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 September 30, 2001
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 O-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)
14 East 60th Street, Suite 402, New York, New York 10022
(Address of Principal Executive Offices)
(212) 688-9223
(Issuer's Telephone Number, Including Area Code)
N/A
-----------------------------------------------------
(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 outstanding of each of the Issuer's classes
of common equity, as of the latest practicable date: Common Stock, $.001 par
value: 7,472,224 shares outstanding as of November 12, 2001.
SHOPNET.COM, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated balance sheets at September 30, 2001 (unaudited) and June 30, 2001. 3
Consolidated statements of operations and comprehensive income for the three months ended September 30,
2001 and 2000 (unaudited). 4
Consolidated statement of stockholders' equity for the three
months ended September 30, 2001 (unaudited).
5
Consolidated statements of cash flows for the three months ended
September 30, 2001 and 2000 (unaudited).
6
Notes to consolidated financial statements (unaudited). 7-17
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 20-26
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 27
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 27
Item 3. DEFAULTS UPON SENIOR SECURITIES 27
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 27
Item 5. OTHER INFORMATION 27
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 27
SIGNATURES 28
2
SHOPNET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, 2001 June 30, 2001
(Unaudited) (Audited)
Current assets:
Cash .............................................................................. $ 259 $ 24,703
Cash - restricted ................................................................. 972,336 969,582
Accounts receivable, net .......................................................... 89,522 77,706
Other receivables ................................................................. 34,060 62,734
Inventory ......................................................................... 395,442 796,538
Prepaid expenses .................................................................. 66,534 70,762
Advances to officer ............................................................... 41,971 40,000
----------- -----------
Total current assets .............................................................. 1,600,124 2,042,025
----------- -----------
Property and equipment, net ......................................................... 75,569 72,137
Film production and distribution costs, net ......................................... 1,204,728 1,204,728
Costs in excess of net assets of business acquired .................................. 709,523 727,261
Investments in movie ventures ....................................................... 246,376 246,439
Deferred tax asset - non-current .................................................... 202,500 202,500
Other assets ........................................................................ 20,635 20,635
Marketable securities - affiliate ................................................... -- 6,350
----------- -----------
Total assets ................................................................... $ 4,059,455 $ 4,522,075
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Due to factor ..................................................................... $ 1,781,111 $ 1,700,337
Accounts payable .................................................................. 159,587 138,218
Accrued expenses .................................................................. 40,379 21,965
Current portion of capital lease obligations ...................................... 17,391 17,953
Other taxes payable ............................................................... -- 743
Deferred tax liability ............................................................ 3,606 3,606
----------- -----------
Total current liabilities ........................................................... 2,002,074 1,882,822
----------- -----------
Capital lease obligations, net of current portion ................................... -- 3,758
----------- -----------
Total liabilities .......................................................... 2,002,074 1,886,580
----------- -----------
Commitments and contingencies
Stockholders' equity:
Common stock - $.001 par value, 20,000,000 shares authorized,
7,472,244 shares issued and outstanding .......................................... 7,472 7,472
Additional paid-in capital ........................................................ 6,638,852 6,638,852
Accumulated deficit ............................................................... (4,588,943) (4,017,179)
----------- -----------
Accumulated other comprehensive income ............................................ -- 6,350
----------- -----------
Total stockholders' equity ..................................................... 2,057,381 2,635,495
----------- -----------
Total liabilities and stockholders' equity .......................................... $ 4,059,455 $ 4,522,075
=========== ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
3
SHOPNET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
2001 2000
----------- -----------
Net sales ................................................... $ 365,113 $ 253,243
Cost of sales ............................................... 405,322 298,135
----------- -----------
Gross loss .................................................. (40,209) (44,892)
----------- -----------
Expenses:
Selling, general, and administrative expenses ........... 470,829 554,043
Amortization of costs in excess of net assets of business
acquired .............................................. 17,738 17,738
----------- -----------
Total expenses .............................................. 488,567 571,781
----------- -----------
Loss before other income (expense)
and provision for income taxes ............................. (528,776) (616,673)
----------- -----------
Other income (expense):
