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, 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)
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 [ ]
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: 7,472,244 shares outstanding as of November 4, 2002.
SHOPNET.COM, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page
Number
---------
Item I. FINANCIAL STATEMENTS
Consolidated balance sheets as of September 30, 2002 (unaudited) and June 30, 2002 (audited) 3
Consolidated statements of operations and comprehensive income (unaudited) for the three months
ended September 30, 2002 and September 30, 2001 (unaudited) 4
Consolidated statements of stockholders' equity for the three months ended September 30, 2002
(unaudited) 5
Consolidated statements of cash flows for the three months ended September 30, 2002 and September
30, 2001 (unaudited) 6
Notes to consolidated financial statements 7
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 20
Item 3. Controls and Procedures 28
PART II. OTHER INFORMATION
SHOPNET.COM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of September 30, 2002 and June 30, 2002
ASSETS Sept. 30, June 30,
2002 2002
----------- -----------
(unaudited) (audited)
Current assets:
Cash .................................................................................... $ 4,541 $ 3,309
Accounts receivable, net ................................................................ 12,416 19,109
Other receivables ....................................................................... 107,507 88,118
Inventory ............................................................................... 136,943 230,049
Prepaid expenses ........................................................................ 287,228 298,968
Advances to officer ..................................................................... 40,000 40,000
----------- -----------
Total current assets ...................................................... 588,635 679,553
----------- -----------
Property and equipment, net ............................................................. 70,268 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 ............................................................................ 27,078 27,078
----------- -----------
2,499,974 2,499,750
----------- -----------
Total assets .............................................................. $ 3,088,609 $ 3,179,303
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Due to factor ........................................................................... $ 1,188,032 $ 690,595
Accounts payable ........................................................................ 216,342 280,003
Accrued expenses ........................................................................ 36,750 4,782
Capital lease obligations ............................................................... 2,918 3,938
Other taxes payable ..................................................................... 2,891 2,214
Deferred tax liability .................................................................. 5,188 5,188
----------- -----------
Total current liabilities ................................................. 1,452,121 986,720
----------- -----------
Total liabilities ......................................................... 1,452,121 986,720
----------- -----------
Commitments and contingencies
Stockholders' equity
Common stock- $.001 par value, 20,000,000 shares authorized, 7,472,244
shares issued and outstanding at September 30, and June 30, 2002
7,472 7,472
5% Convertible debentures ............................................................... 15,000 --
Capital in excess of par value .......................................................... 6,638,852 6,638,852
Accumulated deficit ..................................................................... (5,024,836) (4,453,741)
----------- -----------
Total stockholders' equity ................................................ 1,636,488 2,192,583
----------- -----------
Total liabilities and stockholders' equity .............................................. $ 3,088,609 $ 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)
For The Three Months Ended September 30, 2002 And 2001
(unaudited)
Sept. 30, Sept. 30,
2002 2001
----------- -----------
Net sales ............................................................ $ 19,807 $ 365,113
Cost of sales ........................................................ 101,447 405,322
----------- -----------
Gross loss ........................................................... (81,640) (40,209)
----------- -----------
Expenses:
Selling, general, and administrative expenses .................... 466,268 470,829
Amortization of costs in excess of net assets of business acquired -- 17,738
----------- -----------
Total expenses ....................................................... 466,268 488,567
----------- -----------
Loss before other income (expenses) and provision for income taxes ... (547,908) (528,776)
----------- -----------
Other income (expenses):
Equity in earnings (loss) of affiliate ........................... -- (63)
Rental income .................................................... -- 9,050
Interest and finance expense ..................................... (23,187) (61,574)
Interest income .................................................. -- 9,599
----------- -----------
Total other income (expense) ......................................... (23,187) (42,988)
----------- -----------
Loss before (benefit) provision for income taxes ..................... (571,095) (571,764)
(Benefit) provision for income taxes ................................. -- --
----------- -----------
Net loss ............................................................. (571,095) (571,764)
Other items of comprehensive (loss) income ........................... -- (6,350)
----------- -----------
Comprehensive loss ................................................... (571,095) $ (578,114)
----------- -----------
