revenue from the motion picture and amortized no film costs.
For the six months ended December 31, 2002 and 2001 the
Company has not written down its film production and distribution
costs, as the carrying value of the asset equals its estimated
net realizable value.
f) Litigation
On or about June of 2000, an action was brought in the
Queens County Supreme Court against the Company and several
others claiming, among other things, that the Company allegedly
breached a contract and engaged in fraudulent statements
(including supposedly promising the plaintiff options and then
not allowing the plaintiff to exercise these options).
-14-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 9- COMMITMENTS AND CONTINGENCIES (continued)
The plaintiff seeks, among other things, compensatory
damages in the amount of $497,500, punitive damages in the amount
of $995,000, together with costs and attorney's fees. The Company
intends to contest the action vigorously and believes that such
claims against it are baseless and without merit.
NOTE 10- STOCKHOLDERS' EQUITY
a) Warrants
i) Initially, each Warrant issued in the initial public
offering of September 24, 1996 entitled the holders thereof to
purchase one share of the Company's common stock at an exercise
price of $6.50 per share, until September 9, 2002. On August 31,
2002, the Company extended the term of its warrants by 18 months,
the Warrants will now expire on March 10, 2003. On June 23, 1997,
the Board of Directors approved a reduction in the exercise price
of the Warrants from $6.50 to $3.00. On February 5, 1998, the
Company affected a one for three reverse split of the Company's
common stock.
Accordingly, the Company adjusted the terms of the Warrants
to reflect the reverse split such that exercise of three Warrants
would entitle the holder to purchase one share of common stock at
an exercise price of $9.00. Giving effect to the January 1999
100% common stock dividend, the January 2001 10% common stock
dividend and the May 2001 20% common stock dividend, the warrants
have been cumulatively adjusted such that the exercise of each
warrant at an exercise price of $3.41 purchases .88 of a share of
common stock.
ii) On April 15, 1998, the Company's Board of Directors
authorized the distribution of warrants to all shareholders of
the Company's common stock as of May 8, 1998. Pursuant to the
distribution, each shareholder of record will receive one warrant
to purchase one share of common stock at an exercise price of
$4.00 per share. The warrants, which are exercisable for a period
of three years, commencing one year after issuance and receipt by
shareholder, shall be issued and distributed once the Company has
file a registration statement for same and same has been declared
effective by the Securities and Exchange Commission. The Company
to date has not filed the registration statement.
b) 5% Convertible Debentures
On June 17, 2002, the Company appointed Alliance Long Term
Capital Corp. as its placement agent in connection with the
proposed private placement on a best "efforts basis" of up to
$1,500,000 of 5% Convertible Debentures and up to $1,500,000 of
10% Non-Convertible Debentures. The term of this Agreement
commenced on June 17, 2002 and shall terminate on the earlier of
the completion of the Placement or can be terminated at any time
after six months from June 17, 2002. The agreement was terminated
on December 19, 2002.
-15-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 10- STOCKHOLDERS' EQUITY (continued)
b) 5% Convertible Debentures (continued)
Both of the Convertible Debentures and the Debt will pay
interest semi-annually and shall have a maturity date of four
years from the date of issuance. The Convertible Debentures will
be secured by the assets of the Company and will be subordinated
to the factor's first security interest in all the assets of the
Company.
On August 28, 2002, the Company received the sum of $15,000
representing payment for a subscription of $15,000 of the 5%
Convertible Debentures as referenced above. On August 31st,
$15,000 of these convertible debentures were issued by the
Company. No additional 5 % convertible Debentures nor any 10%
Non-Convertible Debentures have been issued.
At any time prior to or at the time of repayment of this
Note by the Company, the Holder may elect to convert some or all
of the principal and interest owing on this Note into shares of
the Company's common stock, subject to the restrictions contained
herein. The conversion rate shall equal the amount to be
converted, divided by 30% of the average closing bid price of the
common stock of the 90 trading days prior to the date of
conversion. Such election to convert shall be evidenced by
completion of the conversion notice and delivery of such notice
to the Company. The Holder's right to convert the obligations due
under this Note to common stock shall supercede the Company's
right to repay such obligations in cash, subject to the
restrictions contained herein.
The 5% convertible debentures were issued to Amigal Salit,
Ltd., an Israeli Company controlled by the sister-in-law of a
relative of the Company's President and CEO.
On November 6, 2002, the holder of the $15,000 Convertible
Debentures ("Amigal Salit, Ltd.") elected to convert these notes
into 595,238 shares of the Company's $.001 par value common
stock. On that date, the Company issued 595,238 common shares to
Amigal.
