10KSB/A 1 netguru_10ka3-033102.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDMENT NO. 3 TO FORM 10-KSB (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number: 0-28560 NETGURU, INC. (Exact name of small business issuer in its charter) DELAWARE 22-2356861 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 22700 SAVI RANCH PARKWAY, YORBA LINDA, CA 92887 (Address of principal executive offices) (Zip Code) Issuer's telephone number: (714) 974-2500 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of exchange on which registered NONE NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $0.01 PAR VALUE (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] State issuer's revenues for its most recent fiscal year: $24,284,000. The aggregate market value of the voting stock held by non-affiliates of the registrant as of May 2, 2003 was $14,621,990. The number of shares outstanding of the registrant's only class of Common Stock, $.01 par value, was 17,325,150 on May 2, 2003. DOCUMENTS INCORPORATED BY REFERENCE: NONE TABLE OF CONTENTS PART I PAGE Item 1. Description of Business.......................................... 3 PART II Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................ 13 Item 7. Financial Statements............................................. 35 PART III Item 10. Executive Compensation............................................36 Item 13. Exhibits and Reports on Form 8-K................................. 39 Signatures....................................................... 42 Certification.................................................... 43 Index to Consolidated Financial Statements....................... F-1 Index to Exhibits Filed With This Amendment No.3 to Form 10-KSB.. 44 2 NETGURU, INC. PART I ITEM 1. DESCRIPTION OF BUSINESS. OVERVIEW We were incorporated in 1981 under the name Research Engineers, Inc. and changed our name to netGuru, Inc. in 2000. We are a Delaware corporation. Our primary business offerings are: o Engineering software products, maintenance and services (including digital media and animation products and services) for businesses worldwide; o Information technology, or IT, services (including value-added IT services); and o Internet content and e-commerce activities (including collaborative software and commerce solutions, long-distance communication services that include call termination services and prepaid phone cards, travel services, and applications service provider, or ASP, solutions). PRODUCTS AND SERVICES ENGINEERING SOFTWARE SOLUTIONS Over the past 21 years, we have continuously improved our core competency and established a strong brand for our engineering software within the architectural/engineering/construction, or A/E/C, markets worldwide. Our engineering software primarily is used for the specific calculations required for the design of civil and structural engineering projects. We have established our leadership position in the engineering software industry by being the first-to-market for personal computer-, or PC-, based engineering software and by being the first mover to penetrate foreign markets. Currently, 46 of the 50 largest engineering design firms in the world use our engineering software. We have 19,000 customers, with over 47,000 installations and approximately 160,000 users in 85 countries. Our stand-alone and network-based engineering software products provide fully integrated, easy-to-use design automation and analysis solutions for use by engineering analysis and design professionals worldwide. We have developed a comprehensive line of structural, mechanical, civil and process/piping engineering software products, including our STAAD.Pro(R) family of products, FabriCAD, ADLPIPE, STARDYNE(R), CIVILSOFT and CIVILMASTER(R). Our products assist engineers in performing mission-critical functions, including analysis and design of industrial, commercial, transportation and utility structures; pipelines, machinery, automotive and aerospace products; and survey, contour and digital terrain modeling. All of our engineering software products use our proprietary Windows-based graphics engine that provides a modern graphics environment for model development, visualization/verification and drawing generation. These products are also designed for use with third-party computer aided design, or CAD, drafting systems, including AutoCAD and MicroStation. Our structural and civil engineering products provide eight international language options and twelve local design codes required by our worldwide markets. 3 We generate revenues from software licensing fees and annual support fees established at the time of the initial contract. Suggested list prices for most of our software products range from approximately $995 to $7,000. We offer limited production for two-dimensional and three-dimensional animation used by businesses in corporate promotions, Website design, gaming and motion pictures. IT SERVICES We are an IT total solutions provider, or TSP. Our IT services division has provided contracted IT services and software solutions to almost every vertical industry market (that is, a particular industry or group of enterprises to whom similar goods and services can be sold), with an emphasis on engineering, aerospace, e-commerce, semiconductors, finance, education, insurance, manufacturing, distribution, retail, government, pharmaceuticals and healthcare. As a TSP, we provide our business-to-business clients with services that involve integration of multiple existing third party software solutions, and we also offer value-added IT services by incorporating our proprietary collaborative software technology and/or our engineering solution software into enterprise solutions designed to accomplish our clients' current objectives and grow with our clients' enterprises. We specialize in providing IT services that involve mission critical applications that deliver round-the-clock performance. We offer our IT services through our two service offices located in Boston, Massachusetts and San Jose, California. We provide IT services both on a project basis and through on-site consulting. When we provide IT services on a project basis, we assume full project management responsibility. Typically, projects are of a fixed duration and are charged at a fixed price. When we provide on-site consulting services, we bill our clients on a time and materials basis. We provide IT services to customers in the United Kingdom, France and Germany in addition to customers in North America. We strive to contain costs while remaining competitive by utilizing our production centers in India to support our IT services business. INTERNET CONTENT, E-COMMERCE AND COLLABORATIVE SOFTWARE SOLUTIONS Our Internet content and e-commerce solutions comprise long-distance communication services that include call termination services and prepaid phone cards and travel services targeted toward certain niche markets. Our collaborative software solutions consist of our e-review and related products and ASP solutions. Long-Distance Communication Services ------------------------------------ We offer to communication service providers global long-distance call termination services through our gateway in the U.S. by traditional delivery methods such as international leased lines and satellite access. Our long-distance call termination services involve a number of steps. We collect voice traffic from long-distance service providers. We convert analog traffic to digital traffic where necessary using software licensed from a third-party and carry the traffic on our communications infrastructure. We then drop off the traffic at a point where another service provider picks up this traffic and carries it to its destination or to another service provider. We receive our revenues from the long-distance service provider from whom we received the traffic, and we pay the service provider to whom we drop off the traffic. As is typical of other small long-distance call termination service providers, we do not have long-term commitments with third parties to purchase or sell these communication services. 4 Our managed communications network is designed to be a premium communications and data network built with carrier-grade communications switches and equipment linked by a combination of the Internet, international leased lines and satellite access. We monitor and control our communications network round-the-clock to deliver high quality voice communications. In the United States, our communications gateway and switch is located in a leased communications facility in Los Angeles, California. We sell prepaid phone cards through our automated proprietary Website. The phone cards are available for both domestic and international long-distance calls. Most phone cards are paid for by credit card. Long distance call termination services are paid for by wire transfer or check within one or two weeks after we provide the service. Travel Services --------------- We offer online international travel services that primarily are targeted toward the Asian community and persons of Indian origin located throughout the world. Our travel services primarily consist of domestic and international flight reservations and ticketing, vacation travel planning and services, and travel services specifically tailored to the needs of our business client companies. Most online travel sales are paid for by credit card. Collaborative Software Solutions -------------------------------- In April 2000, we acquired Allegria Software, Inc., a developer of Web-based document management and collaborative tools for engineers and manufacturers, and we added Allegria Software's e-Review and ForReview collaborative products to our offerings. Our collaborative software innovations have changed the way engineers conduct their day-to-day business. Once installed at a host location, our eReview collaborative software enables a host and other participants to engage in real-time Web-based conferencing and document sharing anywhere and anytime in over 150 widely used document formats. eReview allows our customers to bridge physical distances in their global business environments by enabling decision makers to communicate without costly and time consuming travel to geographically dispersed locations. Complementing eReview, our WebWorks software provides comprehensive project-based document and team management functions. Our collaborative products can be implemented as stand-alone enterprise solutions or as an integrated system working in concert with our other products. Due to our engineering experience, our collaborative software is ideally suited for multi-faceted A/E/C projects but also has direct application for many other industries. ASP Services ------------ As an ASP, we offer our engineering products and solutions online at WEB4ENGINEERS.COM. On this site, we offer versions of our current software products such as STAAD.Pro(R), CIVILMASTER(R) and FabriCAD that are Web-enabled, which means that our customers can use these products from our Website by paying a fee instead of purchasing these products. We also offer our collaborative software product, eReview, in a Web-enabled version, which our customers can use for interactive Web-based meetings to view, annotate and markup documents online in real-time. 5 We also provide ASP services to engineering and construction software companies. Our services involve Web-hosting our clients' applications software and data at our facilities. We generally collect our revenues from these services through prepaid credit card sales or credit card sales at time of usage. In addition, we have licensed our ASP technologies to other companies and have contracted with them to supervise their development of specific versions of the ASP model. We plan to continue to explore opportunities to license our ASP technologies for use in various languages and countries as well as in various industries other than engineering and construction. CUSTOMERS ENGINEERING SOFTWARE SOLUTIONS We currently license our software products to more than 19,000 companies accounting for over 47,000 software installations. Based on our customer surveys, we estimate that there are approximately 160,000 users at these installations worldwide. Our customers include: Bechtel Corporation British Telecom Exxon Corporation Fluor Daniel, Inc. General Dynamics Jet Propulsion Laboratories NASA Rocketdyne Siemens AG Toyo Engineering IT SERVICES During the fiscal year ended March 31, 2002, we provided IT consulting services to over 150 corporate customers in the U.S., including Fidelity, Sun Microsystems, Cisco Systems and Hewlett Packard. No single customer represented more than 5% of our business. INTERNET CONTENT, E-COMMERCE AND COLLABORATIVE SOFTWARE SOLUTIONS Our long distance call termination services are provided to companies offering similar services. Our prepaid phone card products are offered to consumers for retail consumption. Our travel services are offered to businesses and individual customers. In April 2000, we acquired Allegria Software, Inc., a developer of Web-based document management and collaborative tools for engineers and manufacturers, and added their e-Review and ForReview collaboration products to our offerings. Some of our eReview customers are: Agilent Technologies Astley-Gilbert Case New Holland CADopia, LLC Constructware Ebuild Engineered Software LG Engineering & Construction Corp. Integrated Technical Software MatrixOne Paxonix RISA Technologies (SRAC)/Dassault Systems Structural Research Analysis Corp. Tekla, Inc. 6 SALES AND MARKETING ENGINEERING SOFTWARE SOLUTIONS We market and sell our engineering analysis and design software products domestically and internationally through our network of branch offices, subsidiaries and independent sales representatives in the United States, United Kingdom, Germany, Japan, France, Scandinavia, Australia, China, Singapore, India, Indonesia, Korea, Thailand, Malaysia, South Africa, Mexico, Russia, the Middle East and Latin America. We also plan to market and sell our engineering software products online through our engineering portal, WEB4ENGINEERS.COM. We use extensive print advertising, trade show participation and direct mail campaigns to generate sales leads. In response to product inquiries generated through these activities, and through our engineering portal, elaborate evaluation/demonstration software packages, complete with full user manuals and working programs are created. Finally, our telesales professionals and international distributors close the sales. We utilize this sales approach in connection with the marketing and sales of product enhancements, upgrades and new products to current customers. We also generate awareness for our products by posting banners on the Web pages of professional engineering societies, newsgroups and similar forums on the Internet. Our Internet strategy includes providing online product demonstrations and online use of our products for discrete projects. IT SERVICES We market our IT services offerings primarily through industry-focused print advertisements, direct mailings to targeted prospects and online on our Internet portals. We market and sell our IT services on a direct basis and through customer referrals. INTERNET CONTENT, E-COMMERCE AND COLLABORATIVE SOFTWARE SOLUTIONS Our marketing efforts relating to Internet and e-commerce activities have been significantly reduced. Our marketing resources are now being focused on our other divisions. We continue to maintain our current customer base, and we will service direct referrals from our existing customers. We market our eReview collaboration software both domestically and internationally using direct marketing through our network office branches, subsidiaries and reseller channels. We extensively use print advertising, telemarketing, e-mail and direct mail campaigns as our primary lead generation activities. CUSTOMER SERVICE AND SUPPORT ENGINEERING SOFTWARE SOLUTIONS Purchasers of our engineering and software products are typically provided with 120 days of product support without charge and a multimedia training CD-ROM. We also provide "Gold level" support for our engineering software customers who need a higher level of mission critical technical support. Following the 120-day period, customers may elect to purchase ongoing support either on a one-year contract basis or on an as-used fee basis. To provide quality technical support worldwide, we employ engineers and software specialists and maintain product support centers in North America, Europe, the Asia/Pacific region and India. In addition, through our Web site, we provide e-mail technical support to users of these products. 