Basic loss per share ................................................. $ (.08) $ (.08)
=========== ===========
Diluted loss per share ............................................... $ (.07) $ --
=========== ===========
Weighted average number of shares outstanding ........................ 7,472,244 7,472,244
=========== ===========
Weighted average number of common shares outstanding assuming dilution 7,869,069 --
=========== ===========
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, 2002
(unaudited)
Accumulated
Capital Other Total
Common Stock Convertible In Excess of Accumulated Comprehensive Stockholders'
Shares Amount Debentures Par Value Deficit Income (loss) equity
----------- ---------- ----------- ----------- ----------- -------- -----------
Balances at June 30, 2002 ........... 7,472,244 $ 7,472 $ 0 $ 6,638,852 $(4,453,741) $ 0 $2,192,583
August 30, issuance of 5% convertible
debentures ........................ 15,000 15,000
Net loss (unaudited) ................ -- -- -- -- (571,095) -- (571,095)
----------- ---------- ----------- ----------- ----------- -------- -----------
Balances at September 30, 2002 ...... 7,472,244 $ 7,472 $ 15,000 $ 6,638,852 $(5,024,836) $ $1,636,488
=========== ========== =========== =========== =========== ======== ===========
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 Three Months Ended September 30, 2002 And 2001
(unaudited)
2002 2001
--------- ---------
Cash flows from operating activities:
Net loss ...................................................................... $(571,096) $(571,764)
--------- ---------
Adjustments to reconcile net income to net cash used in operating
activities:
Equity in loss of affiliate .............................................. -- 63
Amortization and depreciation ............................................ 5,570 24,621
Decrease (increase) in:
Cash-restricted .......................................................... -- (2,754)
Accounts receivable ...................................................... 6,693 (11,816)
Other receivables ........................................................ (19,389) 28,674
Inventory ................................................................ 93,106 401,096
Prepaid expenses ......................................................... 11,740 4,228
Advances to officer ...................................................... -- (1,971)
Increase (decrease) in:
Due to factor ............................................................ 497,437 80,774
Accounts payable ......................................................... (63,660) 21,369
Accrued expenses ......................................................... 31,968 18,414
Other taxes payable ...................................................... 677 (743)
--------- ---------
Net cash used in operating activities ............................................ (6,954) (9,809)
--------- ---------
Cash flows from investing activities:
Acquisition of property and equipment ......................................... (5,794) (10,315)
--------- ---------
Net cash used in investing activities ............................................ (5,794) (10,315)
--------- ---------
Cash flows from financing activities:
Issuance of 5% convertible debentures ........................................... 15,000 --
Principal payments on capital leases ............................................. (1,020) (4,320)
--------- ---------
Net cash used in financing activities ............................................ 13,980 (4,320)
--------- ---------
Net increase (decrease) in cash .................................................. 1,232 (24,444)
Cash, beginning of period ........................................................ 3,309 24,703
--------- ---------
Cash, end of period .............................................................. $ 4,541 $ 259
========= =========
Supplemental disclosure of cash flow information: cash paid during the period for:
Interest ................................................................. $ 22,495 $ 61,574
========= =========
Income taxes ............................................................. $ 345 $ --
========= =========
The accompanying notes should be read in conjunction with the consolidated
financial statements
-6-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE 1- ORGANIZATION
Shopnet.com, Inc. ("Shopnet" or the "Company") was
incorporated in the State of Delaware on September1, 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 31st to June 30th .
NOTE 2- INTERIM RESULTS AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements
as of September 30, 2002 and for the three month periods ended
September 30, 2002 and September 30, 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 September 30, 2002 and the results of
operations and cash flows for the three month periods ended
September 30, 2002 and 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 14, 2002.
The Company in the quarter ended September 30, 2002 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 December 2001, the Company consolidated all of its
operations in the New York metropolitan region into one new
facility (See Note 8(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 improved bookings for the current fiscal year.
-7-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE 3- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) Recently adopted accounting principles - Film accounting
Pursuant to Statement of Financial Accounting Standards
("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 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, 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 No. 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.
For the three months ended September 30, 2001, there is no
computation of diluted earnings (loss) per share as the 5%
convertible debentures had not been issued.
-8-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
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 SFAS No. 142 (Goodwill and Other Intangible assets).