Equity in earnings (loss) of affiliate .................. (63) --
Write down of film costs ............................... -- (50,000)
Rental income ........................................... 9,050 5,500
Interest and finance expense ............................ (61,574) (42,588)
Interest income ......................................... 9,599 27,596
----------- -----------
Total other income (expense) ....................... (42,988) (59,442)
----------- -----------
Loss before provision for
income taxes ............................................... (571,764) (676,115)
Provision for income taxes .................................. -- 5,410
----------- -----------
Net loss .................................................... (571,764) (681,525)
Other items of comprehensive (loss) income .................. (6,350) 70,612
----------- -----------
Comprehensive loss .......................................... $ (578,114) $ (610,913)
----------- -----------
Basic:
Net loss per share ...................................... $ (.08) $ (.09)
=========== ===========
Weighted average number of
common shares outstanding .................................. 7,472,244 7,472,244
=========== ===========
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 THREE MONTHS ENDED SEPTEMBER 30, 2001
Accumulated
Additional Other Total
Common Stock Paid-in Accumulated Comprehensive Stockholders'
Shares Amount Capital Deficit Income (Loss) Equity
--------- --------- ----------- ------------ ------------ -----------
Balances at June 30, 2001(audited) 7,472,244 $ 7,472 $ 6,638,852 $(4,017,179) $ 6,350 $ 2,635,495
Net loss (unaudited) ............. -- -- -- (571,764) -- (571,764)
Comprehensive loss ............... -- -- -- -- (6,350) (6,350)
--------- --------- ----------- ------------ ------------ -----------
Balances at September 30, 2001 ... 7,472,244 $ 7,472 $ 6,638,852 $(4,588,943) $ -- $ 2,057,381
========= ========= =========== ============ ============ ===========
The accompanying notes should be read in conjunction with the consolidated
financial statements
5
SHOPNET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
2001 2000
------------ ---------
Cash flows from operating activities:
Net loss $ (571,764) $ (681,525)
Adjustments to reconcile net income to net
cash used in operating activities:
Equity in loss of affiliate 63 -
Write down of film costs - 50,000
Amortization and depreciation 24,621 28,676
Decrease (increase) in:
Accounts receivable (11,816) 4,742
Other receivables 28,674 -
Inventory 401,096 280,410
Prepaid expenses 4,228 (599)
Advances to officer (1,971) -
Increase (decrease) in:
Due to factor 80,774 182,567
Accounts payable 21,369 13,774
Accrued expenses 18,414 12,208
Other taxes payable (743) -
Customer deposits - 80,000
------------------- ----------------
Net cash used in operating activities (7,055) (29,747)
------------------- ----------------
Cash flows from investing activities:
Acquisition of property and equipment (10,315) (694)
Investment in joint venture - (5,000)
------------------- ----------------
Net cash used in investing activities (10,315) (5,694)
------------------- ----------------
Cash flows from financing activities:
Repayments of line of credit - (213,894)
Principal payments on capital leases (4,320) (4,592)
------------------- ----------------
Net cash used in financing activities (4,320) (218,486)
------------------- ----------------
Net decrease in cash and restricted cash (21,690) (253,927)
Cash and restricted cash, beginning of period 994,285 1,642,832
------------------- ----------------
Cash and restricted cash, end of period $ 972,595 $ 1,388,905
=================== ================
Supplemental disclosure of cash flow information: Cash paid during the period
for:
Interest $ 61,574 $ 23,673
=================== ================
Income taxes $ - $ -
=================== ================
The accompanying notes should be read in conjunction with the consolidated
financial statements
6
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
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, 2001, 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 September 30, 2001 and for the three month periods ended
September 30, 2001 and 2000 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 September 30, 2001 and the results of
operations and cash flows for the three month periods ended
September 30, 2001 and 2000. The financial data and other
information disclosed in these notes to the interim financial
statements related to these periods are unaudited. The results
of operations for the three month periods ended September 30,
2001 and 2000 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, 2001 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, 2001 and for
the six month period then ended and notes thereto included in
the Company's report on Form 10-KSB filed on October 15, 2001.
The Company in the quarter ended September 30, 2001 has
implemented a number of initiatives which it believes will
reduce its costs of operations and alleviate in the following
nine months its working capital deficiency. In particular, the
Company believes that the repayment of its indebtedness to
Century (See Note 6(b)) and the recent reductions in interest
rates will reduce interest expense. Shopnet has chosen not to
renew its lease for its executive facilities. Commencing in
December 2001, the Company will consolidate all of its
operations in the New York metropolitan region into one new
facility (See Note 9(a)), creating a savings through synergies
in office expense and a 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.
7
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
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 three months ended September
30, 2001. 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
product 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
directly to expense, instead of those costs being capitalized
to film costs, which was required under the previous
accounting rules. SOP 00-2 also requires all film costs to be
classified in the balance sheet as non-current assets.