7 IT SERVICES Our IT services are primarily project-based and time and materials-based technology consulting services which do not generally involve on-going customer service and support. Our IT services group can provide, on a project-basis, on-going high quality support as contracted by the customer on a 24x7x365 basis to meet the customer's information management needs from our facilities in Boston, Massachusetts and San Jose, California. Customer service and support are essential to our continued success and brand development efforts. In our communication business, we intend to take full advantage of our customer service and support capabilities and infrastructure to further enhance our users' experience and foster user loyalty. We have established user support teams in our local offices to enable us to rapidly respond to e-mail inquiries and provide technical advice on a 24x7x365 basis in English and the relevant local languages. We also proactively solicit feedback from our users in order to understand their preferences and to enhance their experience on our network. INTERNET CONTENT, E-COMMERCE AND COLLABORATIVE SOFTWARE SOLUTIONS Technical customer service and support services are generally not required for Internet content and e-commerce activities. We provide full technical support to all our collaboration software clients by phone, fax, e-mail, remote diagnostics and desktop application sharing making use of our own technology. Each support contract is customized to meet the individual client's needs. RESEARCH AND DEVELOPMENT Our current research and development efforts are focused on Internet technologies, applications software Web-enabling and collaboration technologies and enhancements to our current engineering software product offerings. Our research and development efforts with respect to Internet technologies have been focused on creating, developing and implementing our WEB4ENGINEERS.COM Web site. We developed a comprehensive Java-based content management system in order to manage content, live broadcasts and video on a remote basis. Audio and video compression technologies have also been developed to increase the speed over which audio and video can be broadcast over the Internet. We use an interactive viewing, markup and collaboration tool on Java Servlet and RMI technologies on our WEB4ENGINEERS.COM portal to conduct real time viewing and mark-up conferences. We have developed this system to permit integration with major document management and enterprise resource planning systems. We spent approximately $1,824,000 and $2,706,000, on research and development activities during fiscal 2002 and 2001, respectively. We offer a broad range of products and services designed to keep pace with the latest technological advances and address the increasingly sophisticated needs of our customers in all of our targeted markets. We continually focus on expanding our existing product and service offerings with acquired, upgraded and new products and services, and actively seeking opportunities to expand our product and service offerings through acquisitions and strategic alliances. 8 Our research and development group includes specialists in engineering software, ASP technologies, IT services, Internet and telecommunications. We have established research and development facilities in the United States, India and the United Kingdom. Our offshore research and development facilities in India are used to develop content and technologies for our Internet portal, to develop our digital media and animation technology, to provide IT services resources for our projects in the United States, and to develop and maintain local engineering software design codes. These projects require significant man-hours. Due to the availability of skilled technical resources in India at a fraction of the cost for comparable personnel in the United States, these projects can be completed in a cost effective manner. We believe our offshore technical resources provide a significant competitive advantage. To ensure our products meet the requirements of our users and that our software development, validation and maintenance processes meet applicable regulatory guidelines on software development, we have established an extensive quality assurance and quality control process. COMPETITION We face significant competition within each of our target markets: engineering software products and ASP services for the worldwide engineering community; Internet-based IT services for businesses worldwide; and traditional telephony services to and from global destinations. We expect that competition will intensify as the market for Internet-based solutions aimed at the global community develops and expands. We compete primarily on the basis of service, reliability and customer support, and to a lesser extent on price, ease of use and content. In general, we face significant competition in each of our business segments. Many of our existing and potential competitors have competitive advantages over us, including, but not limited to, the following: o longer operating histories; o greater name recognition; o larger customer base; o significantly greater financial, technical and other resources; and o broader service and/or product offering. To be competitive, we must be able to keep up with technological advances and continue to enhance our products and services. We may not be able to compete successfully in one or more of our target markets. Our inability to do so could adversely impact our business, financial condition and results of operations. ENGINEERING SOFTWARE PRODUCTS AND SERVICES The engineering software industry is intensely competitive and rapidly changing. A number of companies offer products that target the same markets as our products. In addition, our products occasionally compete with analysis tools that are developed internally by engineering firms. We believe that we have significant competitive advantages in the industry based on our high caliber development effort, demonstrated understanding of the needs of the engineering design industry, ability to attract and retain customers, capability to develop, acquire and implement emerging technologies, ability to provide technical support and demonstrated capability to provide attractive price points for our products. There can be no assurance, however, that our competitors will not develop products that are superior or achieve greater market acceptance compared to ours or that we will be able to compete successfully in these markets. 9 Our competitors in this segment, include Computers and Structures, Inc., RISA Technologies, RAM International, GT Strudl, and MSC Software, to name a few. Over the past twelve years, industry research has placed us among the top providers of general-purpose structural engineering analysis and design software. We believe we are among the leaders in this marketplace due to our technical innovations such as the use of open architecture (enabling an engineer to seamlessly integrate our software with other applications such as AutoCAD, MicroStation and Excel) and graphical user interface in our structural engineering software. We are among the top revenue generators in this marketplace. We are also a leader in terms of worldwide market penetration since we believe we were the first to incorporate international design codes into our software. IT SERVICES The IT services business is extremely competitive since it is not capital intensive. Our competitors in the IT consulting services industry include IT services companies such as Cognizant Technology Solutions and Scient Corporation, consulting affiliates of large accounting firms, other technology companies and in-house management information services departments. We believe that the use of our proprietary collaboration software to add value to our IT services differentiates us and may provide us competitive advantage over some of our competition. We believe we are among the smaller providers of IT services in terms of revenue and size. INTERNET CONTENT, E-COMMERCE AND COLLABORATIVE SOFTWARE SOLUTIONS In our current long-distance calling card telephony business, as well as in our call termination services, we face competition primarily from international long distance telecommunications carriers and other wholesale carriers, such as Startec Global Communication and Fusion Technologies. Our travel services face competition from travel sites of major airlines as well as from full-service travel sites such as travelocity.com, orbitz.com and expedia.com, and from independent travel agents and agencies. We are among the smallest providers of telephony and travel services and our geographic focus is limited to India and the Asian market for such services, because we believe we understand the needs of this target market. This focus enables us to limit our advertising costs by targeting our advertisements toward specialized ethnic-oriented media, which in turn enables us to offer services that are attractive to this cost conscious market. Our ASP services face competition from Informative Graphics Corporation, Cimmetry Systems, Inc. and CoCreate Software. Based on revenue, we are one of the smallest providers of ASP services. Although the ASP services model applies to a wide spectrum of industries, our initial target for our ASP services is the structural engineering and complementary industries market. We use our proprietary, document-centered collaborative software as a tool to enhance our ASP services, allowing us to offer a flexible and cost-effective solution because our services are capable of supporting over 150 widely used document formats. The collaborative software and services business is highly competitive and changes rapidly. We believe we are among the top providers of collaborative software and services in that we have bridged the gap between two-dimensional and three-dimensional desktop viewing applications and generic Web-based conferencing technologies. We compete based on our technical expertise and the versatility of our eReview collaborative software, which software enables a host and other participants to engage in real-time Web-based conferencing and document sharing anywhere and anytime in over 150 widely used document formats. Our collaborative software and services face competition from WebEx, eRoom, Cimmetry, Informative Graphics and PlaceWare. INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS Our intellectual property rights are an important aspect of our business. We rely primarily on a combination of contract, copyright, trademark and trade secret laws, domain registration, license and confidentiality agreements and software security measures to protect our proprietary technology. We require all of our employees and other parties with access to our confidential information to execute agreements prohibiting the unauthorized use or disclosure of our technology. In addition, we periodically review our proprietary technology for patentability, although we currently do not have any patents. Despite these precautions and even though we have not experienced any misappropriation of our technology over our 21-year history, we believe that existing laws provide limited protection for our technology and that it may be possible for a third party to misappropriate our technology or to independently develop similar technology. 10 Our protective measures may be even less effective in the emerging Internet law field. Internet law is a new and developing area of the law, and online contracting, privacy and liability issues, among others, are still being resolved. This lack of certainty is further exacerbated in India, where the use of the Internet is less evolved than in the U.S. In addition, effective copyright and trade secret protection may not be available in every jurisdiction where we distribute our products, particularly in foreign countries where the laws generally offer no protection or less protection than the laws of the U.S. The laws of India and other foreign countries in which we operate do not protect intellectual property rights to the same extent as those of the U.S. For example, India's statutory laws do not protect service marks. Because a significant portion of our sales of products and services comes from international markets, this lack of copyright and trade secret protection could adversely affect our business and results of operations if a third party were successful in copying our products and services and marketing products and services similar to ours. We distribute our engineering software products under "shrink-wrap" software license agreements, which grant end-users licenses to (rather than ownership of) our products and which contain various provisions intended to protect our ownership and confidentiality of the underlying technology. Shrink-wrap licenses, which are not signed by the end-user, may be unenforceable in certain jurisdictions. In addition to shrink-wrap licenses, our software is distributed with a third party "hardware lock" which is a security device that is attached to the central processing unit to prevent unauthorized access to licensed software. Our trademarks include netGuru.com, NETGURUINDIA.COM, WEB4ENGINEERS.COM, Allegria Software, ForReview, e-Review, QSE, FabriCAD, STAAD.etc. and ADLPIPE. Our registered trademarks include STAAD(R), STAAD.Pro(R), STARDYNE(R) and CIVILMASTER(R). We may not be able to secure adequate protection for our trademarks in the United States and in the other countries in which we do business. GOVERNMENT REGULATION REGULATION OF THE INTERNET UNITED STATES AND EUROPE. The U.S. Congress has passed or is considering passing legislation regulating certain aspects of the Internet, including online content, copyright infringement, user privacy, taxation, access charges, digital signatures and liability for third-party activities. The European Union also has enacted several directives relating to the Internet, including directives that address the use of personal data, e-commerce activities, security, commercial piracy, consumer protection and taxation of e-commerce transactions. Various states in the U.S. have adopted and/or are considering adopting Internet-related legislation and regulations. Governmental authorities in the U.S. and abroad are considering other legislative and regulatory proposals to further regulate the Internet. Areas of potential regulation include libel, pricing, quality of products and services and intellectual property ownership. We cannot predict what new laws will be enacted, or how courts will interpret existing and new laws, and therefore are uncertain as to how new laws or the application of existing laws will affect our business. In addition, our business may be indirectly affected by legislation that affects the ability of our customers to engage in e-commerce activities. Increased regulation of the Internet may decrease the growth in the use of the Internet, which could decrease the demand for our products and services, increase our cost of doing business or otherwise harm our business, results of operations and financial condition. 