Under SFAS No. 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
unit level. Under SFAS No. 142, the fair value of a reporting
unit is compared to its carrying amount, including its
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), then
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 determined that no impairment existed as of
September 30, 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 $218,500
through September 30, 2002, for a 50% interest in a new
entity, Battle Studies Productions, LLC ("Battle Studies") a
limited liability company. Battle Studies will be treated as
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,
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 three months ended
September 30, 2002 and the three months ended September 30,
2001, the Company recorded $0, and $63, in net equity losses,
respectively.
-9-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
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 is 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 No. 115, the securities were considered available for
sale and therefore the carrying value was based on the fair
market value of the securities at September 30, 2002 and
2001 which amounted to $0, respectively.
The change in the fair market value of the securities during
the periods were 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, 2002 Play Co. filed for protection under
Chapter Eleven of the U.S. Bankruptcy 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
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"), 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
For The Three Months Ended September 30, 2002 And 2001
NOTE 7- DUE TO FACTOR (continued)
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 expired on September 1, 2001 but was extended
for another year. At the Company's option, the letter of
credit can be extended for a period of nine 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.
On September 15, 2001, the Company entered into a
Reimbursement Agreement with certain individuals ("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 (13/4%) 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 $12,500, 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 tot he 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.
-11-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE 7- DUE TO FACTOR (continued)
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.
The following table summarizes the percentage due each party,
as noted above, as a percentage of net sales for the three
months ended September 30, 2002.
% of
Net Sales Amount
--------------- ------------
RAYA 0.58 $ 115
ZAT 1.16 230
ARC 1.75 347
--------------- ------------
Total 3.49 $ 692
=============== ============
Interest expense related to the factor agreement totaled
$22,472 and $51,372 for the three months ended September 30,
2002 and 2001, respectively. Century has a secured interest in
Breaking Waves' inventory as collateral for the advances. As
of September 30, 2002, the net advances to Breaking Waves from
Century amounted to $1,188,032.
NOTE 8- 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 three months ended September 30, 2002
amounted to $25,598.
-12-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE 8- COMMITMENTS AND CONTINGENCIES (Continued)
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 September 30,
2002 Breaking Waves had one customer, which comprised 71%, of
net sales. For the three months ended September 30, 2001,
Breaking Waves had 2 customers which compromised 85% of net
sales.
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
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 $33,000
and $34,531 for the three months ended September 30, 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.
Through September 30, 2002, the Company had invested
$1,971,956 for the co-production and distribution of such
motion pictures whereas the co-producers have invested
$100,000. For the three months ended September 30, 2002 and
2001, the Company derived no revenue from the motion picture
and has not amortized film costs.
The Company had previously written down its film production
and distribution costs in order to reduce the asset to its
estimated net realizable value of $1,204,728.
-13-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE 8- COMMITMENTS AND CONTINGENCIES (continued)
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.
On or about December 2001, a group of over 275 foreign
plaintiffs commenced an action entitled Abeln v. Arbel, et. al
in the United States District Court for the Southern District
of New York naming the Company, along with over 30 other
entities and individuals as defendants. The Company was never
served with the summons and complaint, and could not discern
if such service as effectuated. Thus, the Company was not yet
a party to the suit.
In August, 2002, the Plaintiffs voluntarily dismissed this
action.
NOTE 9- 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, January 200 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
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.
-14-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE 9- STOCKHOLDERS' EQUITY (Continued)
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.
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.
NOTE - 10 RELATED PARTIES TRANSACTIONS
a) For the three months ended September 30, 2002
financial consulting fees in the amount of $11,225,
were paid to a corporation and an individual who are
related to the Company's President and CEO.
b) During October 1996, pursuant to two promissory
notes, the Company loaned two of its officers a total
of $87,000 bearing interest at three and one-half
percent (6 1/2) payable over three years. As of
September 30, 2002, the unpaid portion amounted to
$37,000, which has been classified as a current
asset. Additionally, the Company's President was also
advanced additional funds totaling $3,000 which are
non-interest bearing. The funds are due on demand and
are classified as current.
-15-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE - 11 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 make 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.