Provisions of SOP 00-2 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, 2001, 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 will be adopting the provisions of
this new standard beginning with the first quarter of 2002.
During June 2001 SFAS No. 141, "Business Combinations" ("SFAS
No. 141") was released. This standard addresses financial
accounting and reporting for business combinations. All
business combinations within the scope of SFAS 141 are to be
accounted for using one method - the purchase method. The
provisions of SFAS 141 apply to all business combinations
initiated after June 30, 2001. Use of the pooling - of -
interests method for those business combinations is
prohibited. It also applies to all business combinations
accounted for using the purchase method for which the date of
acquisition is July 1, 2001 or later.
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
is being amortized over the useful lives of the related assets
which is fifteen years. Amortization expense totaled $17,738
for each of the three months ended September 30, 2001 and
2000.
8
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
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
September 30, 2001, $217,500 for a 50% interest in a new
entity, Battle Studies Productions, LLC ("Battle Studies") a
limited liability company. Battle Studies will be treated 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 September 30,
2001, $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 three months ended
September 30, 2001 and 2000, the Company recorded a $63 and
$-0-, respectively, net equity losses.
NOTE 6 - MARKETABLE SECURITIES - AFFILIATE
Breaking Waves owns 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 is also the President of Shopnet and Breaking Waves.
Breaking Waves' ownership percentage is approximately 1.5% of
Play Co. 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 September 30, 2001 and 2000 which amounted to
$-0- and $337,000, respectively. 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 has 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 are therefore considered
non-current (See Note 6 (b)).
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.
9
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 7 - DUE TO FACTOR
a) CIT Group
On August 20, 1997, Breaking Waves entered into a factoring
and revolving inventory loan and security agreement (as
amended December 9, 1998) with CIT Group (formerly, Heller
Financial, Inc. "CIT") to sell their interest in all present
and future receivables without recourse. Breaking Waves paid
CIT a factoring commission of .85% of the first $5,000,000 of
receivables sold and .65% of receivables sold in excess of
$5,000,000 for each year.
Breaking Waves took advances of up to 85% of the receivable,
with interest at the rate of 1 3/4% over prime. In connection
with the factoring agreement, the Company agreed to maintain
$1,150,000 of cash in a segregated account in order to
collateralize standby letters of credit. In addition, during
1999, Breaking Waves was required to transfer an additional
$200,000 of cash as collateral for the standby letter of
credit.
On or about September 12, 2000 the agreement with CIT was
cancelled and a new factoring agreement was entered into as
discussed below. As of September 30, 2000, there was a balance
due CIT for the net advances to Breaking Waves which amounted
to $24,921. Interest expense related to this agreement totaled
$-0- and $33,686 for the three months ended September 30, 2001
and 2000.
b) 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.
In connection with the factoring agreement, the Company agreed
to continue maintaining $1,150,000 of cash in a segregated
account in order to collateralize standby letters of credit
for Breaking Waves. Additionally, Breaking Waves was required
to pledge as additional collateral $200,000 of its own cash
and its investment in Play Co., which is represented by
1,270,000 shares of Play Co.'s common stock.
10
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 7 - DUE TO FACTOR (cont'd)
b) Century Business Credit Corporation (cont'd)
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.
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. On December 20, 2000, Breaking Waves
paid a fee of $42,500 to the Trust and reimbursed the Trust
for all related professional and other fees incurred by the
Trust in connection with such transaction.
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 further amending
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 expires on September 1, 2002 but can be
extended year to year at the Company's option for a period of
ten years. 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.
11
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 7 - DUE TO FACTOR (cont'd)
b) Century Business Credit Corporation (cont'd)
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 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,
including systems to control expenses, methods to enhance and
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 $209,500 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.
Interest expense related to the factor agreement totaled
$51,372 and $6,870 for the three months ended September 30,
2001 and 2000, respectively. Century has a secured interest in
Breaking Waves' inventory as collateral for the advances. As
of September 30, 2001, the net advances to Breaking Waves from
Century amounted to $1,781,111.