11 REGULATION OF COMMUNICATIONS SERVICES UNITED STATES. The Communications Act of 1934 and Federal Communications Commission, or FCC, regulations govern the international long distance telecommunication services that we provide over circuit-switched networks. The FCC distinguishes providers of long distance services as either "dominant" or "non-dominant." We are classified by the FCC as a non-dominant carrier and are regulated as such. The FCC generally does not exercise direct oversight over non-dominant carriers, although it has the statutory power to do so. While the FCC does not regulate the specific rates that we charge for our international long-distance services, non-dominant carriers are required to offer such services under rates, terms, and conditions that are just, reasonable and not unreasonably discriminatory. The FCC has jurisdiction to act upon complaints filed by third parties, or brought on the FCC's own motion, against any common carrier, including non-dominant carriers, for failure to comply with statutory obligations. In the past, all non-dominant carriers were required to file tariffs listing the rates, terms and conditions of service. That requirement was eliminated by virtue of a decision from a federal appellate court that upheld the right of the FCC to forbear from requiring tariff filings. The FCC also has the authority to impose more stringent regulatory requirements and change a carrier's regulatory classification from non-dominant to dominant. The FCC is more likely to impose more stringent requirements for carriers that provide facilities-based service, as we do, and carriers that provide service to other carriers. In the current regulatory atmosphere, however, we believe that the FCC is unlikely to do so. The FCC imposes only minimal reporting requirements on non-dominant carriers, although we are subject to certain reporting, accounting and record-keeping obligations. At present, the FCC exercises its regulatory authority to set rates primarily with respect to the rates of dominant carriers, and it has increasingly relaxed its control in this area. INDIA. Our current plans for our telecommunications offerings contemplate using third parties in India to provide required call termination and call origination services. We believe that if such third parties are properly licensed in India to provide such services, we will not be required to comply with the Indian government's regulations concerning telecommunications. EMPLOYEES As of March 31, 2002, we had 301 employees, including 96 in product development and related support services, 102 in IT consulting, 39 in sales and marketing and 64 in finance and administration. Of the 301 employees, 298 employees were full time employees and 3 were part time employees. As of that date, 143 of our employees were located in the United States and 158 were located in international locations. 12 PART II ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. We intend that those forward-looking statements be subject to the safe harbors created by those sections. These forward-looking statements generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance, and can generally be identified by the use of the words "believe," "intend," "plan," "expect," "forecast," "project," "may," "should," "could," "seek," "pro forma," "estimates," "continues," "anticipate" and similar words. The forward-looking statements and associated risks may include, relate to, or be qualified by other important factors, including, without limitation: o our ability to achieve and maintain profitability and obtain additional working capital, if required; o our ability to successfully implement our future business plans; o our ability to attract strategic partners, alliances and advertisers; o our ability to hire and retain qualified personnel; o the risks of uncertainty of trademark protection; o risks associated with existing and future governmental regulation to which we are subject; and o uncertainties relating to economic conditions in the markets in which we currently operate and in which we intend to operate in the future. These forward-looking statements necessarily depend upon assumptions and estimates that may prove to be incorrect. Although we believe that the assumptions and estimates reflected in the forward-looking statements are reasonable, we cannot guarantee that we will achieve our plans, intentions or expectations. The forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ in significant ways from any future results expressed or implied by the forward-looking statements. We do not undertake to update, revise or correct any forward-looking statements. Any of the factors described above or in the "Risk Factors" section of this report could cause our financial results, including our net income (loss) or growth in net income (loss) to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. 13 OVERVIEW We were incorporated in 1981 under the name Research Engineers, Inc. and changed our name to netGuru, Inc. in 2000. We are a Delaware corporation. Our primary business offerings are: o Engineering software products, maintenance and services (including digital media and animation products and services) for businesses worldwide; o Information technology, or IT, services (including value-added IT services); and o Internet content and e-commerce activities (including Web-based engineering and collaborative software and commerce solutions, long-distance communication services that include call termination services and prepaid phone cards, and travel services). We have provided computer-aided engineering software solutions to our customers for over 21 years. For the past 19 years, we have supported our engineering software business with our India-based software programming and IT resources. In 1999, we acquired two IT services companies in the U.S., which further expanded our IT resources and capabilities. Our Internet portal services were started in 1999 and were refocused in fiscal 2001 toward telecommunication and travel services. A more expansive discussion of our business and services is contained in the "Business" section of this report. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of our net revenues.
YEAR ENDED MARCH 31, ---------------------------------------------- 2002 2001 ---- ---- Net revenues 100.0% 100.0% Cost of revenues 52.8 53.5 --------------------- ------------------- Gross profit 47.2 46.5 --------------------- ------------------- Selling, general and administrative expenses 53.5 44.1 Research and development expenses 7.5 8.6 Amortization of goodwill 5.3 4.3 Depreciation and other amortization 5.1 2.6 Impairment charge 6.8 - Restructuring 0.1 7.7 --------------------- ------------------- Operating loss (31.1) (20.8) Interest (expense) income, net (0.7) 0.6 Other (expense) income, net (0.1) 0.5 --------------------- ------------------- Loss before income taxes (31.9) (19.7) Income tax expense (4.9) (1.5) --------------------- ------------------- Net loss (36.8)% (21.2)% ===================== ===================
14 NET REVENUES. Net revenues decreased by $7,018,000 (22.4%) to $24,284,000 in fiscal 2002 from $31,302,000 in fiscal 2001. Our total net revenues for the current year primarily consisted of revenues from (1) IT services, (2) engineering software products, maintenance and services (including digital media products and animation services), and (3) Internet content, e-commerce, and collaborative software solutions. IT services net revenues represented 40.6% of total net revenues in fiscal 2002 compared to 57.6% in fiscal 2001. In dollar terms, IT services net revenues were $9,869,000 in fiscal 2002 compared to $18,019,000 in fiscal 2001, a decrease of 45.2%. During the past year, the IT services industry was adversely affected by a slow economy and many of our customers reduced spending on technology consulting and systems integration services. Due to the slower economy many companies were faced with financial constraints and as such canceled or postponed many contracted jobs. In addition, the demand for some of our services decreased during fiscal 2002, which caused us to reduce our billing rates approximately 23% from fiscal 2001. As a result, our IT services revenues declined in fiscal 2002 from prior fiscal years. In anticipation of improvement in our IT services revenues toward the latter part of fiscal 2002, which improvement did not materialize, we continued to employ consultants and thus continued to incur costs with no resulting increase in our revenues. Subsequent to year-end, we responded to these business conditions by eliminating excess capacity through workforce reductions and aggressively reducing discretionary costs to lower the cost of operating this segment of our business. We expect that this period of economic uncertainty may continue to impact our IT services revenue throughout fiscal 2003. Software sales, maintenance and services net revenues increased as a percentage of total net revenues to 38.4% in fiscal 2002 from 32.2% in fiscal 2001 largely due to greater declines in other segments. In dollar terms, software sales, maintenance and services net revenues were $9,313,000 in fiscal 2002 compared to $10,066,000 in fiscal 2001, a decrease of 7.5%. The decrease is primarily the result of: o decline in dealer sales revenue of approximately $385,000. In fiscal 2002, our dealers, who are primarily based in Asia, did not perform at the levels they had in the past due to the slow Asian economy. o decline in digital media and animation services revenues of approximately $188,000. We were unable to secure new projects related digital media and animation services in India. o decline in STAAD 3 user upgrade revenues of approximately $550,000. STAAD 3 is an older product and in order for our customers to upgrade to STAAD.Pro, the newer product, we charged them an upgrade fee. In fiscal 2002, the number of STAAD 3 users had significantly decreased as customers upgraded to STAAD.Pro, which in turn decreased our STAAD 3 upgrade revenues. This decrease was offset by an increase of approximately $318,000 in revenues from new licenses of STAAD.Pro. Internet content and e-commerce and collaborative software solutions net revenues increased as a percentage of total revenues to 21.0% in fiscal 2002 from 10.3% in fiscal 2001. In dollar terms, net revenues from this segment were $5,102,000 in fiscal 2002 compared to $3,217,000 in fiscal 2001, an increase 58.6% over the prior year. This increase is primarily the result of: o increase in phone cards and call termination services revenues of approximately $1,073,000 due to a full year's revenues reflected in fiscal 2002 compared to seven months' revenues in the prior year; and 15 o increase in travel services revenues of approximately $667,000 due to a full year's revenues in fiscal 2002 as a ticket consolidator for a certain airlines compared to six months' revenues in the prior year as a ticket consolidator. GROSS PROFIT. Gross profit as a percentage of net revenues increased to 47.2% in fiscal year 2002, from 46.5% for fiscal 2001. In dollar terms, total gross profit decreased by $3,098,000 (21.3%) to $11,462,000 in fiscal 2002 from $14,560,000 in fiscal 2001, due to the decline in gross profit from the IT services segment, but was offset by slight increases in other areas. Historically, the gross profit percentage from the IT services segment has been lower than the gross profit percentage from the software sales and support segment because service revenue has a higher cost of labor associated with it, consisting largely of the cost of the consultants performing the services. In fiscal 2002 IT services gross profit percentage declined to 24.2% from 32.2% in fiscal 2001. In dollar terms, IT services gross profit decreased by $3,411,000 (58.9%) to $2,385,000 from $5,796,000 as a result of the market slowdown for the IT industry. As noted above, we continued to employ consultants who remained idle and whose hours were not billable and thus incurred costs, resulting in lower gross profit for fiscal 2002. The cost of revenues for IT services includes the salaries, bonuses, and benefits for all of the consulting employees including consultants who are "idle" and not billable to a particular customer or project. Our IT service consultants generally receive higher salaries than our technical support employees and we have employed more consultants than technical support staff, both of which contributed to the lower gross margin as compared to the software sales and support segment. The gross profit percentage in the software sales and support segment increased to 88.1% in fiscal 2002 from 77.1% in fiscal 2001. Our software sales and support segment generally produces a higher gross margin than our other segments due to the lower costs associated with each sale. The cost of revenues for the software sales and support segment includes amortization of capitalized software development, printing services, direct supplies such as hardware locks and recording media, salaries for the technical support employees, and freight out. The increase in the gross profit percentage from the prior fiscal year is due to a reduction in the cost of direct supplies and printing services, consolidation of our technical support staff and decreased amortization of software development. We have decreased the number of technical support staff in the U.S. offices and instead are using our resources and staff we already have in place in India. Gross profit from Internet, e-commerce and collaborative software solutions declined to 17.1% in fiscal 2002 from 31.2% in fiscal 2001 primarily due to a decrease in the gross profit percentage from our travel business. Our travel business gross profit percentage decreased 14.8% from 29.1% in fiscal 2001 to 14.3% in fiscal 2002 due to pricing pressures and the market slowdown in the travel industry. We believe this trend will continue due to competition from other online travel services, many of which have greater resources than we have, as well as due to reductions in travel agency commissions caused by pricing pressures experienced by the airline industry. The cost of revenues for our Internet, e-commerce and collaborative software solutions includes the cost of buying minutes from another carrier and the cost of purchasing certain airline tickets that we sell as a ticket consolidator. Due to the highly competitive nature of telephony and travel services, the gross profit from this segment is lower than the gross profit of our other two business segments. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative ("SG&A") expenses decreased by $814,000 (5.9%) to $13,001,000 in fiscal 2002 from $13,815,000 in fiscal 2001 primarily due to cost control measures put in place at the end of fiscal 2001. The major components of the decrease in SG&A expenses were a $425,000 reduction in advertising expense due to cost control measures, a $375,000 reduction in salaries expense due to attrition, a $237,000 reduction in IT sales commissions due to decreased volume of IT sales, a $181,000 reduction in bad debt expense due to improved accounts 16 receivable collections, and a $188,000 reduction in dealer sales commissions due to a decrease in software revenues from dealers, offset by a $611,000 increase in consulting expenses. Approximately, $525,000 of the $611,000 increase in consulting expenses was non-cash related to the issuance of common stock in consideration for services. RESEARCH AND DEVELOPMENT EXPENSES. Research and development ("R&D") expenses consist primarily of software developers' wages. In fiscal 2002, R&D expenses decreased by $882,000 (32.6%) to $1,824,000 from $2,706,000 in fiscal 2001. Approximately $507,000 of this was due to increased capitalization of software development expenses as a result of achieving technological feasibility on our WebWorks development efforts. The remainder of the decrease in R&D expenses is due to cost control measures put in place during the fourth quarter of fiscal 2001. DEPRECIATION AND AMORTIZATION EXPENSES. In fiscal 2002, depreciation and other amortization expenses (excluding goodwill amortization) increased by $445,000 as a result of a higher level of capital expenditures in fiscal 2001. IMPAIRMENT CHARGE. In fiscal 2002, we recorded an impairment charge of $1,651,000. Of this amount $684,000 represented the write-off of capitalized film production costs, $651,000 represented the write-off of assets of Interra Global, one of our subsidiaries in India, and $316,000 represented the write-down of goodwill related to the purchase of e-Destinations, our travel services subsidiary. We wrote off capitalized film production costs, since revenues-to-date and forecasted revenues from these film assets did not support carrying value of the recorded amounts. We surrendered the license held by Interra Global and recorded the above-noted impairment charge related to the write-off of the assets of this subsidiary in the fourth quarter of fiscal 2002. As a result of uncertainties faced by our travel business, in accordance with Statement of Financial Accounting Standard (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", we recorded an impairment charge of $316,000 to write down the value of goodwill associated with the acquisition of our travel subsidiary, e-Destinations, Inc., which is included in our Internet, e-commerce and collaborative software segment. The amount of the write down represented the excess of the carrying amount of goodwill over its fair value. The fair value of goodwill associated with the acquisition of e-Destinations was determined by calculating the present value of estimated expected future cash flows in accordance with SFAS No. 121. There may be further impairment in the future when we implement SFAS No. 142, "Goodwill and Other Intangible Assets" beginning in April 2002. SEGMENT PROFITABILITY. Operating loss in the software sales, maintenance and services segment increased to $4,021,000 in fiscal 2002 from $3,773,000 in fiscal 2001. Operating loss in the software sales, maintenance and services segment included an impairment charge of $684,000 related to the write-off of capitalized film production costs in fiscal 2002 and restructuring costs of $208,000 in fiscal 2001. In the IT services segment, a higher level of gross profit in fiscal 2001 contributed to operating income of $1,994,000, whereas in fiscal 2002 the amount of gross profit was not enough to cover the operating expenses, resulting in an operating loss of $749,000. Operating loss in the Internet, e-commerce and collaborative software solutions segment decreased to $2,802,000 in fiscal 2002 from $4,740,000 in fiscal 2001. Operating loss in the Internet, e-commerce and collaborative software solutions segment in fiscal 2001 included $2,192,000 of restructuring costs. RESTRUCTURING. In March 2001, we announced plans to restructure our operations. As a result of this restructuring plan, we recorded a restructuring charge of $2,400,000 in the fourth quarter of fiscal 2001. The restructuring plan consisted of four major points: 1) refocused strategic direction of Internet service provider (ISP) initiatives; 2) refocused strategic direction of Internet portal initiatives; 3) consolidation of technical support activities; and 4) elimination of our in-house legal department. 17 With regard to our ISP initiatives in India, we redirected our primary focus toward communication and connectivity services targeted at the corporate market. Our original focus related to ISP services was that we planned to offer ISP services to both consumers and businesses in India. With the proposed acquisition of a 30% ownership interest in Vital Communications, Ltd., an IT communications technology company, we had planned to start providing ISP services for the 10,000 customers of Vital Communications as a first step toward becoming an ISP in India. The total amount charged for the refocus of ISP operations in fiscal 2001 was $1,998,000. This total charge consisted of $171,000 in contractual obligations and $1,827,000 in asset write-offs related to ISP operations in India. These charges did not include any employee costs. However, they included the write-off of $537,000 paid toward our proposed acquisition of a 30% ownership interest in Vital Communications, the write-off of $346,000 related to capitalized connectivity charges for the ISP business, and the write-off of $944,000 of ISP infrastructure equipment. The ISP infrastructure equipment related to the Voice Over Internet Protocol (VOIP) technology. The equipment was determined to have no resale value because VOIP technology was not permitted in India and because it was not cost-effective to sell the equipment in countries where VOIP was permitted since the technology had changed. The restructuring related to the ISP operations resulted in elimination of depreciation and amortization expenses that would have resulted from the ISP related assets. In the Internet portal business, we redirected our primary focus toward the telephony and travel services offered through the portal. The restructuring of ISP and portal operations mainly consisted of the write-off of non-performing assets and therefore did not affect ongoing operations. The refocus of ISP initiatives and portal operations enabled us to focus on those areas of the Internet based operations that we believed we could be successful. The restructuring related to the ISP initiatives and portal operations resulted in elimination of depreciation and amortization expenses that would have resulted if these assets were not written off. The amount of future depreciation and amortization expense that would have resulted from these assets if they were not written off is approximately $399,000 per year. In March 2001, we closed our Boston technical support office. The technical support function in the Boston area was a redundant operation while it was ongoing, since we had a comparable technical support capability at our California facility. Technical support activities previously offered from that office have been consolidated into the California facility. By consolidating the technical support functions, beginning in April 2001, we reduced employee costs by approximately $221,000 per year and reduced facility costs by approximately $51,000 per year. The elimination of the in-house legal department primarily consisted of the termination of one employee whose position was not refilled. Due to the size of our operations, a full-fledged internal legal department was unnecessary. We are able to obtain cost-effective legal services, as and when needed from our continuing external legal counsel. By eliminating the in-house legal department, we reduced employee costs by approximately $127,000 per year beginning in April 2001. Of the total restructuring charge of $2,400,000, cash payments totaling $2,100,000 were expended in fiscal 2001 and $177,000 in fiscal 2002. In March 2002, we increased our restructure liability by $25,000 due to additional expenses related to the restructuring plans announced in March 2001. The remaining personnel costs and contractual obligations related to the restructuring amounted to $157,000 at March 31, 2002. As of the date of filing of this report, the remaining personnel costs had been satisfied. The remaining contractual obligations will be satisfied at the termination of the Boston facility lease in September 2003. OTHER EXPENSE (INCOME). Net interest changed by $353,000 to net interest expense of $160,000 in fiscal 2002 as compared to net interest income of $193,000 in fiscal 2001. The change is primarily due to the decrease in cash balances invested in interest earning accounts. INCOME TAXES. Net income tax expense increased to $1,192,000 in fiscal 2002 compared to net income tax expense of $457,000 in fiscal 2001. In fiscal 2002 we increased our valuation allowance against deferred tax assets by $1,334,000. In assessing the realizability of the net deferred tax assets, we consider whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon either the generation of future taxable income during the periods in which those temporary differences become deductible or the carryback of losses to recover income taxes previously paid during the carryback period. The valuation allowance was offset by approximately $305,000 of income tax benefits due to recovery of taxes paid in prior years, as described in Note 10 of the notes to our audited consolidated financial statements included in this report. 18 CRITICAL ACCOUNTING POLICIES We have identified the following as accounting policies critical to our company: o revenue recognition; o capitalization of software development and purchased technology; o allowances for accounts receivable; o impairment of long-lived assets including goodwill; and o deferred income taxes. Revenue Recognition ------------------- We recognize revenue when the following criteria are met: 1. Persuasive evidence of an arrangement exists, such as agreements, purchase orders or written or online requests; 2. Delivery has been completed and no significant obligations remain; 3. Our price to the buyer is fixed and determinable; and 4. Collectibility is probable. Our revenues arise from the following segments: IT services; software sales, maintenance and services (including digital media products and services); and products and services sold via Internet portals, including telecommunication and travel services. IT services revenue is recognized primarily on a time and materials basis, with time at a marked-up rate and materials and other reasonable expenses at cost, once the services are completed and no significant obligations remain. Certain IT services contracts are fixed price contracts where progress toward completion is measured by mutually agreed upon pre-determined milestones for which we recognize revenue upon achieving the milestones. Our fixed price IT contracts are typically for a short duration ranging from one to three months. Revenue from software sales is recognized upon shipment, provided that no significant post-contract support obligations remain outstanding and collection of the resulting receivable is probable. Our software sales do not provide a specific right of return. At the time of sale, we typically provide free 120-day initial maintenance and support to the customer. Costs relating to this initial 120-day support period, which consist primarily of telephone support, are not considered material. After the initial support period, customers may choose to purchase ongoing maintenance contracts that include telephone, e-mail and other methods of support, and the right to receive upgrades. Revenue from these maintenance contracts is deferred and recognized ratably over the life of the contract, usually twelve months. Revenues from digital media and animation services are recognized upon achievement of certain pre-determined milestones. In October 1997, the Accounting Standards Executive Committee ("AcSEC") of the AICPA issued Statement of Position ("SOP") 97-2, SOFTWARE REVENUE RECOGNITION. We adopted SOP 97-2 in the first quarter of fiscal 1999. SOP 97-2 distinguishes between significant and insignificant vendor obligations as a basis for recording revenue with a requirement that each element of a software licensing arrangement be separately identified and accounted for based on relative fair values of each element. We determine the fair value of each element in multi-element transactions based on vendor-specific objective evidence ("VSOE"). VSOE for each element is based on the price charged when the same element is sold separately. In 1998, the AICPA issued SOP 98-9, MODIFICATION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION, WITH RESPECT TO CERTAIN TRANSACTIONS, which modifies SOP 97-2 to allow for use of the residual method of revenue recognition provided that certain criteria have been met. We adopted SOP 98-9 in 19 the first quarter of fiscal 2000. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the transaction fee is recognized as revenue. We recognize revenues from products and services sold via Internet portals, including telecommunication and travel services, net of purchase costs when the products and services are delivered and collectibility is probable. Revenues from certain phone card transactions are deferred and recognized on the basis of usage. Certain travel services, based on their nature, are recognized at the gross sales value with purchase costs stated as a separate cost of revenues in accordance with Emerging Issues Task Force Issue No. 99-19, "RECORDING REVENUE GROSS AS A PRINCIPAL VERSUS NET AS AN AGENT." Accounting for Software Development Cost and Purchased Technology ----------------------------------------------------------------- We develop software in-house, employ third parties to develop software for us as well as purchase software technology. Costs related to the development of certain software products are capitalized. Capitalization of costs begins when technological feasibility has been established and ends when the product is available for general release to customers. Additional costs to enhance products after release are expensed as they are incurred. Capitalized software development costs and purchased technology are amortized using the straight-line method over three to five years, or the ratio of actual sales to anticipated sales, whichever is greater. The resulting net book value of the capitalized software asset is reviewed periodically for recoverability based on estimated future revenues from products based on that particular technology. When significant uncertainties exist with respect to the recoverability of the capitalized cost of the asset, we write the cost of the asset down to its potential recoverable value. Allowance for Accounts Receivable --------------------------------- We sell to our customers on credit and grant credit to those who are deemed credit worthy based on our analysis of their credit history. We review our accounts receivable balances and the collectibility of these balances on a periodic basis. Based on our analysis of the length of time that the balances have been outstanding, the pattern of customer payments, our understanding of the general business conditions of our customers and our communications with the customers, we estimate the recoverability of these balances. When recoverability is uncertain and the unrecoverable amounts can be reasonably estimated, we record bad debt expense and increase the allowance for accounts receivable by an amount equal to the amount estimated to be unrecoverable. Impairment of Long-lived Assets Including Goodwill -------------------------------------------------- We apply the provisions of SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. This statement requires that long-lived assets and certain identifiable intangibles (including Goodwill) be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If the asset is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. We apply the provisions of SFAS No. 86 (SFAS 86), "ACCOUNTING FOR THE COST OF COMPUTER SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED" for evaluating unamortized capitalized software development costs. At each balance sheet date, 20 we compare the unamortized software development cost of each product to the net realizable value of the product. The amount by which the unamortized software development cost exceeds the net realizable value of the product is written off. Deferred Income Taxes --------------------- We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. In assessing the realizability of the net deferred tax assets, we consider whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon either the generation of future taxable income during the periods in which those temporary differences become deductible or the carryback of losses to recover income taxes previously paid during the carryback period. LIQUIDITY AND CAPITAL RESOURCES Historically, we have relied upon cash from financing activities to fund most of the cash requirements of our operating and investing activities. Currently we finance our operations (including capital expenditures) primarily through existing cash and cash equivalent balances. We have used debt and equity financing when appropriate and practicable. Our principal sources of liquidity at March 31, 2002 consisted of $3,466,000 of cash and cash equivalents. Cash and cash equivalents decreased by $4,492,000 or 56.4% during the fiscal year ended March 31, 2002. The primary reasons for this decline were cash used in operations, capital expenditures, repayment of bank debt, payments toward capital lease obligations and repurchase of common stock. Although cash expenditures were higher than usual in April and May 2002, cash consumption is anticipated to be approximately $150,000 per month through the end of March 2003. Net cash used in operations was $3,225,000 in fiscal 2002 compared to $661,000 in fiscal 2001. Net loss was the primary reason for the decrease in cash during fiscal 2002. Increases in prepaid expenses and other current assets, and income tax receivable, along with decreases in accounts payable, accrued expenses, accrued restructuring charges and deferred revenues contributed to the usage of cash in fiscal 2002, offset by a decrease in accounts receivable, net of bad debt expense of $358,000. In fiscal 2001, the primary reason for net cash used in operations was the net loss for fiscal 2001, offset largely by the return of a large deposit balance. Increases in accounts receivable (net of bad debt expense of $590,000), prepaid expenses and other assets, and decreases in accrued expenses, income taxes payable and accrued restructuring costs offset by increases in accounts payable and deferred revenues contributed to the usage of cash in fiscal 2001. Net cash used in investing activities in fiscal 2002 consisted primarily of capital expenditures of $394,000 compared to $4,598,000 in fiscal 2001. In fiscal 2001, capital expenditures included purchases of hardware for our Internet portal, ASP services and ISP businesses. Payments to acquire companies, net of cash acquired, accounted for approximately $72,000 in fiscal 2002 and $2,042,000 in fiscal 2001, which were largely attributable to the acquisitions of Allegria and Interra Global. In fiscal 2002, cash was used in financing activities whereas in fiscal 2001 financing activities provided cash. We used $943,000 in fiscal 2002 to repay bank debt and capital lease obligations and to repurchase common stock in settlement of repurchase obligations entered into at the time of acquisition of 21 Allegria. Cash provided by financing activities during fiscal 2001 resulted from many factors. The largest impact was the result of a private equity financing in June 2000. On June 22, 2000, we closed a private equity financing and issued to two investors, in a private transaction not involving a public offering, 200,000 shares of our common stock for approximately $3,075,000, net of certain commissions and offering costs. This increase in fiscal 2001 was largely offset by net repayment of capital lease obligations and long-term bank debt, including a repayment of a $600,000 note payable to the prior owner of NetGuru Systems. We incurred net losses of $8,944,000 and $6,637,000 and have used cash in operations of $3,225,000 and $661,000 in fiscal years 2002 and 2001, respectively. Our future capital requirements will depend upon many factors, including sales and marketing efforts, the development of new products and services, possible future strategic acquisitions, the progress of research and development efforts, and the status of competitive products and services. We believe we will be able to generate cash from operations or through additional sources of debt and equity financing. We have continued our program to reduce costs and expenses. If adequate funds are not available, we may be required to delay, scale back, or eliminate our research and development programs and our marketing efforts or to obtain funds through arrangements with partners or others who may require us to relinquish rights to certain of our technologies or potential products or assets. The following table summarizes our contractual obligations and commercial commitments at March 31, 2002 (in thousand dollars):
------------------------------------------------------- PAYMENTS DUE BY PERIOD ------------------------------------------------------- LESS THAN AFTER CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS ----------------------- ----- ------ --------- --------- ------- Long-Term Debt 826 259 542 15 10 Capital Lease Obligations 1,444 417 737 290 -- Operating Leases 4,483 590 837 690 2,366 -------------------------------------------------------- Total Contractual Cash Obligations 6,753 1,266 2,116 995 2,376 TOTAL AMOUNTS LESS THAN 1 OTHER COMMERCIAL COMMITMENTS COMMITTED YEAR 1-3 YEARS 4-5 YEARS OVER 5 YEARS ---------------------------- --------- ---- --------- --------- ------------ Purchase commitment 800 800 -- -- -- ------------------------------------------------------------- Total Commercial Commitments 800 800 -- -- -- =============================================================
As indicated above, we historically have relied upon cash from financing activities to fund most of the cash requirements of our operating and investing activities. We have not been able to generate sufficient cash from our operating activities in the past, and there is no assurance we will be able to do so in the future. However, we believe that current and future available capital resources will be adequate to fund our operations for the next twelve months, because we are continuing to implement cost containment measures in an effort to reduce cash consumption both domestically and abroad and are working to increase sales of our software products. The results of these combined efforts have reduced our cash used in operations to approximately $150,000 per month. We intend to continue these combined efforts with the goal of eliminating our monthly cash consumption by March 31, 2003. 22 Our line of credit expired in August 2001 and we are currently in negotiations with financial institutions to secure a new line of credit. We currently are seeking financing but do not have any final commitments for additional financing other than a $500,000 credit line from a major stockholder under which we have not made any borrowings. We may use a portion of any funds we receive from financing to intensify our current marketing efforts. Because the benefits of enhanced marketing efforts likely would not be realized for at least several months after the efforts are expended, the elimination of our cash consumption likely would be postponed. To the extent we are in need of any additional financing, we cannot assure you that any such additional financing will be available to us on acceptable terms, or at all. In addition, any future financing may cause significant dilution to existing stockholders. Any debt financing or other financing of securities senior to common stock likely will include financial and other covenants that will restrict our flexibility. At a minimum, we expect these covenants to include restrictions on our ability to pay dividends on our common stock. If adequate funds from operating or financing activities are not available, we may be required to delay, scale back or eliminate portions of our operations and product development efforts or to obtain funds through arrangements with strategic partners or others that may require us to relinquish rights to certain of our technologies or potential products or other assets. Accordingly, our inability to obtain any needed financing could result in a significant loss of ownership and/or control of our proprietary technology and other important assets and could also hinder our ability to fund our continued operations and our product development efforts that historically have contributed significantly to our competitiveness. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS During July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "BUSINESS COMBINATIONS." This statement requires that all business combinations be accounted for using the purchase method of accounting and redefines goodwill and other intangibles that should be recognized separate from goodwill. SFAS 141 is effective for all business combinations initiated after June 30, 2001. During July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "GOODWILL AND OTHER INTANGIBLE ASSETS." This statement requires that goodwill and other intangibles with an indefinite useful life not be amortized, but be tested for impairment at least annually. SFAS 142 is effective for fiscal years beginning after December 15, 2001; however, for new business combinations that occur after June 30, 2001, SFAS 142 is effective for those transactions. We will adopt SFAS 142 beginning April 1, 2002 and are currently evaluating the impact of SFAS 142 on our consolidated financial statements. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143 ("SFAS 143"), "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS." This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, or normal use of the asset. SFAS 143 is effective for fiscal years beginning after June 15, 2002. We do not expect the adoption of SFAS 143 to have a material impact on our consolidated financial position or results of operations. 23 In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS." This statement addresses financial accounting and reporting for the impairment of long-lived assets and supersedes SFAS 121, and the accounting and reporting provisions of APB No. 30, "REPORTING THE RESULTS OF OPERATIONS FOR A DISPOSAL OF A SEGMENT OF A BUSINESS." SFAS 144 is effective for fiscal years beginning after December 15, 2001. We will adopt SFAS 144 beginning April 1, 2002. We do not expect the adoption of SFAS 144 to have a material impact on our consolidated financial position or results of operations. RISK FACTORS AN INVESTMENT IN SHARES OF OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN ADDITION TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS ANNUAL REPORT ON FORM 10-KSB, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS BEFORE DECIDING TO INVEST OR MAINTAIN AN INVESTMENT IN SHARES OF OUR COMMON STOCK. THIS ANNUAL REPORT CONTAINS OR INCORPORATES BY REFERENCE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THE FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS ANNUAL REPORT. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, IT IS LIKELY THAT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS WOULD BE HARMED. AS A RESULT, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU COULD LOSE PART OR ALL OF YOUR INVESTMENT. OUR PLANS TO RETURN TO PROFITABILITY DEPEND ON OUR ABILITY TO INCREASE REVENUES DESPITE CUTTING COSTS IN A VARIETY OF AREAS, WHICH MAY NOT BE FEASIBLE. We incurred net losses of $8,944,000 and $3,172,000 for the fiscal year ended March 31, 2002 and the nine months ended December 31, 2002, respectively. We used cash in operations totaling $3,225,000 and $2,284,000 for the fiscal year ended March 31, 2002 and the nine months ended December 31, 2002, respectively. During the past year we have significantly reduced our operating expenses. However, in order to achieve profitability, we must increase our revenues while continuing to control our expenses. We are continuing to implement cost containment measures in an effort to reduce our cash consumption from operations both domestically and abroad, and we are working to increase sales of our software products. The results of these combined efforts have reduced our cash used in operations to approximately $150,000 per month. We intend to continue these combined efforts with the goal of generating positive cash flow from operations in the quarter ending June 30, 2003. To accomplish this goal, we are tailoring our cost containment measures to ensure that each of our operating units or costs centers will generate positive cash flow. If adequate funds from operating activities are not available, we may be required to delay, scale back or eliminate portions of our operations and product development efforts or to obtain funds through arrangements with strategic partners or others that may require us to relinquish rights to certain portions of our technologies or potential products or other assets. Furthermore, because some of the areas of expense cutting, such as sales and marketing and research and development, involve activities that we ordinarily undertake with the expectation that they will contribute to future revenues, obtaining and maintaining profitability may be difficult, even with reduced expenses. Even if near-term profitability can be achieved through cost-cutting, it will not be sustainable if the effect of cost-cutting is to impede future revenue growth. IF WE ARE UNABLE TO RAISE CAPITAL IN THE FUTURE, WE MAY BE UNABLE TO FUND OPERATING CASH SHORTFALLS. Our future capital requirements will depend upon many factors, including sales and marketing efforts, the development of new products and services, possible future strategic acquisitions, the progress of our research and development efforts, and the status of competitive products and services. As of March 31, 2002 and December 31, 2002, we had working capital of $3,766,000 and $2,271,000, respectively, and an accumulated deficit of $16,805,000 and $19,977,000, respectively. As of those dates, we had $3,466,000 and $2,656,000, respectively, in cash and cash equivalents and $3,325,000 and $3,321,000, respectively, of accounts receivable, net of allowance for doubtful accounts. 24 We believe that current and future available capital resources will be adequate to fund our operations for the next twelve months. However, historically we have not been able to generate sufficient cash from our operating activities and have relied upon cash from financing activities to fund most of the cash requirements of our operating and investing activities. To the extent we are in need of any additional financing, it may not be available to us on acceptable terms, or at all. Our inability to obtain any needed financing could result in a significant loss of ownership and/or control of our proprietary technology and other important assets and could also hinder our ability to fund our continued operations and our product development efforts that historically have contributed significantly to our competitiveness. Any financing may cause significant dilution to existing stockholders. Any debt financing or other financing of securities senior to common stock likely will include financial and other covenants that will restrict our flexibility. At a minimum, we expect these covenants to include restrictions on our ability to pay dividends on our common stock. WE ANTICIPATE THAT OUR ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 142 "GOODWILL AND OTHER INTANGIBLE ASSETS" WILL INCREASE OUR LOSSES FOR THE FISCAL YEAR ENDED MARCH 31, 2003 BY AN ESTIMATED $5.4 MILLION DUE TO AN IMPAIRMENT WRITE DOWN FOR OUR IT SERVICES DIVISION AND COULD ALSO CAUSE US TO INCUR LARGE LOSSES IN FUTURE ACCOUNTING PERIODS IF WE DETERMINE THAT THERE HAS BEEN A SIGNIFICANT IMPAIRMENT OF GOODWILL. In July 2001, the Financial Accounting Standards Board, or FASB, issued Statement 142, "Goodwill and Other Intangible Assets." We adopted this statement effective April 1, 2002. Under this statement, goodwill is no longer amortized and became subject to annual testing for impairment beginning April 1, 2002. The provisions of this statement require us to perform a two-step test to assess goodwill for impairment. In the first step, we compare the fair value of each reporting unit to its carrying value. If the fair value exceeds the carrying value, then goodwill is not impaired and we need not proceed to the second step. If the carrying value of a reporting unit exceeds its fair value, then we must determine and compare the implied fair value of the reporting unit's goodwill to the carrying value of its goodwill. If the carrying value of the reporting unit's goodwill exceeds its implied fair value, then we will record an impairment loss in the amount of the excess. With regard to a reporting unit's goodwill balance at April 1, 2002, we were required to perform the first step of the annual testing for impairment by September 30, 2002. If the results of that step indicated that goodwill may be impaired, we were then required to complete the second step as soon as possible, but no later than March 31, 2003. We assessed the fair value of our three reporting units by considering their projected cash flows, using risk-adjusted discount rates, and by the market approach in evaluating the market valuation of the units as compared to competing companies. Given consideration of relevant factors, we concluded that, as of April 1, 2002, an impairment write-down for our IT services division was required. We currently estimate the impairment write-down for our IT services division to be approximately $5.4 million. The actual amount of the impairment and, therefore, the write-down for our IT services division, will be reported with our results for the year ended March 31, 2003. We are required to perform additional reviews for impairment annually, or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of the net carrying amount. We cannot predict whether or when there will be additional impairment charges, or the amount of any such charges. If the charges are significant, the market price of our common stock may decline. 25 THE VOTING POWER OF YOUR INVESTMENT AND OUR EARNINGS PER SHARE WOULD BE SUBSTANTIALLY DILUTED IF ALL OR A SIGNIFICANT PORTION OF THE DECEMBER 2002 NOTE WERE CONVERTED INTO SHARES OF OUR COMMON STOCK AT THE INITIAL CONVERSION PRICE. The 6% convertible note in the original principal amount of $2,000,000, or the December 2002 note, that we issued to Laurus Master Fund, Ltd., or Laurus, on December 13, 2002, initially was convertible by Laurus into up to 1,250,000 shares of our common stock at an initial fixed conversion price of $1.60 per share. This number of shares represented approximately 7.2% of the 17,325,150 shares of our common stock that were outstanding on May 2, 2003. As a result, if the entire principal balance of the December 2002 note were converted at the initial conversion price, substantial dilution of the voting power of your investment and of our earnings per share would occur. THE MARKET PRICE OF OUR COMMON STOCK AND THE VALUE OF YOUR INVESTMENT COULD SUBSTANTIALLY DECLINE IF ALL OR A SIGNIFICANT PORTION OF THE DECEMBER 2002 NOTE WERE CONVERTED INTO SHARES OF OUR COMMON STOCK AND RESOLD INTO THE MARKET, OR IF A PERCEPTION EXISTS THAT A SUBSTANTIAL NUMBER OF SHARES WILL BE ISSUED UPON CONVERSION OF THE NOTE AND THEN RESOLD INTO THE MARKET. If the conversion prices at which the December 2002 note is converted are lower than the price at which you made your investment, immediate dilution of the value of your investment will occur. In addition, sales of a substantial number of shares of common stock issued upon conversion of the note, or even the perception that such sales could occur, could adversely affect the market price of our common stock, which would mean that the note would be convertible into an increased number of shares of our common stock in cases where, as described elsewhere in these risk factors, the conversion price is based upon a discount from the closing price of our common stock. You could, therefore, experience a substantial decline in the value of your investment as a result of both the actual and potential conversion of the December 2002 note. THE VOTING POWER AND VALUE OF YOUR INVESTMENT COULD DECLINE IF THE DECEMBER 2002 NOTE IS CONVERTED AT A REDUCED PRICE DUE TO OUR ISSUANCE OF LOWER-PRICED SHARES. The $1.60 initial fixed conversion price of the December 2002 note will be subject to downward weighted-average anti-dilution adjustments in most cases where we issue securities at a purchase, exercise or conversion price that is less than the then-applicable fixed conversion price of the note. For example, if the fixed conversion price were $1.60 per share and we were to issue 1,000,000 shares of common stock at a price of $1.00 per share in a transaction that is not excluded from the anti-dilution provisions, then the fixed conversion price would be reduced to $1.57 per share, and an additional approximate 23,885 shares of common stock would become issuable upon conversion of the principal amount of the note. Consequently, the voting power and value of your investment would decline if conversions occurred at the new fixed conversion price. THE MARKET PRICE OF OUR COMMON STOCK COULD SUBSTANTIALLY DECLINE AND THE VOTING POWER AND VALUE OF YOUR INVESTMENT COULD BE SUBJECT TO UNLIMITED ADDITIONAL DILUTION IF THE DECEMBER 2002 NOTE WERE CONVERTED ON ONE OR MORE OCCASIONS AT AN ALTERNATE CONVERSION PRICE THAT APPLIES IF WE ARE IN DEFAULT OR IF WE ISSUE A CALL NOTICE UNDER THAT NOTE, PARTICULARLY IF LAURUS SEQUENTIALLY CONVERTS PORTIONS OF THE NOTE INTO SHARES OF OUR COMMON STOCK AT ALTERNATE CONVERSION PRICES AND RESELLS THOSE SHARES INTO THE MARKET. If we are in default or we issue call notices under the December 2002 note, then an alternate conversion price based on a discount from the market price of our common stock may apply, and the note could become convertible into an unlimited number of additional shares of our common stock, particularly if Laurus sequentially converts portions of the note into shares of our common stock at alternate conversion prices and resells those shares into the market. If Laurus sequentially converts portions of the December 2002 note into shares of our common stock at alternate conversion prices and resells those shares into the market, then the market price of our common stock could decline due to the additional shares available in the market, particularly in light of the relatively thin trading volume of our common stock. This decline would reduce the alternate conversion price, which in turn would permit Laurus to convert additional portions of the December 2002 note into a greater number of shares of our common stock at the reduced alternate conversion price while a default is continuing under the note. Consequently, if a default occurs and is continuing, and if Laurus repeatedly converts portions of the note at alternate conversion prices and then resells those underlying shares into the market, a continuous downward spiral of the market price of our common stock could occur that would benefit Laurus at the expense of other existing or potential holders of our common stock, creating a conflict of interest between Laurus and investors who purchase the shares of common stock resold by Laurus following conversion of the note. 26 For example, if a conversion of the note occurs while we are in default under the note or the related purchase agreement, then the conversion price of the note will be equal to the lesser of the fixed conversion price or 70% of the average of the three lowest closing prices of our common stock during the preceding 30 trading days. So, if we were in default under the note and Laurus then elected to convert $100,000 of the principal amount of the note at a time when the fixed conversion price was $1.60 per share and the average of the three lowest closing prices of our common stock during the thirty preceding trading days also was $1.60, then the applicable conversion price would be $1.12 rather than $1.60, and the number of shares issuable upon the conversion would be 89,286 based upon the alternate conversion price rather than 62,500 based upon the fixed conversion price. The resale of those shares into the market would very likely depress the market price of our common stock because our stock is thinly traded and because Laurus could resell those shares at a discount to the market price and still realize a profit. For example, Laurus could resell the 89,286 shares at a price of $1.30, which is $0.18 above the hypothetical $1.12 alternate conversion price but $0.30 below the $1.60 hypothetical market price. If such a sale were to cause the average of the three lowest closing prices of our common stock to decline from $1.60 to $1.30 during the thirty trading days preceding Laurus' next conversion at an alternate conversion price, then Laurus could convert all or any remaining portion of the note at a conversion price equal to 70% of $1.30, or $0.91, and then resell those shares at a discount from this new, lower market price while still making a profit on the resale, such as selling for $1.00 and still realizing a $0.09 profit while causing the market price to go to $1.00. Consequently, the market price of our common stock could substantially decline and the voting power and value of your investment could be subject to unlimited additional dilution if Laurus repeatedly converts portions of the note at alternate conversion prices and then resells those underlying shares into the market. CONTRACTUAL LIMITATIONS THAT RESTRICT LAURUS' ABILITY TO CONVERT THE DECEMBER 2002 NOTE MAY NOT NECESSARILY PREVENT SUBSTANTIAL DILUTION OF THE VOTING POWER AND VALUE OF YOUR INVESTMENT. The contractual limitations that restrict Laurus' ability to convert the December 2002 note into shares of our common stock are limited in their application and effect and may not prevent substantial dilution of your investment. Laurus may not on any given date convert the note if, and to the extent, that the conversion would result in the issuance of a number of shares of common stock with a dollar value that exceeds 25% of the aggregate dollar trading volume of our common stock during the preceding 30 trading days. However, Laurus may make a series of smaller conversions that do not exceed this limitation but that result in a decline in the market price of our common stock and a decline in the voting power and value of your investment, particularly if Laurus sequentially converts portions of the note into shares of our common stock at alternate conversion prices and resells those shares into the market, as described elsewhere in these risk factors. In addition, Laurus is subject to a contractual 4.99% beneficial ownership limitation that prohibits Laurus from converting the note if and to the extent that the conversion would result in Laurus, together with its affiliates, beneficially owning more than 4.99% of our outstanding common stock. However, this 4.99% limitation automatically becomes void upon an event of default under the note and can be waived by Laurus upon 75 days' advance notice to us. In addition, this 4.99% limitation does not prevent Laurus from converting the note into shares of common stock and then reselling those shares in stages over time where Laurus and its affiliates to do not, at any given time, beneficially own shares in excess of the 4.99% limitation. Further, a contractual limitation that prohibits Laurus from converting the note if, and to the extent, the conversion would result in Laurus and its affiliates beneficially owning more than 3,463,625 shares of our common stock, will be removed if and when we obtain stockholder approval at Laurus' request or if an exemption from applicable Nasdaq corporate governance rules becomes available. Consequently, these limitations will not necessarily prevent substantial dilution of the voting power and value of your investment. 