-16-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE - 11 SEGMENT INFORMATION (continued)
Information about the two segments is as follows:
Three months ended Three months ended
September 30, 2002 September 30, 2001
Segment Consolidated Segment Consolidated
----------- ------------ ----------- ------------
Sales:
Swimwear sales ......................... $ 19,807 $ 365,113
Film production ........................ -- --
----------- -----------
Total sales .................................. $ 19,807 $ 365,113
=========== ===========
Operating income (loss):
Swimwear sales ......................... $ (296,069) $ (425,275)
Film production ........................ (600) (641)
----------- -----------
Total operating income ....................... (296,669) (425,916)
----------- -----------
Corporate:
General and administrative expense ..... (251,239) (85,122)
----------- -----------
(Loss) equity in earnings of affiliate . -- (63)
Amortization expense ................... -- (17,738)
Interest income ........................ -- 9,599
Interest and finance expense ........... (23,187) (61,574)
Other .................................. -- 9,050
----------- -----------
Loss before (benefit) provision for income tax
(571,095) (571,764)
----------- -----------
(Benefit) provision for income tax ........... -- --
----------- -----------
Net (loss) income ............................ $ (571,095) $ (571,764)
=========== ===========
Identifiable assets:
Swimwear sales ......................... $ 417,222 $ 882,393
Film productions ....................... 1,450,889 1,451,104
Corporate .............................. 1,220,498 1,725,958
----------- -----------
Total assets ................................. $ 3,088,609 $ 4,059,455
=========== ===========
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.
-17-
SHOPNET.COM, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For The Three Months Ended September 30, 2002 And 2001
NOTE - 12 SUBSEQUENT EVENTS
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 November 8, 2002, the Company issued 595,238
shares to Amigal.
Upon this conversion, Amigal owns approximately 7.4% of the
Company's outstanding common shares.
-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 September 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 Productions, Inc.
("Hollywood"), to which it assigned its motion picture business thereby
rendering Shopnet a holding company for Hollywood and another wholly-owned
subsidiary, Breaking Waves, Inc. ("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 Initial
Public Offering, 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 31st to June 30th.
The consolidated financial statements at September 30, 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 March 31, 2002 and June 30, 2001:
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 September 30, 2002 as compared to the three months ended
September 30, 2001
For the three months ended September 30, 2002 and 2001, the Company
reported a consolidated net loss of $571,095 and $571,764.
Breaking Waves
For the three months ended September 30, 2002 and 2001, Breaking Waves
generated net sales of $19,807 and $365,113, respectively, with related cost
of sales amounting to $101,447 and $405,322, respectively. The decrease in
sales amounting to $345,306, or approximately 95%, from 2001 to 2002 and the
decrease in cost of sales of $303,875 or 75% from 2001 to 2002, was primarily
attributable to the carry over of a significant amount of close out goods
from the year ended June 30, 2001, which were partially sold during the three
months ended September 30, 2001. Normally, the quarter ended September 30th
is historically a seasonally slow sales period. In the quarter ended
September 30, 2002 the Company did not have a significant amount of close out
goods available for sales.
The gross loss for the three months ended September 30, 2002 amounted
to $81,640, or 412% of sales as compared to the three months ended September
30, 2001 during which it amounted to $40,209, or 11% of sales. The variance
is primarily attributable to the effect of the establishment of a valuation
allowance to the opening inventory as of July 1, 2002, which increased cost
of sales in the quarter ended September 30, 2002.
-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 September
30:
2002 2001
---------- ----------
Officers, office staff, designer and sales , salaries and related benefits $ 139,713 $ 146,816
Commission expense ........................................................ (19,460) (17,954)
Warehousing costs ......................................................... 3,171 9,123
Royalty fees .............................................................. 33,000 39,531
Rent expense .............................................................. 25,598 22,803
Factor commissions ........................................................ 472 4,801
Miscellaneous general corporate overhead expenses ......................... 221,389 179,946
Interest expense in connection with its factoring agreement amounted to
$22,472 and $51,372 for the three months ended September 30, 2002 and 2001,
respectively. The decrease is due to the a lower factor balance during the
three months ended September 30, 2002.
Breaking Waves owned 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 was approximately 1.5% of Play Co.'s outstanding Common Stock. 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 September 30, 2002 and 2001 which amounted to $0, 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 had 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 were therefore considered
non-current. On March 28, 2002, 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 $0 and $6,350 for the
three months ended September 30, 2002 and 2001, respectively, which has been
recorded as a component of comprehensive income (loss) in the statements of
operations.