Upon this conversion, Amigal owns approximately 7.4% of the
Company's outstanding common shares.
NOTE - 11 RELATED PARTIES TRANSACTIONS
a) For the six months ended December 31, 2002 and 2001
financial consulting fees were paid to a corporation and an
individual who are related to the Company's President and CEO
amounting to $18,725 and $17,445, respectively.
b) During October 1996, pursuant to two promissory notes, the
Company loaned two of its officers a total of $87,000 bearing
interest at six and one-half percent (6 1/2) payable over three
years. As of December 31, 2002, the unpaid portion amounted to
$37,000, which has been classified as current. As of December 31,
2002, the Company's President was also advanced additional funds
totaling $3,000 which are non-interest bearing and due on demand
and are classified as current.
-16-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE - 12 SEGMENT INFORMATION
The Company's operations have been classified into two
segments: swimwear sales and film productions. These operating
segments were based on the nature of the projects and services
offered. Operating segments are defined as components of an
enterprise about which separate financial information is
available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and assess
performance. The Company's CEO has been identified as the chief
decision maker. The Company's chief operating decision maker
directs the allocation of resources to operating segments based
on the profitability and cash flow of the respective segments.
Six Months Ended December 31,
2002 2001
------------------------------------- -------------------------------
Segment Consolidated Segment Consolidated
--------------- ------------------ ----------------- ------------------
Sales:
Swimwear sales $ 750,678 $ 1,700,705
Film production - -
--------------- -----------------
Total sales $ 750,678 $ 1,700,705
================== ==================
Operating income (loss):
Swimwear sales $ 504,039 $ (187,260)
Film production (600) (600)
------------------ ------------------
Total operating income (loss) $ 504,039 $ (187,860)
------------------ ------------------
Corporate:
General and administrative expense $ (981,746) $ (189,204)
------------------ ------------------
(Loss) equity in earnings of affiliate - (63)
Amortization expense - (35,476)
Interest income 936 10,933
Interest and finance expense (90,185) (155,919)
Other - 9,050
------------------ ------------------
Loss from operating before (benefit) (567,556) (548,539)
Provision for income tax - -
------------------ ------------------
Net (loss) income $ (567,556) $ (548,539)
================== ==================
Identifiable assets:
Swimwear sales $ 4,302,913 $ 3,604,624
Film productions 1,450,504 1,451,104
Corporate 1,200,816 1,228,942
------------------ ------------------
Total assets $ 6,954,233 $ 6,284,670
================== ==================
-17-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE - 12 SEGMENT INFORMATION (continued)
Operating profit is total revenue less cost of sales and
operating expenses and excludes general corporate expenses,
interest expenses and income taxes. Identifiable assets are those
used by each segment of the Company's operations. Corporate
assets are primarily cash and investments.
-18-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
CAUTIONARY STATEMENTS ON FORWARD-LOOKING STATEMENTS
Statements contained in this report which are not historical facts and may
be considered forward looking information with respect to plans, projections, or
future performance of the Company as defined under the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are subject to
risks and uncertainties which could cause actual results to differ materially
from those projected. The words "anticipate ", "believe", "estimate", "expect",
"objective", and "think" or similar expressions used herein are intended to
identify forward-looking statements. The forward-looking statements are based on
the Company's current views and assumptions and involve risks and uncertainties
that include, among other things, the effects of the Company's business, actions
of competitors, changes in laws and regulations, including accounting standards,
employee relations, customer demand, prices of purchased raw material and parts,
domestic economic conditions, including housing starts and changes in consumer
disposable income, and foreign economic conditions, including currency rate
fluctuations. Some or all of the facts are beyond the Company's control.
General
Shopnet.com, Inc. ("Shopnet" or the "Company") was incorporated in the
State of Delaware on December 1, 1995 as Hollywood Productions, Inc. On May 10,
1999, Shopnet filed an amendment to its Articles of Incorporation effecting a
change in its name to its current one. On May 12, 1999, it incorporated a new
wholly-owned subsidiary, Hollywood, to which it assigned its motion picture
business thereby rendering Shopnet a holding company for Hollywood and another
wholly-owned subsidiary, Breaking Waves. Shopnet was formed initially for the
purpose of acquiring screenplays and producing motion pictures. In September
1996, in connection with the completion of its IPO, it acquired all of the
capital stock of Breaking Waves which designs, manufactures, and distributes
private and brand name label children's swimwear. As of June 30, 2002, the
company changed its year end from December 31 to June 30.