12
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 8 - LINE OF CREDIT
On March 30, 2000, the Company entered into a revolving line
of credit agreement with a bank. Total available credit under
the line of credit is $250,000. Total outstanding balance was
payable in monthly installments including 9% interest. As a
condition of the line of credit, the Company was required to
deposit $250,000 in a certificate of deposit as collateral
with the bank. The line of credit was repaid in full and
closed as of July 12, 2000.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
a) Lease commitments
Shopnet and Breaking Waves have entered into lease agreements
for their administrative offices. Shopnet leases its
administrative office pursuant to a 5-year lease expiring
November 30, 2001 at annual rent amounting to approximately
$70,000, before annual escalations. Breaking Waves leased its
administrative offices pursuant to a lease requiring annual
payments of $71,600 expiring December 2004. Lastly, Breaking
Waves terminated its lease effective November 30, 2001. A new
6 year lease expiring September 30, 2007 was signed in July
2001 and is effective beginning December 1, 2001. Annual rent
under the new lease is $84,915 through December 31, 2004 and
$95,760 for the remainder of the lease. Lastly, Breaking Waves
leases an offsite office for one of its designers on a month
to month basis with annual payments approximating $11,000. The
Company and Breaking Waves' approximate future minimum rentals
under non-cancelable operating leases in effect on September
30, 2001 are as follows:
2002 $ 111,861
2003 84,915
2004 84,915
2005 90,338
2006 95,760
Thereafter 119,700
--------------
$ 587,489
Rent expense for the three months ended September 30, 2001 and
2000 amounted to $35,870 and $41,300, respectively.
b) Significant vendors and customers
Breaking Waves purchases 100% of its inventory from two
vendors in Indonesia and the other from Samoa. Breaking Waves
believes other sources and vendors are available and that it
is not dependent exclusively on these vendors. For the three
months ended September 30, 2001 Breaking Waves had two
customers, which comprise 85%, of net sales. For the three
months ended September 30, 2000, Breaking Waves had two
customers which compromised 100% of net sales.
13
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 9 - COMMITMENTS AND CONTINGENCIES (cont'd)
c) Seasonality
Breaking Waves' business is considered seasonal with a large
portion of its revenues and profits being derived between
November and March. 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
i) On October 16, 1995, Breaking Waves entered into a license
agreement with Beach Patrol, Inc. ("Beach") for the
exclusive use of certain trademarks in the United States.
The agreement covered a term from January 1, 1996 to June
30, 1998 and contained a provision for an additional
three-year extension, at the option of Breaking Waves,
through and until June 30, 2001. Breaking Waves had
exercised this option, thereby so extending the agreement.
The agreement called for minimum annual royalties of
$75,000 to $200,000 over the life of the agreement with
options based on sales levels from $1,000,000 for the
first year to $4,000,000 in the sixth year. Breaking Waves
has negotiated an additional two-year extension thereby
extending the agreement through and until June 30, 2003,
and it contains a provision for an additional two-year
extension, at the option of Breaking Waves, through and
until June 30, 2005. The new agreement signed February 28,
2001 and effective July 1, 2001 calls for minimum annual
royalties of $50,000 to $87,500 over the life of the
extension with options based on sales levels from
$1,000,000 for the seventh year to $1,750,000 in the tenth
year. Breaking Waves recorded royalties under this
agreement totaling $5,000 and $63,897 during the three
months ended September 30, 2001 and 2000 respectively.
ii) 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 $34,531 and $-0- for the three months
ended September 30, 2001 and 2000, respectively.
14
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 9 - COMMITMENTS AND CONTINGENCIES (cont'd)
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-producer agreeing to finance $100,000 of the costs 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 September 30, 2001, the Company invested $1,971,956 for
the co-production and distribution of such motion picture
whereas the co-producers have invested $100,000. For the three
months ended September 30, 2001 and 2000, the Company derived
no revenue from the motion picture and amortized no film
costs.
For the three months ended September 30, 2001 and 2000 the
Company has written down its film production and distribution
costs by $-0- and $50,000, respectively, in order to reduce
the asset to 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). 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.
15
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 10 - STOCKHOLDER'S EQUITY
a) Earnings per share
Earnings per common share is computed pursuant to Statement of
Financial Accounting Standards (SFAS) No. 128 "Earnings Per
Share" ("EPS"). Basic earnings per share is computed as net
income (loss) available to common shareholders divided by the
weighted average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution that could
occur from common shares issuable through stock options,
warrants and other convertible securities. Diluted EPS is not
presented since the effect would be anti-dilutive.
b) 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, 2001. On August 31, 2001, 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, January 2000 10%
common stock dividend and May 2000 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 filed 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.
16
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 11 - RELATED PARTIES TRANSACTIONS
a) For the three months ended September 30, 2001 and 2000
financial consulting fees were paid to a corporation and an
individual who are related to the Company's President and CEO
amounting to $11,800 and $10,000, 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 September 30, 2001, the unpaid portion
amounted to $37,000, which has been classified as current. As
of September 30, 2001, 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.