Breaking Waves generated net losses of $508,710 and $483,113, for the
three months ended September 30, 2002 and 2001, respectively.
-22-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
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 September 30, 2002 and 2001, Hollywood
generated no sales from its motion picture "Dirty Laundry". Although sales
prior to and including the three 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
further write downs were necessary as of September 30, 2002 and 2001,
respectively. Hollywood generated a loss of $600 and $641 for the three
months ended September 30, 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 three months ended September 30, 2002, Shopnet generated no
income. For the three months ended September 30, 2001, 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
$61,786 and $85,029 for the three months ended September 30, 2002 and 2001.
This represents a decrease of $23,243, or approximately 27%.
The major components of the Company's expenses are as follows for the
three months ended September 30:
2002 2002
------------- --------------
Salaries (officer and office staff) and stock compensation and related
benefits $33,445 $40,058
Rent - 13,068
Legal and professional fees 2,798 7,750
Consulting fees 14,475 6,000
Other general corporate and administrative expense 11,068 18,153
Shopnet generated a net loss of $61,786 and $88,010 for the three
months ended September 30, 2002 and 2001, respectively.
-23-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources
At September 30, 2002, the Company's consolidated working capital
deficit amounted to $863,486.
At September 30, 2002, current assets consisted primarily of cash,
receivables, inventory and prepaid expenses. 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, 2002, the Company did not
have cash deposits in accounts in excess of Federal Deposit Insurance
Corporation limits.
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"), 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 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 expired on September 1, 2001 but
was extended for another year. At the Company's option, the letter of credit
can be extended for a period of nine additional 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.
-24-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources (continued)
On September 15, 2001, the Company entered into a Reimbursement
Agreement with certain individuals ("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 (13/4%)
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
$12,500, 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 tot he 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 $209,500
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.
The following table summarizes the percentage due each party, as noted
above, as a percentage of net sales for the three months ended September 30,
2002.
% of
Net Sales Amount
--------------- ------------
RAYA 0.58 $ 115
ZAT 1.16 230
ARC 1.75 347
--------------- ------------
Total 3.49 $ 692
=============== ============
Interest expense related to the factor agreement totaled $22,472 and
$51,372 for the three months ended September 30, 2002 and 2001,
respectively. Century has a secured interest in Breaking Waves' inventory as
collateral for the advances. As of September 30, 2002, the net advances to
Breaking Waves from Century amounted to $1,188,032.
-25-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Liquidity and Capital Resources (continued)
The Company anticipates that its current available cash will be
sufficient for the next twelve months and does not anticipate any cash
shortfalls. The Company expects its indebtedness to Century to increase to
more than $3 million during the months of September 2002 through January 2003
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 borrowings and interest rates will
generate additional savings of approximately $60, 000 in the current fiscal
year.
The Company has recently refocused its sales efforts, to the extent
possible, to eliminate unprofitable or low margin sales.
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 three months ended September 30, 2002 and 2001, the Company,
recorded $0 and $63, respectively, of equity losses for its proportionate
share of Battle Studies. No revenues have been derived from this film as of
September 30, 2002.
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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Investments in Joint Ventures (continued)
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, 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 The Girl LLC under the equity
method. The Company's initial investment of $35,000 was cumulatively reduced
by its proportionate share of losses in the amount of $1,298 recorded under
the equity method. As of September 2002, the investment in The Girl, LLC, was
$33,702.
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 three months ended September 30, 2002 amounted to
$25,598.
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
$33,000 and $34,531 for the three months ended September 30, 2002 and 2001,
respectively.
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ITEM 3. CONTROLS AND PROCEDURES
As of September 30, 2002, an evaluation was performed under the
supervision and with the participation of the Company's management, including
the Chief Executive Officer and the 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 the Chief Financial Officer,
concluded that the Company's disclosure controls and procedures were
effective as of September 30, 2002. There have been no significant changes in
the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to September 30, 2002.
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) Exhibits
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.
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: November 14, 2002
CERTIFICATION
I, Harold Rashbaum, certify that:
1. I have reviewed this quarterly report of Form 10-QSB 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: November 14, 2002
/s/ Harold Rashbaum
Harold Rashbaum
Chief Executive Officer
Chief Financial Officer
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