The consolidated financial statements at December 31, 2002 and 2001
included the accounts of Shopnet and its wholly owned subsidiaries, Breaking
Waves and Hollywood (collectively referred to as the "Company") except where
otherwise indicated after elimination of all significant intercompany
transactions and accounts.
The following discussion and analysis should be read in conjunction with
the consolidated financial statements and related footnotes which provide
additional information concerning the Company's financial activities and
condition. Since Shopnet and its subsidiaries operate in different industries,
the discussion and analysis is presented by entity in order to be more
meaningful.
Critical Accounting Policies
a) Principles of consolidation
The accompanying consolidated financial statements include the accounts of
Shopnet and its wholly owned subsidiaries, Breaking Waves and Hollywood (the
"Company"), after elimination of all significant intercompany transactions and
accounts. Affiliated companies which are 20 to 50 percent owned are accounted
for under the equity method.
b) Inventory
Inventory consists of finished goods and is valued at the lower of cost
(using the first-in, first-out method) or market. All inventory is pledged as
collateral for factored receivables pursuant to a factoring agreement with a
financial institution
-19-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Critical Accounting Policies (continued)
c) Film production and distribution costs
The Company follows industry standards in capitalizing film production and
distribution costs. Film production and distribution costs include all costs
associated with the writing, producing, and distribution of the film. Film costs
include the costs of production, prints, pre-release, and other advertising
expected to benefit future periods. These costs, as well as participation and
talent residuals, are charged against earnings on an individual film basis in
the ratio that the current year's gross film revenues bear to management's
estimate of total remaining ultimate gross film revenues from all sources.
Film costs are stated at the lower of cost or estimated net realizable
value on an individual film basis. Revenue and cost forecasts are continually
reviewed by management and revised when warranted by changing conditions.
Estimates of total gross revenue can change significantly due to the level of
amortization, as adjusted. Such adjustments could have a material effect on the
results of operations in future periods. When estimates of total revenue and
costs indicate that a feature film will result in an ultimate loss, additional
amortization is recognized to the extent required to produce a zero gross margin
over the remaining life of the film.
d) Equity Method of Accounting
Investments in significantly (20 to 50 percent) owned affiliates are
accounted for by the equity method of accounting, whereby the investment is
carried at cost of acquisition, plus the Company's equity percentage in
undistributed earnings or losses since acquisition. Reserves are provided where
management determines that the investment or equity in earnings is not
realizable.
e) Income taxes
The Company accounts for income taxes in accordance with the "liability
method" of accounting for income taxes. Accordingly, deferred tax liabilities
and assets are determined based on the difference between the financial
statement and tax basis of assets and liabilities, using enacted tax rates in
effect for the year in which the differences are expected to reverse. Current
income taxes are based on the respective periods' taxable income for federal,
state and city income tax reporting purposes.
f) Revenue and cost recognition
The terms of Breaking Waves' sales are FOB shipping point thereby revenue
is recognized upon shipment from the warehouse. Sales returns are recorded upon
acceptance of the goods by the warehouse. Duty costs, which are a component of
cost of sales, are recorded upon the clearance of such goods through customs.
Revenues from the theatrical distribution of motion pictures are recognized
when motion pictures are exhibited. Revenues from video sales are recognized,
together with related costs, on the date that video units are made widely
available for sale by retailers. Revenues from the licensing of feature films,
together with related costs, are recorded when the material is available for
telecasting by the licensee and when certain other conditions are met. Film
production and distribution costs are stated at the lower of unamortized cost or
estimated net realizable value. In accordance with Financial Accounting
Standards Board's Statement of Financial Accounting Standards ("SFAS") No. 53,
"Financial Reporting by Producers and Distributors of Motion Pictures Films,"
the individual film forecast method is used to amortize film costs.
-20-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Critical Accounting Policies (continued)
g) Earnings per share
Earnings per common share is computed pursuant to SFAS No. 128 "Earnings
Per Share." Basic earnings per share is computed as net income (loss) available
to common share holders divided by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur from common shares issuable through stock options,
warrants and convertible preferred stock.
h) Use of estimates
In preparing financial statements in conformity with generally accepted
accounting principles generally accepted in the United States of America,
management is required to make estimates and assumption which affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting period. The most significant estimate with regard
to these financial statements is the estimate of projected income of motion
pictures which is the basis used in amortizing film production and distribution
costs. Actual results could differ from those estimates.
i) Fair value disclosure at December 31, 2002 and June 30, 2002:
The carrying value of cash, accounts receivable, inventory, accounts
payable, accrued expenses, and capital lease obligations are a reasonable
estimate of their fair value.