17
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 12 - SEGMENT INFORMATION
The Company's operations have been classified into two
segments: swimwear sales and film productions. Theses
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 assessing 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. Information about the
two segments is as follows:
Three months ended September 30,
2001 2000
------------------ ----------------------------------------
Segment Consolidated Segment Consolidated
Sales:
Swimwear sales $ 365,113 $ 253,243
Film production - -
------------- -------------
Total sales $ 365,113 $ 253,243
============= ==============
Operating income (loss):
Swimwear sales $ (425,275) $ (460,285)
Film production (641) (50,200)
-------------- ---------------
Total operating income (425,916) (510,485)
-------------- ---------------
Corporate:
General and administrative
expense (85,122) (138,400)
-------------- ---------------
(Loss) equity in earnings of affiliate (63) -
Amortization expense (17,738) (17,738)
Interest income 9,599 27,596
Interest and finance expense (61,574) (42,588)
Other 9,050 5,500
-------------- ---------------
Loss from operations before (benefit)
provision for income tax (571,764) (676,115)
-------------- ---------------
Provision for income tax - 5,410
-------------- ---------------
Net (loss) income $ (571,764) $ (681,525)
============== ==================
Identifiable assets:
Swimwear sales $ 882,393 $ 978,499
Film productions 1,451,104 1,761,064
Corporate 1,725,958 2,230,502
-------------- ---------------
Total assets $ 4,059,455 $ 4,970,065
============== ==================
18
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(UNAUDITED)
NOTE 12 - SEGMENT INFORMATION (cont'd)
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.
NOTE 13 - SUBSEQUENT EVENT
During October 2001, Century released the Company from its
requirement of maintaining a minimum cash balance as a result of
the events discussed in Note 6 (b). Upon Century removing the
restriction, the Company paid and reduced the amount due to
Century in October and November 2001 by an aggregate of $620,000.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
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, 2001, the
company changed its year end from December 31 to June 30.
The consolidated financial statements at September 30, 2001 and 2000
include 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.
Three months ended September 30, 2001 as compared to the three months ended
September 30, 2000
For the three months ended September 30, 2001 and 2000, the Company
reported a consolidated net loss of $571,764 and $681,525 after an income tax
expense of $-0- and $5,410 and a comprehensive net loss of $578,114 and
$610,913, respectively.
Breaking Waves
For the three months ended September 30, 2001 and 2000, Breaking Waves
generated net sales of $365,113 and $253,243, respectively, with related cost of
sales amounting to $405,322 and $298,135, respectively. The increase in sales
amounting to $111,870, or approximately 44%, from 2000 to 2001 was primarily
attributable to the introduction of the new Gottex and Coral Cove lines. The
gross loss for the three months ended September 30, 2001 amounted to $40,209, or
11% of sales as compared to the three months ended September 30, 2000 during
which it amounted to $44,892, or 18% of sales.
20
Selling, general, and administrative expenses during the three months
ended September 30, 2001 and 2000 amounted to $385,066 and $415,393,
respectively. The decrease amounting to $30,327 or approximately 7%, is
primarily attributable to a decrease in royalty fees.
The major components of the Breaking Waves selling, general, and
administrative expenses are as follows for the three months ended September 30:
2001 2000
------------------ -------------------
Officers, office staff, designer and
sales salaries and related benefits $ 146,816 $ 128,904
Commission expense (17,954) (10,277)
Warehousing costs 9,123 598
Royalty fees 39,531 63,897
Rent expense 22,803 22,784
Factor commissions 4,801 2,006
Miscellaneous general corporate
overhead expenses 179,946 207,481
Interest expense in connection with its factoring agreement amounted to $51,372
and $40,556 for the three months ended September 30, 2001 and 2000,
respectively. The increase is due to the increase in sales.
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 September 30, 2001 and 2000 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 they 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.
Breaking Waves recorded an unrealized (loss) gain of ($6,350) and $70,612 for
the three months ended September 30, 2001 and 2000, respectively, which has been
recorded as a component of comprehensive income (loss) in the statements of
operations.
Breaking Waves generated net losses of $483,113 and $503,510, for the
three months ended September 30, 2001 and 2000, respectively.
Breaking Waves' comprehensive loss was $(6,350) for the three months
ended September 30, 2001 versus comprehensive income of $70,612 for the three
months ended September 30, 2000.