27 CONVERSIONS OF THE DECEMBER 2002 NOTE AT DRAMATICALLY REDUCED CONVERSION PRICES COULD RESULT IN A CHANGE OF CONTROL OF OUR COMPANY. A change of control of our company could occur if, as discussed elsewhere in these risk factors, conversions of the December 2002 note occur at dramatically reduced conversion prices, such as if Laurus sequentially converts portions of the note at alternate conversion prices into shares of our common stock and resells those shares into the market. If a change of control occurs, then the stockholders who historically have controlled our company would no longer have the ability to exert significant control over matters that could include the election of directors, changes in the size and composition of the board of directors, and mergers and other business combinations involving our company. Instead, one or more other stockholders could gain the ability to exert this type of control and may also, through control of the board of directors and voting power, be able to control certain decisions, including decisions regarding the qualification and appointment of officers, dividend policy, access to capital (including borrowing from third-party lenders and the issuance of additional equity securities), and the acquisition or disposition of our assets. IF CONVERSIONS OF THE DECEMBER 2002 NOTE AT DRAMATICALLY REDUCED CONVERSION PRICES RESULT IN A CHANGE OF CONTROL OF OUR COMPANY OR THE FAILURE OF OUR COMMON STOCK TO MEET NASDAQ MINIMUM BID PRICE REQUIREMENTS, THEN WE COULD BE DELISTED FROM THE NASDAQ NATIONAL MARKET, WHICH COULD REDUCE THE LIQUIDITY OF OUR COMMON STOCK AND INHIBIT OR PRECLUDE OUR ABILITY TO RAISE ANY NEEDED WORKING CAPITAL FROM EQUITY INVESTORS. A change of control of our company or a substantial decline in the market value of our common stock could occur if, as discussed elsewhere in these risk factors, conversions of the December 2002 note occur at dramatically reduced conversion prices, such as if Laurus sequentially converts portions of the note into shares of our common stock and resells those shares into the market. Nasdaq's qualification standards require, among other things, that issuers apply for initial inclusion on Nasdaq following a change of control. Nasdaq looks at many factors in determining whether a change of control has occurred, including without limitation, changes in the management, board of directors, voting power and ownership of a company. If Nasdaq determines that a change of control has occurred due to conversions of the December 2002 note or otherwise, we would need to file a new listing application if we want to maintain our Nasdaq listing. We do not know whether, at the time, if any, that we would file a new listing application with Nasdaq, we would meet the initial listing standards of either The Nasdaq National Market or The Nasdaq Small Cap Market. In addition, Nasdaq's quantitative listing standards require, among other things, that listed companies maintain a minimum bid price of $1.00. If our bid price falls and remains below $1.00 for at least 30 consecutive trading days, whether due to sequential conversions of the note and resales of the underlying shares or otherwise, we may be delisted if we do not regain compliance with the bid price requirement within any applicable grace period. If we are delisted from The Nasdaq National Market, our stock price could decline and the ability of our stockholders and of any potential or future investors to achieve liquidity from our common stock could be severely limited. This could inhibit, if not preclude, our ability to raise any needed additional working capital through equity offerings on acceptable terms. IF WE ARE UNSUCCESSFUL IN ACHIEVING AND MAINTAINING COMPLIANCE WITH OUR REGISTRATION OBLIGATIONS WITH REGARD TO THE DECEMBER 2002 NOTE AND RELATED WARRANT, WE WILL INCUR SUBSTANTIAL MONETARY PENALTIES. The agreements we entered into in connection with our issuance of the December 2002 note require us to, among other things, register for resale the shares of common stock issued or issuable under the note and the accompanying warrant and maintain the effectiveness of the registration statement for an extended period of time. We currently are not in compliance with our registration obligations and are subject to liquidated damage assessments of 1% of the principal amount of the note for the first 45 days of non-compliance and 2% of the principal amount of the note for each month of non-compliance thereafter, subject to pro ration for partial months. If we are unable to obtain and maintain effectiveness of the required registration statement, then we may be required to pay additional liquidated damages, which would adversely affect our business, operating results, financial condition, and ability to service our other indebtedness by negatively impacting our cash flows. 28 OUR LIMITED OPERATING HISTORY AND LACK OF EXPERIENCE IN OUR NEW OR PROPOSED LINES OF BUSINESS MAKES IT DIFFICULT TO PREDICT OUR FUTURE SUCCESS. We have only recently diversified our business and are now offering Internet-based business-to-business services and telephony services to the global community. We intend to provide integrated communications services to and from global destinations to consumers, carriers and businesses. As a result, we have limited or no operating histories in each of these new or proposed lines of business. Therefore, our historical financial information is of limited value in projecting our future success in these markets. OUR EXPANSION INTO NEW LINES OF BUSINESS MAY DIVERT MANAGEMENT'S ATTENTION FROM OUR EXISTING OPERATIONS AND PROVE TO BE TOO COSTLY. We have been in the engineering software business for over 21 years, and our two IT consulting businesses have a combined 14 years of operating experience. We have only recently entered the Internet content and commerce services, Internet-based IT business-to-business services, and telephony services markets. In the future, we may expand into the integrated Indian-focused communications markets. Our expansion into these new and proposed lines of business may be difficult for us to manage because they involve different disciplines and require different expertise than our core businesses. Consequently, this expansion may detract management's time and attention away from our core businesses, and we may need to incur significant expenses in order to develop the expertise and reputation we desire, which could prevent us from generating revenues from these lines of business in amounts sufficient to justify the expenses we incur in operating them. OUR SUCCESS DEPENDS ON OUR ABILITY TO RETAIN OUR CURRENT MANAGEMENT TEAM. Our founder, Chairman and Chief Executive Officer, Amrit K. Das, and our President and Chief Operating Officer, Jyoti Chatterjee, have each been with us for more than 21 years. Their experience, expertise, industry knowledge and historical company knowledge would be extremely difficult to replace if we were to lose the services of either of them. The precise impact of the loss of services of either of them is extremely difficult to predict, but would likely result in, at a minimum, significant costs to recruit, hire and retain a successor and impaired operating results while the successor was being recruited and transitioning into the position. We do not currently maintain life insurance on the lives of either of these officers. THE MARKETS IN WHICH WE CURRENTLY COMPETE AND PLAN TO COMPETE ARE AND WILL CONTINUE TO BE HIGHLY COMPETITIVE, WHICH HAS RESULTED IN SIGNIFICANT PRICE COMPETITION AND LOWER PROFIT MARGINS AND MAY ALSO RESULT IN REDUCED REVENUES OR LOSS OF MARKET SHARE. The Internet-based services, Internet-based engineering software products and services and telephony services markets each are highly competitive. The market for Internet-based products and services is characterized by an increasing number of entrants due to low start-up costs. Some of our competitors and potential competitors have larger technical staffs, more established and larger marketing and sales organizations and significantly greater financial resources than ours. Our competitors may develop products and services that are superior to ours or that achieve greater market acceptance. Our future success will depend significantly upon our ability to increase our share of our target markets and to sell additional products, product enhancements and services to our customers. We are experiencing pricing and margin pressures as we work to expand our software products and services market share. We also are experiencing lower profit margins in our telephony operations due to the turmoil in that market sector. As a result of these pricing and margin pressures, we may experience declines in our revenues and market share. 29 IF THE QUALITY AND MAINTENANCE OF THE THIRD-PARTY COMMUNICATIONS INFRASTRUCTURE ON WHICH WE RELY SUFFERS, OUR SERVICE COULD BE DISRUPTED, OUR REPUTATION COULD BE HARMED AND WE COULD LOSE CUSTOMERS. We rely on a third-party communications infrastructure to carry our voice traffic. We have no control over whether the infrastructure on which we rely will be adequately maintained by the third parties or whether the third parties will be able to upgrade or improve their equipment and prevent it from becoming obsolete. If the third parties fail to maintain, upgrade or improve their equipment, our ability to provide services would be impaired or interrupted. Impairments or interruptions, particularly impairments or interruptions that are frequent or long-lasting, could harm our reputation and cause us to lose existing or potential customers. OUR OPERATING RESULTS MAY BE ADVERSELY IMPACTED BY EXCHANGE RATE FLUCTUATIONS. We have established and acquired international subsidiaries that prepare their balance sheets in the relevant foreign currency. In order to be included in our consolidated financial statements, these balance sheets are converted, at the then current exchange rate, into U.S. dollars, and the statements of operations are converted using weighted average exchange rates for the applicable periods. Foreign currency denominated sales may result in gains and losses on the conversion to U.S. dollars. Therefore, exchange rate fluctuations can have a detrimental effect on our reported operating results. We do not engage in hedging activities to protect against the risk of currency fluctuations. WE SELL A SIGNIFICANT PORTION OF OUR PRODUCTS AND SERVICES TO CUSTOMERS IN INTERNATIONAL MARKETS IN WHICH WE MAY HAVE DIFFICULTY PROTECTING IMPORTANT INTELLECTUAL PROPERTY RIGHTS. Sales of our products and services to customers located outside the U.S. accounted for approximately 24.8% and 19.1% of our net revenue for the fiscal years ended March 31, 2002 and March 31, 2001, respectively, and 33.3% of our net revenue for the nine months ended December 31, 2002. Our intellectual property rights are an important aspect of our international business. We rely primarily on a combination of contract, copyright, trademark and trade secret laws, domain registration, license and confidentiality agreements and software security measures to protect our proprietary technology. However, we believe that existing laws provide limited protection for our technology and that it may be possible for a third party to misappropriate our technology or to independently develop similar technology. 30 Protective measures we take may be even less effective in the emerging Internet law field because online contracting, privacy and liability issues, among others, are still being resolved. This lack of certainty is even greater in India, where the use of the Internet is less evolved than in the U.S. In addition, effective copyright and trade secret protection may not be available in every jurisdiction where we distribute our products, particularly in foreign countries where the laws generally offer no protection or less protection than the laws of the U.S. The laws of India and other foreign countries in which we operate do not protect intellectual property rights to the same extent as those of the U.S. For example, India's statutory laws do not protect service marks. Because a significant portion of our sales of products and services comes from international markets, this lack of copyright and trade secret protection could adversely affect our business and results of operations if a third party were successful in copying our products and services and marketing products and services similar to ours. CONFLICTS INVOLVING INDIA AND FUTURE CHANGES IN THE INDIAN GOVERNMENT POLICY FAVORING ECONOMIC LIBERALIZATION COULD MAKE OUR INDIAN OPERATIONS ECONOMICALLY UNVIABLE. During the fiscal year ended March 31, 2002 and the nine months ended December 31, 2002, we derived only approximately 5.5% and 5.2%, respectively, of our total net revenues from sales made by our Indian operations, primarily to customers in India. However, nearly one-half of our employees, many of whom are engaged in non-sales activities such as technical support and research and development, were based in India. India has from time to time experienced civil unrest and hostilities with its neighboring countries. Although the Indian government has changed three times since 1996, the government of India has pursued policies of economic liberalization throughout the past decade. These policies have resulted in significantly increased opportunities for publicly and privately held businesses in the information technology services markets in 31 which we operate in India. However, we cannot assure you that the current government will remain in power or that these policies will continue. A significant change in the Indian government's policies could cause our operations in India to become more expensive or more difficult, and in either case cause us to have to re-evaluate the economic viability of operating there. Moreover, if civil unrest or hostilities involving India and any of its neighboring countries should occur, it could have an adverse effect on the communication infrastructure in India, which could, in turn, cause our operations there to cease making economic sense. In that event, we may need to expend significant time and resources in relocating and conducting our Indian operations elsewhere. THE WAR IN THE MIDDLE EAST COULD ADVERSELY AFFECT INTERNATIONAL TRAVEL WHICH, IN TURN, COULD NEGATIVELY IMPACT REVENUES FROM OUR TRAVEL BUSINESS AND FOR OUR COMPANY OVERALL. The war between Iraq and the coalition forces may adversely impact international travel. Since our travel division derives over 80% of its revenues from international travel, decreases in international travel are likely to reduce revenues from our travel business and for our company overall. If the war or subsequent factors affect international travel patterns for more than a short period, our revenues and results of operations cold be negatively impacted. REVENUES FOR OUR TRAVEL SERVICES DIVISION AND FOR OUR COMPANY OVERALL COULD BE NEGATIVELY AFFECTED IF INTERNATIONAL TRAVEL DECLINES DUE TO THE OUTBREAK OF SEVERE ACUTE RESPIRATORY SYNDROME, OR SARS. Our travel business, which focuses on travel to India and neighboring countries could be adversely affected if the cause or mode of transmission of SARS is not determined soon. The uncertainty regarding SARS may cause travelers to become reluctant to travel by air, which could reduce the demand for our travel services. This, in turn, could negatively impact revenues from our travel division and for our company overall. 