Three months ended December 31, 2002 as compared to the three months ended
December 31, 2001
For the three months ended December 31, 2002, the Company reported
consolidated net income of $3,538 as compared to a consolidated income of
$23,225 for the three months ended December 31, 2001.
Breaking Waves
For the three months ended December 31, 2002 and 2001, Breaking Waves
generated net sales of $730,871 and $1,335,592, respectively, with related cost
of sales amounting to $145,792 and $693,300 respectively. The decrease in sales
amounting to $604,721, or approximately 46%, from 2001 to 2002 was primarily
attributable to the subsequent deferment on new orders into the next period.
The gross profit for the three months ended December 31, 2002 amounted to
$585,079, or 80% of sales as compared to the three months ended December 31,
2001 during which it amounted to $642,292, or 48% of sales.
Selling, general, and administrative expenses during the three months ended
December 31, 2002 and 2001 amounted to $515,479 and $404,277, respectively. The
increase amounting to $111,202 or approximately 28%, is primarily attributable
to an increase in selling expenses as a result of increased sales efforts.
-21-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Breaking Waves (continued)
The major components of the Breaking Waves selling, general, and
administrative expenses are as follows for the three months ended December 31:
2002 2001
---------------- ------------
Officers, office staff, designer and sales , salaries and related benefits $ 182,632 $169,966
Commission expense 39,418 11,135
Warehousing costs (5,340) 76,541
Royalty fees 63,680 13,080
Rent expense 27,590 25,814
Factor commissions 8,505 8,663
Miscellaneous general corporate overhead expenses 198,994 99,078
Interest expense in connection with its factoring agreement amounted to
$66,998 and $51,461 for the three months ended December 31, 2002 and 2001,
respectively. The increase is due primarily to an increase in sales orders which
resulted in additional borrowings by Breaking Waves.
Breaking Waves generated net income of $97,543 and a loss of $238,056 for
the three months ended December 31, 2002 and 2001 respectively.
Hollywood
On May 12, 1999, Shopnet incorporated a wholly-owned subsidiary, Hollywood,
to which it assigned its film production business. All film related operations
prior to May 12, 1999 were conducted by Shopnet under its former name.
For the three months ended December 31, 2002 and 2001, Hollywood generated
no sales form its motion picture "Dirty Laundry". Although sales prior to and
including the six months ended June 30, 2002 were minimal, the company expects
to effect increased sales during the fiscal year ending June 30, 2002 and
thereafter as a result of the implementation of a new marketing strategy which
among other things, emphasizes the development of new marketing and distribution
arrangements for "Dirty Laundry". Upon a review of the net realizable value of
the movie cost, management has determined that no write down was necessary as of
December 31, 2002 and 2001, respectively, Accordingly, Hollywood generated a
loss of $600 each for the three months ended December 31, 2002 and 2001,
respectively.
Subsequent to "Dirty Laundry", Hollywood also has invested in other movie
ventures, some of which have generated revenue to date. See "Investment in Joint
Ventures."
-22-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Shopnet.com
For the three months ended December 31, 2002, Shopnet generated no income.
For the corresponding three month period ends December 31, 2001, it generated
only minimal income comprised of interest from its money market and other
ancillary revenue from its corporate office.
Shopnet's selling, general, and administrative expense amounted to $71,271
and $104,082 for the three months ended December 31, 2002 and 2001. This
represents a decrease of $32,811, or approximately 32%.
The major components of the Company's expenses are as follows for the three
months ended December 31:
2002 2001
--------------- --------------
Salaries (officer and office staff) and stock compensation and related benefits $28,741 $30,586
Rent - 6,442
Legal and professional fees 17,312 47,330
Consulting fees 7,500 5,945
Other general corporate and administrative expense 17,718 13,779
Shopnet generated a net loss of $71,271 and $103,784 for the three months
ended December 31, 2002 and 2001, respectively. These net losses include, on a
consolidated basis, amortization of goodwill of $17,738 for the period ended
December 31, 2001.
Six months ended December 31, 2002 as compared to the six months ended
December 31, 2001
For the six months ended December 31, 2002 and 2001, the Company reported a
consolidated net loss of $567,556 and $548,539 after an income tax expense of $0
and a tax benefit of $16,974 and a comprehensive net loss of $567,556 and
$554,889, respectively.
Breaking Waves
For the six months ended December 31, 2002 and 2001, Breaking Waves
generated net sales of $750,678 and $1,700,715, respectively, with related cost
of sales amounting to $247,239 and $1,098,622, respectively. The decrease in
sales amounting to $950,027, or approximately 56%, from 2001 to 2002 was
primarily attributable to the subsequent deferment of new orders into the next
period.