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.
21
For the three months ended September 30, 2001 and 2000, Hollywood
generated no sales from its motion picture "Dirty Laundry." Although sales prior
to and including the six months ended June 30, 2001 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." There can be no assurance that
the Company's new marketing and distribution strategies will be successful in
generating sales from "Dirty Laundry." Upon a review of the net realizable value
of the movie costs, management has determined that a $-0- and $50,000 write down
was necessary as of September 30, 2001 and 2000, respectively. Accordingly,
Hollywood generated a loss of $641 and $50,200 for the three months ended
September 30, 2001 and 2000, 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 three months ended September 30, 2001 and 2000, Shopnet
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
$85,029 and $138,650 for the three months ended September 30, 2001 and 2000,
respectively. This represents a decrease of $53,621, or approximately 39%.
The major components of the Company's expenses are as follows for the
three months ended September 30:
2001 2000
------------ -----------
Salaries (officer and office staff) and stock compensation
and related benefits $ 40,058 $ 50,792
Rent 13,068 18,945
Legal and professional fees 7,750 31,146
Consulting fees 6,000 4,000
Other general corporate and administrative expense 18,153 33,767
Shopnet generated a net loss of $88,010 and $127,814 for the three
months ended September 30, 2001 and 2000, respectively. These net losses
include, on a consolidated basis, amortization of goodwill of $17,738 in each
period.
Liquidity and Capital Resources
At September 30, 2001, the Company's consolidated working capital
deficit amounted to $401,950.
At September 30, 2001, current assets consisted primarily of restricted
cash and cash equivalents, including certificates of deposit of approximately
$750,000 collateralizing standby letters of credit and cash of approximately
$220,000 pledged to the Company's factor. The Company considers highly liquid
investments with maturities of three months or less at the time of purchase to
be cash equivalents. At September 30, 2001, the Company maintained cash deposits
in accounts in excess of Federal Deposit Insurance Corporation limits by
approximately $651,000; it believes that such risk is minimal.
In September 2000, Breaking Waves entered into a factoring and
revolving inventory loan and security agreement with 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
22
customer disputes and possible credit losses on unapproved receivables. Breaking
Waves may take advances of up to 85% of the receivables, with interest at the
rate of 1 3/4% over prime. In connection with the factoring agreement, the
Company agreed to maintain $1,150,000 of cash in a segregated account in order
to collateralize standby letters of credit for Breaking Waves. Additionally,
Breaking Waves was required to pledge as additional collateral $200,000 of its
own cash and the Play Co. Shares.
The Company's certificates of deposit in the amount of approximately
$750,000 at September 30, 2001 represented a portion of the required collateral
of $1,150,000. The balance of $400,000 came from a third party which is a trust
("Trust"), the beneficiary of which is the granddaughter of the Company's
President and Chief Executive Officer and the daughter of a principal
stockholder of the Company.
In September 2001, Century increased the required collateral in the
amount of $300,000, from $1,150,000 to $1,450,000. Subsequent to September 30,
2001, the Company effected financing arrangements with two parties (one of which
is the Trust, the other relatives of a principal stockholder of the Company)
providing for assets in the aggregate amount of $1,050,000 ("Financing"),
representing a portion of the $1,450,000 required collateral. The provision of
the assets in connection with the financing arrangements provided for the
$300,000 increase in required collateral and replacement of the Company's
certificates of deposit in the amount of $350,000. Giving effect to such
transactions, subsequent to September 30, 2001, the Company continued to have
certificates of deposit in the amount of $400,000 collateralizing the letters of
credit.
The assets provided by such parties are available to Breaking Waves for
a ten year term, subject to earlier termination in the event of default.
Breaking Waves is obligated to make an annual payment to each of the two
entities which provided such assets, equal to an aggregate of 1-1/4% of net
sales of Breaking Waves through June 30, 2002, and an aggregate of 1-3/4% of net
sales of Breaking Waves for each year the letter of credit is available
thereafter, payable 45 days after the end of each fiscal quarter. In October
2001, such entities received funds in the aggregate amount of $36,750 reflecting
advance payment of such amounts.
At September 30, 2001, the Company was indebted to Century in the
aggregate amount of approximately $1,800,000. Subsequent to September 30, 2001,
the Company obtained the consent of Century to utilize its restricted cash in
the amount of approximately $620,000 (consisting of the certificates of deposit
in the amount of $400,000 and the approximately $220,000 in cash pledged to
Century by Breaking Waves) to pay down its indebtedness, reducing it to
approximately $1,200,000 in November 2001.