The gross profit for the six months ended December 31, 2002 amounted to
$503,439, or 67% of sales as compared to the six months ended December 31, 2001
during which it amounted to $602,083, or 35% of sales. The increase in the gross
profit percentage can be attributable to an increase in inventory of $582,375 at
December 31, 2002 as compared to inventory on hand at December 31, 2001.
Selling, general, and administrative expenses during the six months ended
December 31, 2002 and December 31, 2001 amounted to $834,424 and $789,343,
respectively. The increase amounted to $2,599 or less than 1%.
-23-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Breaking Waves (continued)
The major components of the Breaking Waves selling, general, and
administrative expenses are as follows for the six months ended December 31:
2002 2001
---------------- ------------
Officers, office staff, designer and sales , salaries and related benefits $ 278,001 $ 246,138
Commission expense 19,958 (6,819)
Warehousing costs (2,169) 85,664
Royalty fees 96,680 52,611
Rent expense 53,188 48,617
Factor commissions 8,977 13,464
Miscellaneous general corporate overhead expenses 379,789 349,668
Interest expense in connection with its factoring agreement amounted to
$63,702 and $102,833 for the six months ended December 31, 2002 and 2001,
respectively. The decrease is due to a decrease in sales, as well as a reduction
in the stated prime interest rate.
Breaking Waves owns 1,270,000 unregistered common shares ("Play Co.
Shares") of Play Co. Toys & Entertainment Corp. ("Play Co, " a toy retailer and
a publicly traded company whose Chairman of the Board is also the President of
Shopnet and Breaking Waves).
Breaking Waves' ownership percentage is approximately 1.5% of Play Co.'s
outstanding Common Stock. The investment in Play Co. is accounted for under the
requirements of SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities. " Under SFAS 115, the securities are considered available for
sale and therefore the carrying value is based on the fair market value of the
securities at December 31, 2002 and 2001 which amounted to $0 and $337,000,
respectively. The change in the fair market value of the securities during the
periods is recorded as an unrealized gain or loss as a component of
comprehensive income. The company has pledged such shares as collateral for a
standby letter of credit in connection with Breaking Waves' factoring agreement
with Century Business Credit Corporation ("Century") and the are therefore
considered non-current.
On March 28, 2001, Play Co. filed for protection under Chapter Eleven of
the United States Code with the United States Bankruptcy Court for the Southern
District of New York. The filing was converted into a Chapter Seven filing on
August 28, 2001.
-24-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Breaking Waves (continued
Breaking Waves recorded an unrealized (loss) of $(6,350) for the six months
ended December 31, 2001, which has been recorded as a component of comprehensive
income (loss) in the statement of operations.
Breaking Waves generated a net loss of $433,301 for the six months ended
December 31, 2002 and a net loss of $187,860 for the six months ended December
31, 2001.
Hollywood
For the six months ended December 31, 2002 and 2001, Hollywood generated no
sales form its motion picture "Dirty Laundry". Although sales prior to and
including the six months ended June 30, 2002 were minimal, the company expects
to effect increased sales during the fiscal year ending June 30, 2002 and
thereafter as a result of the implementation of a new marketing strategy which
among other things, emphasizes the development of new marketing and distribution
arrangements for "Dirty Laundry". Upon a review of the net realizable value of
the movie cost, management has determined that no write down was necessary as of
December 31, 2002 and 2001, respectively, Accordingly, Hollywood generated a
loss of $1,200 and $1,241 for the six months ended December 31, 2002 and 2001,
respectively.
Subsequent to "Dirty Laundry", Hollywood also has invested in other movie
ventures, some of which have generated revenue to date. See "Investment in Joint
Ventures."
Shopnet.com
For the six months ended December 31, 2002, Shopnet generated no income.
For the six months ended December 31, 2001, it generated minimal income
comprised of interest from its money market and other ancillary revenue from its
corporate office.
Shopnet's selling, general, and administrative expense amounted to $133,056
and $189,204 for the six months ended December 31, 2002 and 2001. This
represents a decrease of $56,148, or approximately 30%.
The major components of the Company's expenses are as follows for the six
months ended December 31:
2002 2001
------------- ------------
Salaries (officer and office staff) and stock compensation and related
benefits $ 59,693 $ 70,644
Rent - 19,510
Legal and professional fees 20,110 55,080
Consulting fees 18,725 11,945
Other general corporate and administrative expense 34,528 32,025
Shopnet generated a net loss of $133,056 and $209,532 for the six months
ended December 31, 2002 and 2001, respectively. These net losses include, on a
consolidated basis, amortization of goodwill of $17,738 for the six months ended
December 31, 2001.
-25-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources
At December 31, 2002, the Company's consolidated working capital deficit
amounted to $873,575.
At December 31, 2002, current assets consisted primarily of inventory of
$3,954,116 and prepaid expenses of $348,963.
On or about September 12, 2000, Breaking Waves entered into a factoring and
revolving inventory loan and security agreement ("factoring agreement") with
Century Business Credit Corporation ("Century") to sell its interest in all
present and future receivables without recourse. Breaking Waves submits all
sales offers to Century for credit approval prior to shipment, and pays a
factoring commission of .75% of receivables sold.
Century retains from the amount payable to Breaking Waves a reserve for
possible obligations such as customer disputes and possible credit losses on
unapproved receivables. Breaking Waves may take advances of up to 85% of
eligible receivables and up to 50% of the value of finished goods in inventory,
with interest payable monthly at the rate of 1 3/4% over prime.
Pursuant to the terms of a Reimbursement and Compensation Agreement, a
trust ("Trust"), the beneficiary of which is a relative of the Company's
President and Chief Executive Officer ("CEO") and a relative of a principal
stockholder, pledged assets as collateral for securing a $250,000 letter of
credit to replace a portion of a letter of credit previously pledged by the
Company.
Accordingly, on December 20, 2000 the original agreement with the factor
was amended to allow such replacement of collateral. Breaking Waves' Loan and
Security Agreement with Century dated December 20, 2000 requires the provision
of one or more letters of credit in the aggregate amount of $1,150,000 to
partially secure the line of credit. On September 15, 2001, Century required the
Company to increase the amount of collateralized standby letters of credit by
$300,000 raising such amount to $1,450,000.
On May 3, 2001, the Agreement with the Trust was amended so that the letter
of credit secured by the Trust was increased to $400,000. As a condition of the
amendment, the Company entered into a guarantee agreement with Gal Capital
Corp., whose President is a relative of the Company's President and CEO and a
principal stockholder of the Company to act as guarantor of the obligation to
the Trust up to $400,000 in exchange for a fee of $42,500 which the Company paid
on May 3, 2001. The amended letter of credit expired on September 1, 2001 and
was subsequently amended on September 15, 2001.
On September 15, 2001, the Amended and Restated Reimbursement and
Compensation Agreement was entered into and further amended the agreement with
the Trust, so that the letter of credit secured by the Trust was increased to
$750,000. The amended letter of credit expired on September 1, 2002 but can be
extended year to year at the Company's option for a period of ten years. On
September 1, 2002, the letter of credit was extended. Breaking Waves agreed to
reimburse the Trust for any and all losses, fees, charges and expenses to the
Trust in the event the letter of credit is called by Century and / or the
issuing bank demands reimbursement from the Trust. Breaking Waves' obligations
are guaranteed by the Company in addition to being secured by a first security
interest in all of the assets of the Company and a subordinate security interest
in all of the assets of Breaking Waves.
In December 2002, Breaking Waves entered into a Reimbursement and
Compensation Agreement with TERE, S.A., a Swiss entity. As a consequence of
Century being unwilling to grant credit to Breaking Waves unless it received one
or more letters of credit satisfactory to it as well as cash collateral to
partially secure the line of credit in such amounts as it deems appropriate, the
Trust reduced the letter of Credit secured by it to $500,000. TERE, S.A. agreed
to loan Breaking Waves the sum of $250,000 represented by a promissory note.
-26-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources
The funds were deposited as cash collateral with Century to replace the
reduced portion of the letter of credit secured by the Trust.
All obligations under this agreement are guaranteed by the Company and are
secured by a security interest in all of the Company's assets.
As compensation, Breaking Waves paid all interest received from or credited
to it by Century on the sums deposited pursuant to the Cash Collateral Agreement
when received.
The term of the loan is for ten years.
ARC has agreed to pay to TERE, interest at the rate of 8% per annum on
quarterly basis.
On September 15, 2001, the Company entered into a Reimbursement Agreement
with relatives of a principal stockholder who is related to the President and
CEO of the Company ("RAYA") who pledged assets as collateral for securing a
$300,000 letter of credit as additional collateral to secure Breaking Waves'
Loan and Security Agreement with Century. Absent any default, the letter of
credit will remain in effect for ten years. The Agreement is guaranteed by
Shopnet under a separate Security Agreement dated September 15, 2001.