Interest expense related to the Century factoring agreement totaled
$51,372 and $6,870 for the three months ended September 30, 2001 and 2000,
respectively. Century has a continuing interest in Breaking Waves' inventory as
collateral for the advances.
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
agreement ("ARC Consulting Agreement"), ARC was retained to assist the Company
in the acquisition of financing to acquire inventory and for other corporate
purposes, as well as consult with the Company with regard to its ongoing
operations, including systems to control expenses, methods to enhance and
promote sales of Breaking Waves' products and improving production. ARC assisted
the Company in the Financing. 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 ("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 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.
Breaking Waves' ownership interest in Play Co. amounted to
approximately 1.5% as of September 30, 2001 as evidenced by the Play Co. Shares,
which are pledged to Century. As of September 30, 2001, Breaking Waves'
investment in Play Co. decreased to $-0- based on fair market value of its
common stock holdings. On March 28, 2001, Play Co. and certain of its
subsidiaries all filed for protection under Chapter 11 of the United States Code
with the United States Bankruptcy Court for the Southern District of New York.
In August 2001, the case was converted to a Chapter 7 filing.
23
The Company anticipates that its current available cash will be
sufficient for the next twelve months and does not anticipate any cash
shortfalls. In the September 30, 2001 quarter, the Company implemented a number
of initiatives which it believes will reduce its costs of operations and
overhead. In particular, the Company believes that the repayment of its
indebtedness to Century in the amount of approximately $620,000 in the aggregate
will translate into decreased interest expense projected to be approximately
$30,000 per annum. Notwithstanding, the Company expects its indebtedness to
Century to increase to more than $3 million during the months of December and
January as it builds-up its inventory for its peak season. Although there can be
no assurance that interest rates will remain at their current low levels, based
on the Company's anticipated borrowings in the current fiscal year, the Company
believes that recent reductions in interest rates will generate additional
savings of approximately $60,000 in the current fiscal year.
Shopnet has chosen not to renew its lease for its executive facilities.
Commencing in December 2001, the Company will consolidate all of its operations
in the New York metropolitan region into new facilities where Breaking Waves
currently operates, resulting in annualized rental savings estimated at
approximately $60,000 over the next 12 months, plus additional savings in
utilities and other office and personnel expenses resulting from the economies
generated by the consolidated operations. The Company expects that these savings
will be further supplemented by salary reductions the Company began to implement
during the September 30, 2001 quarter, which are expected to amount to
approximately $130,000 during the current fiscal year ending June 30, 2002.
The Company has recently refocused its sales efforts, to the extent
possible, to eliminate unprofitable or low margin sales. This is compounded with
improved sales and orders during the month of October 2001. Breaking Waves
generated sales during the month of October 2001 of approximately $120,000, as
compared to $3,500 during the month of October 2000. Similarly, at October 31,
2001, Breaking Waves had orders of approximately $5.3 million, as compared to
approximately $4.8 million at October 31, 2000, reflecting more than a 10%
increase. Notwithstanding, there can be no assurance that such figures will be
indicative of future results, that the Company will be successful in collecting
all receivables, or that any orders booked as of October 31, 2001 will not
ultimately be cancelled.
Investments in Joint Ventures
Battle Studies Productions, LLC
In April 1998, the Company entered into a co-production agreement with
North Fork 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 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. 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 costs incurred by
same, any remaining proceeds shall be distributed 50% to North Folk and 50% to
the Company. The film was shown in January 1999 in both New York and at the
Brussels Film Festival.
The Company accounts for the investment in Battle Studies on the equity
method. For the three months ended September 30, 2001 and 2000, the Company,
recorded $63 and $-0-, respectively, of equity losses for its proportionate
share of Battle Studies. No revenues have been derived from this film as of
September 30, 2001.
On October 12, 2000, Battle Studies entered into a distribution
agreement with Raven Pictures International ("Raven Pictures") to distribute
Battle Studies' motion picture ("Machiavelli 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 expenses.
24
On January 17, 2001, 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 September 30, 2001,
$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 September 30, 2001, 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.