In exchange for the letters of credit, the Trust and RAYA will
proportionately, based on the total outstanding letters of credit, receive a fee
of one and one quarter percent (1-1/4%) of net sales of Breaking Waves through
June 30, 2002 and thereafter one and three quarters percent (1-3/4%) of net
sales through September 30, 2011. In October 2001, the Trust and RAYA received
advance payments to be applied towards future fees of $24,500 and $12,250,
respectively. All future payments are payable forty five days after the close of
each fiscal quarter. The fees are effective October 1, 2001.
In September 2001, the Company and Breaking Waves retained Arc Financial
Corp. ("ARC"), a British Virgin Island company, for a ten year term to provide
financial consulting services.
Pursuant to the terms of a consulting services. Pursuant to the terms of a
consulting agreement ("ARC Consulting Agreement"), ARC was retained to assist
the Company in the acquisition of financing to acquire inventory and for other
corporate purposes ("Financing"), as well as consult with the Company with
regard to its ongoing operations, promote sales of Breaking Waves' products and
improving production.
Pursuant to the terms of the ARC Consulting Agreement, the Company and
Breaking Waves agreed to compensate ARC (i) an annual fee of $20,000 ("Base
Fee") and (ii) a percentage of annual net sales in the amount of 1-1/4% through
June 30, 2002 and 1-3/4% of net sales for each year of the term thereafter
through September 30, 2011 ("ARC Percentage Fee"), payable 45 days after the
closing of each fiscal quarter.
In October 2001, ARC received (I) a lump sum payment of $209,000 reflecting
full advance payment of the Base Fee and (ii) $36,750 reflecting advance payment
of the Arc Percentage Fee. The agreement with Arc expires September 30, 2011.
The Company and Breaking Waves are entitled to terminate the ARC Consulting
Agreement any time after September 30, 2006, in which event all prepaid fees are
forfeited.
-27-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources
The following table summarizes the percentage due each party, as noted
above, as a percentage of net sales for the three months ended December 31,
2002:
% of
Net Sales Amount
--------------- ---------------
RAYA 0.58 $ 4,353
ZAT 1.16 8,708
ARC 1.75 13,137
--------------- ---------------
3.49 $ 26,198
=============== ===============
Interest expense related to the factor agreement totaled $63,702 and
$102,883 for the six months ended December 31, 2002 and 2001, respectively.
Century has a secured interest in Breaking Waves' inventory as collateral for
the advances. As of December 31, 2002, the net advances to Breaking Waves from
Century amounted to $3,398,122.
On November 8, 2002, the Company borrowed the sum of $50,000 in the form of
a promissory note from Amigal Salit, Ltd., and unrelated party. The note which
is non-interest bearing is due on or before August 15, 2003.
On the same date, the Company entered into an agreement with ARC Financial
Corporation, whereby the Company using the proceeds received from Amigal Salit,
Ltd., agreed to pay $50,000 as an advance against fees to be owned by Breaking
Waves to ARC Financial Corporation in connection with Breaking Waves obligation
to pay certain fees to ARC as part of a consulting agreement as described in
Note 7 (b) herein. The consulting fees being paid in advance under this
agreement are those fees which would become due and payable for the periods
ending December 31, 2002 and March 31, 2003.
Investments in Joint Ventures
Battle Studies Productions, LLC
In April 1998, the Company entered into a co-production agreement with
North Fork Bank for "Machiavelli Rises." The Company and North Fork formed
Battle Studies to finance, produce and distribute the film. Battle Studies will
be treated as a joint venture in order to co-produce motion pictures and to
finance the cost of production and distribution of such motion pictures. The
joint venture retains all rights to the motion pictures, the screenplays, and
all ancillary rights attached thereto. Total production costs to date have
aggregated approximately $425,000 of which the Company has funded approximately
$218,500. In accordance with the terms of the co-production agreement, the
proceeds of the film will be distributed as follows: first, both parties shall
be entitled to recoup their initial investment in the film, at 135% thereof;
then, after repayment to the respective parties of additional cost incurred by
same, any remaining proceeds shall be distributed 50% to North Fork and 50% to
the Company. The film was shown in January 1999 in both New York and the
Brussels Film Festival.
The Company accounts for the investment in Battle Studies on the equity
method. For the six months ended December 31, 2002 and 2001, the Company,
recorded no equity losses for its proportionate share of Battle Studies. No
revenues have been derived from this film as of December 31, 2002.
-28-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
On October 12, 2001, Battle Studies entered into a distribution agreement
with Raven Pictures International ("Raven Pictures") to distribute Battle
Studies' motion picture ("Macheavelli Rises") to foreign countries. Battle
Studies has granted rights under the agreement for the theatrical, video,
non-theatrical and television markets. The term of the agreement is for
twenty-four months for all portions of territory outside of the United States
and English speaking Canada. Battle Studies expects to realize 75% (which is net
of a 25% fee to Raven Pictures) of the expected estimated gross revenues derived
from foreign countries less $20,000 for marketing and advertising expense.
On January 17, 2002, Battle Studies entered into a distribution agreement
with KOAN to distribute and promote Battle Studies' motion picture ("Machiavelli
Rises") in the United States and Canada. Battle Studies has granted rights under
the agreement for free TV, pay TV, cable, satellite, video and DVD markets. The
terms of the agreement is for twenty-four months and it will be automatically
renewed unless KOAN receives a letter of cancellation at least thirty days prior
to the date of termination or if sales have not exceeded $250,000 over the
twenty-four month period. Battle studies expects to realize 70% (which is net of
a 30% fee to KOAN) of the expected estimated gross revenues derived from the
United States and Canada less $5,000 per year for promotional costs.
The Girl, LLC
Pursuant to an agreement dated July 1, 1999 with ALF for the production of
a film entitled "The Girl", Hollywood invested through December 31, 2002,
$35,000 for a 22.533% interest in a new entity, The Girl, LLC a limited
liability company ("Girl LLC"). In return for its participation in Girl LLC,
Hollywood shall be entitled to receive a non-contested, non-dilutable 22.533%
ownership interest in Girl LLC, a recoupment of its investment on no less
favorable terms than any other investor and 22.533% of 100% of any contingent
compensation which shall be actually received by Girl LLC. Girl LLC retains all
rights to the motion pictures, the screenplays, and all ancillary rights
attached thereto. "The Girl" is completed and has been exhibited at several film
festivals. Girl LLC is in the process of attempting to secure video and foreign
distribution arrangements for the film.
Hollywood accounts for the investment in Girl LLC under the equity method.
Accordingly, as of December 31, 2002, the Company has recorded its investment at
$33,702. This represents its initial investment of $35,000 less $1,298 of equity
loss for its proportionate share of Girl LLC.
-29-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Lease Commitments
Shopnet and Breaking Waves jointly share their administrative offices under
a lease agreement signed July 2001 by Breaking Waves. Shopnet is provided office
space by Breaking Waves on a rent-free basis. The lease agreement expires on
September 30, 2007. Annual rent under this lease is $84,915 through December 31,
2004 and $97,560 for the remainder of the lease period. Additionally, Breaking
Waves leases an offsite office for one of its designers on a month to month
basis with annual payments approximating $11,000.
The approximate annual future minimum rentals under non-cancelable
operating lease signed by Breaking Waves are as follows:
For the fiscal year ended June 30:
2003 $ 63,686
2004 84,915
2005 90,338
2006 95,760
2007 95,760
Thereafter 23,940
-----------------
$ 454,399
=================
Rent expense for the six months ended December 31, 2002 and 2001 amounted
to $53,188 and $68,127, respectively.
License Agreement
During June 2000, Breaking Waves entered into a license agreement with an
effective date of November 1, 2000 with Gottex Models Ltd., as Israeli
corporation and Gottex Models (USA) Corp., a New York corporation for the use of
the trademark "Gottex" in the United States of America for children's swimwear.
The agreement calls for a royalty fee of 7% of net sales with guaranteed minimum
annual royalties of $70,000 to $140,000 over the life of the agreement. Breaking
Waves recorded royalties under the agreement totaling $86,680 and $42,611 for
the six months ended December 31, 2002 and December 31, 2001, respectively.
-30-
ITEM 3. CONTROLS AND PROCEDURES
As of December 31, 2002, an evaluation was performed under the supervision
and with the participation of the Company's management, including the Chief
Executive Officer and our Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, The Company's management including the Chief Executive
Officer and Chief Financial Officer, concluded that the Company's disclosure,
our disclosure controls and procedures were effective as of December 31, 2002,
there have been no significant changes in the Company's internal controls or in
other factors that could significantly affect our internal controls subsequent
to December 31, 2002.
-31-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibit
99.1 Certification by Harold Rashbaum, Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
b) Reports
None
-32-
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SHOPNET.COM, INC.
By:/s/Harold Rashbaum
Harold Rashbaum, President,
Chief Executive Officer and
Chief Financial Officer
Dated: February 13, 2002
-33-
CERTIFICATION
I, Harold Rashbaum, certify that:
1. I have reviewed this quarterly report of Form 10-Q of Shopnet.com, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. I am responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiary,
is made know to me by other within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report my conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. I have disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent function);
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: February 13, 2002
/s/Harold Rashbaum
Harold Rashbaum
President
-34-