Factoring Arrangements
CIT Group
On August 20, 1997, Breaking Waves entered into a factoring and
revolving inventory loan and security agreement (as amended December 9, 1998)
with CIT Group (formerly, Heller Financial, Inc. "CIT") to sell their interest
in all present and future receivables without recourse. Breaking Waves paid CIT
a factoring commission of .85% of the first $5,000,000 of receivables sold and
.65% of receivables sold in excess of $5,000,000 for each year. Breaking Waves
took advances of up to 85% of the receivable, with interest at the rate of 1
3/4% over prime. In connection with the factoring agreement, the Company agreed
to maintain $1,150,000 of cash in a segregated account in order to collateralize
standby letters of credit. In addition, during 1999, the Company was required to
transfer an additional $200,000 of cash as collateral for the standby letter of
credit. Interest expense related to this agreement totaled $-0- and $33,686 for
the three months ended September 30, 2001 and 2000, respectively. On or about
September 12, 2000 the agreement with CIT was cancelled and a new factoring
agreement was entered into with Century.
Lease Commitments
The Company's executive offices are located at 14 East 60th Street,
Suite 402, New York New York 10022, (212) 688-9223, comprising approximately
1,800 square feet. The Company leased its office space in November 1996 for a
term of five years, at an approximate base annual rental of $70,000. Upon the
lease's expiration on November 30, 2001, the executive offices will relocate to
Breaking Waves' facilities described below.
Breaking Waves maintains its executive offices and showroom at 112 West
34th Street, New York, New York 10120. Until January 1998, this space was
approximately 1,000 square feet and comprised only office space. In January1998,
Breaking Waves amended its lease and rented an additional 1,000 square feet. The
lease is for a term of seven years, expiring December 2004, at an annual rental
of $71,600. In July 2001, Breaking Waves terminated this lease effective August
31, 2001. A new 6-year lease for an aggregate of 2,200 square feet expiring
September 30, 2007 was signed, which becomes effective on November 1, 2001, or
such later date as the landlord of such premises completes construction. Annual
rent under the new lease is $84,915 through December 31, 2004 and $95,760 for
the remainder of the lease. Breaking Waves also maintains a Florida office,
comprising approximately 780 square feet, with annual payments of approximately
$11,000.
25
License Agreements
On October 16, 1995, Breaking Waves entered into a license agreement with Beach
Patrol, Inc. Pursuant to the licensing agreement, Breaking Waves was given the
right to use certain designs for its children's line under the "Daffy Waterwear"
label from January 1, 1996 to June 30, 1998. Thereafter, the agreement provided
for a three year extension, at the option of Breaking Waves, through and until
June 30, 2001. Breaking Waves has exercised this option, thereby extending the
agreement. The agreement calls for minimum annual royalties of $75,000 to
$200,000 over the life of the agreement with options based on sales levels from
$1,000,000 for the first year to $4,000,000 in the sixth year. Breaking Waves
has negotiated an additional two year extension thereby extending the agreement
through and until June 30, 2003, and it contains a provision for an additional
two year extension, at the option of Breaking Waves, through and until June 30,
2005. The new agreement signed February 28, 2001 and effective July 1, 2001
calls for minimum annual royalties of $50,000 to $87,500 over the life of the
extension with options based on sales levels from $1,000,000 for the seventh
year to $1,750,000 in the tenth year. Breaking Waves recorded royalties and
advertising under this agreement totaling $5,000 and $63,897 during the three
months ended September 30, 2001 and 2000, respectively.
During June 2000, Breaking Waves entered into a license agreement with
an effective date of November 1, 2000 with Gottex Models Ltd., an 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, subject
to certain exceptions. The license agreement also requires the Company to expend
certain minimum amounts on advertising each year. The license agreement is for a
term of three years, subject to earlier termination in accordance with its
terms. In the quarter ending September 30, 2001, Breaking Waves recorded $34,531
in royalty expenses related to the minimum guaranteed royalties contained in its
agreement with Gottex. Breaking Waves recorded no royalties under this agreement
for the three months ended September 30, 2000.
26
PART II
Item 1. Legal Proceedings: 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). 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. We have responded to the complaint and denied the allegations. We intend
to contest this action vigorously and believe that such claims are baseless and
without merit.
The Company is not a party to any other material litigation and is not aware of
any threatened litigation that would have a material adverse effect on its
business. Neither the Company's officers, directors, affiliates, nor owners of
record or beneficially of more than five percent of any class of the Company's
Common Stock is a party to any material proceeding adverse to the Company or has
a material interest in any such proceeding adverse to the Company.
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) Exhibits: None
(b) Reports on Form 8-K: None
27
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized, this 16th day of November 2001.
SHOPNET.COM, INC.
By: /s/ Harold Rashbaum
Harold Rashbaum
President and Chief Executive Officer