32 CHANGING TECHNOLOGY MAY RENDER OUR PRODUCT AND SERVICE OFFERINGS OBSOLETE AND, THEREFORE, UNMARKETABLE. Our ability to compete successfully depends upon the continued compatibility and interoperability of our services with products and architectures offered by various vendors. Although we intend to support emerging standards in the market for Internet access, industry standards may not be established and, if they become established, we may not be able to conform to these new standards in a timely fashion or maintain a competitive position in the market. The announcement or introduction of new products or services by us or our competitors and any change in industry standards could cause our customers to defer or cancel purchases of existing products or services. U.S. FEDERAL OR STATE GOVERNMENTS MAY INCREASE TELEPHONY REGULATION, WHICH COULD CAUSE THAT BUSINESS TO BECOME ECONOMICALLY UNVIABLE, EITHER AS A RESULT OF INCREASED EXPENSES OR AS A RESULT OF LIMITATIONS ON GROWING THAT BUSINESS. Our provision of telecommunication services is subject to government regulation in the U.S. Federal law regulates international and interstate telecommunications, while states have jurisdiction over telecommunications that originate and terminate within the same state. Changes in existing policies or regulations by Congress, by the Federal Communications Commission, or the FCC, or any state could cause operating in this field to become more expensive or could cause expansion to become more difficult, such as by limiting the ability to obtain necessary licenses. We cannot assure you that the regulatory authorities in one or more states or the FCC will not take action causing this business to become unviable for us. OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK. The market prices of securities of technology-based companies like ours, particularly Internet-related companies, currently are highly volatile. The market price of our common stock has fluctuated significantly in the past. In fact, during the 52-week period ended May 2, 2003, the high and low sale prices of a share of our common stock were $3.95 and $0.68, respectively. Our market price may continue to exhibit significant fluctuations in response to a variety of factors, many of which are beyond our control. These factors include, among others, deviations in our results of operations from the estimates of securities analysts, changes in securities analysts' estimates of our financial performance, changes in market valuations of similar companies and stock market price and volume fluctuations generally. Additionally, until the full effects of our cost-cutting efforts that began over a year ago become clear, including whether those cuts have a long-term negative impact on revenues, it is likely that our quarter-to-quarter performance will be unpredictable and our stock price particularly volatile. In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. Because of the volatility of the market price of our common stock, we may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources. 33 OUR NET OPERATING LOSS CARRYFORWARDS MAY BE SUBJECT TO AN ANNUAL LIMITATION ON THEIR UTILIZATION, WHICH MAY INCREASE OUR TAXES AND DECREASE AFTER-TAX INCOME AND CASH FLOWS. As of March 31, 2002, we had available net operating loss carryforwards of $9,321,000 for federal income tax purposes and $5,133,000 for state income tax purposes. Due to the "change in ownership" provisions of the Tax Reform Act of 1986, our net operating loss carryforwards may be subject to an annual limitation on the utilization of these carryforwards against taxable income in future periods if a cumulative change in ownership of more than 50% occurs within any three-year period. To the extent we are unable to fully use these net operating loss carryforwards to offset future taxable income, we will be subject to income taxes on future taxable income, which will decrease our after-tax income and cash flows. THE CONCENTRATION OF OWNERSHIP OF OUR COMMON STOCK GIVES A FEW INDIVIDUALS SIGNIFICANT CONTROL OVER IMPORTANT POLICY DECISIONS AND COULD DELAY OR PREVENT CHANGES IN CONTROL. As of May 2, 2003, our executive officers and directors and their family members together beneficially owned approximately 45.1% of the issued and outstanding shares of our common stock. As a result, these persons have the ability to exert significant control over matters that could include the election of directors, changes in the size and composition of the board of directors, and mergers and other business combinations involving our company. In addition, through control of the board of directors and voting power, they may be able to control certain decisions, including decisions regarding the qualification and appointment of officers, dividend policy, access to capital (including borrowing from third-party lenders and the issuance of additional equity securities), and the acquisition or disposition of our assets. In addition, the concentration of voting power in the hands of those individuals could have the effect of delaying or preventing a change in control of our company, even if the change in control would benefit our stockholders. A perception in the investment community of an anti-takeover environment at our company could cause investors to value our stock lower than in the absence of such a perception. 34 ITEM 7. FINANCIAL STATEMENTS. Our consolidated financial statements are included in this Form 10-KSB beginning on page F-1 following the signature page. 35 PART III ITEM 10. EXECUTIVE COMPENSATION. EXECUTIVE COMPENSATION Information concerning the annual and long-term compensation for services in all capacities to our company of our Chief Executive Officer and our other executive officers whose aggregate cash compensation exceeded $100,000 (collectively, the "Named Executives") during the fiscal years ended March 31, 2002, 2001 and 2000 is shown below. SUMMARY COMPENSATION TABLE
Long-Term Compensation Annual Compensation Awards -------------------------- ------------ Securities Other Annual Underlying All Other Name and Salary Compensation Options Compensation Principal Position Year ($) (1)($) (#) ($) ------------------ ---- --- ------ --- --- Amrit K. Das 2002 335,100 73,219 --- 6,972(2) Chief Executive Officer 2001 334,500 73,183 30,000 15,568(2) 2000 333,600 --- --- 16,855(2) Jyoti Chatterjee 2002 221,568 37,797 --- --- President and Chief 2001 221,100 36,573 30,000 --- Operating Officer 2000 220,276 --- --- --- Clara Young 2002 132,405 24,890 --- --- Corp. Vice President, 2001 128,790 16,203 9,000 --- Chief Administrative 2000 129,211 --- --- --- Officer Stephen Owen 2002 156,181 17,932(3) --- --- Corporate Vice President, 2001 137,625 21,164(3) 12,000 --- President, European 2000 147,621 23,995(3) --- --- Operations Santanu Das 2002 135,458 --- --- 5,150(4) Corporate Vice President, 2001 132,093 --- 30,000 5,150(4) President, Engineering 2000 72,662 --- --- 6,929(4) and Animation Software and ASP
________________________________________________________________________________ (1) The costs of certain benefits are not included because they did not exceed, in the case of each Named Executive, the lesser of $50,000 or 10% of the total annual salary and bonus as reported above. (2) Represents premiums paid by us pursuant to a split-dollar life insurance policy established for the benefit of Amrit Das. (3) Represents car allowance and imputed interest for Mr. Owen's non-interest bearing loan in the amount of $5,100 in 2002, $7,820 in 2001, and $9,520 in 2000. (4) Represents premiums paid by us pursuant to a life insurance policy established for the benefit of Santanu Das. 36 STOCK OPTION GRANTS IN 2002 In fiscal 2002, no options or stock appreciation rights were granted to the Named Executives. OPTION EXERCISES AND FISCAL YEAR-END VALUES Shown below is information with respect to the number of shares of our common stock acquired upon the exercise of options, the value realized, the number of unexercised options at March 31, 2002 and the value of unexercised in-the-money options at March 31, 2002 for the Named Executives in the Summary Compensation Table above. The Named Executives did not hold any stock appreciation rights during fiscal 2002. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
Number of Securities Value of Unexercised In-the-Money Underlying Unexercised Options Options at Fiscal Year-End ($) (a) At Fiscal Year-End (#) Shares Acquired on Value Name Exercise(#) Realized($) Exercisable Unexercisable Exercisable Unexercisable ---- ----------- ----------- ----------- ------------- ----------- ------------- Amrit K. Das --- --- 180,000 20,000 826,200 91,800 Jyoti Chatterjee --- --- 236,000 20,000 1,083,240 91,800 Clara Young --- --- 80,000 6,000 367,200 27,540 Stephen Owen --- --- 84,000 8,000 385,560 36,720 Santanu Das --- --- 180,000 20,000 826,200 91,800
(a) Calculated based on the difference between $4.59, the closing price of our common stock at March 31, 2002, and grant price of the underlying options. LONG-TERM INCENTIVE PLAN AWARDS In fiscal 2002, no awards were given to Named Executives under long-term incentive plans. SALARY DEFERRAL ARRANGEMENT Stephen Owen, who is one of the Named Executives, elected to defer portions of his salary on a pretax basis to a retirement account of his choice during the fiscal years ended March 31, 2002, 2001 and 2000. The amounts deferred in those periods were $29,641, $30,144 and $36,619, respectively. We did not match his contributions. DIRECTORS' COMPENSATION Our directors do not currently receive any cash compensation for service on the Board of Directors or any committee thereof, but directors may be reimbursed for certain expenses in connection with attendance at Board of Directors and committee meetings. At the discretion of the stock option committee of the board of directors, directors may be granted stock options. 37 REPRICING OF OPTIONS AND SARS No adjustments to or repricing of stock options previously awarded to named executives occurred in fiscal 2002. EMPLOYMENT AGREEMENTS In May 1996, we entered into five-year employment agreements with each of Amrit Das (Chairman and Chief Executive Officer) Jyoti Chatterjee (President, Chief Operating Officer, Director) and Clara Young (Corporate Vice President, Chief Administrative Officer, Secretary). In June 2001, we entered into new five-year agreements with each of these individuals and in addition, a five-year employment agreement with Santanu Das (Corporate Vice President, and President, Engineering, Animation Software and ASP). The new agreements provide that Mr. Amrit Das, Mr. Chatterjee, Ms. Young and Mr. Santanu Das will receive minimum base annual salaries of $312,000, $202,800, $117,000 and $120,000, respectively. Each employment agreement also provides for the grant of an annual bonus. The annual salaries and bonuses may be adjusted at the discretion of the Compensation Committee of the Board of Directors. In the event of early termination from employment, except for good cause, the employee shall (a) continue to be paid base salary and bonuses for the remainder of the term of the agreement, (b) continue to receive all benefits and perquisites which he or she had been receiving immediately prior to such termination for the remainder of the term of the agreement, and (c) be immediately vested in all stock options to which he or she would have been entitled during the full term of the agreement had the termination not occurred. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISIONS Each of Messrs. Amrit K. Das, Jyoti Chatterjee and Garret Vreeland served as a member of the compensation committee of the board of directors during fiscal year 2002. None of the members of the compensation committee served as a member of the compensation committee of the board of directors of any other publicly or privately held company. 38 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 2.6 Securities Purchase Agreement, without exhibits and schedules, dated as of September 14, 1999, between the registrant and Triton Private Equities Fund, L.P.***** 2.11 Securities Purchase Agreement dated March 8, 2000 between the registrant, Elliott Associates, L.P. and Westgate International, L.P.+++ 2.12 Exchange Agreement dated March 30, 2000 between the registrant, Elliott Associates, L.P. and Westgate International, L.P. +++ 2.13 Stock Purchase Agreement dated March 27, 2000 between the registrant, Allegria Software, Inc. and GRAL, Inc. +++ 3.1 Form of Certificate of Incorporation of the registrant filed with the Delaware Secretary of State on August 28, 2000.****** 3.5 Bylaws of the registrant.* 4.3 Common Stock Purchase Warrant dated as of September 14, 1999, issued by the registrant to Triton Private Equities Fund, L.P.***** 4.6 Common Stock Purchase Warrant dated March 8, 2000, issued by the registrant to Elliott Associates, L.P. +++ 4.7 Common Stock Purchase Warrant dated March 8, 2000, issued by the registrant to Westgate International, L.P. +++ 4.9 Common Stock Purchase Warrant dated March 8, 2000, issued by the registrant to Shoreline Institutional Finance. +++ 4.10 Warrant Agreement dated February 7, 2000 between the registrant and Cruttenden Roth Incorporated. +++ 10.1 Research Engineers, Inc. 1996 Stock Option Plan.* 10.2 Form of Nonqualified Stock Option Agreement pertaining to the 1996 Stock Option Plan (schedule of options issued pursuant to this Plan is attached thereto).* 10.6 Research Engineers, Inc. 1997 Stock Option Plan.** 10.7 Agreement Not To Compete dated October 1, 1998 between the registrant and Techna Consultancy Private Limited.*** 39 10.8 Research Engineers, Inc. 1998 Stock Option Plan. + 10.11 netGuru, Inc. 2000 Stock Option Plan.++++ 10.12 Employment Agreement dated June 1, 2001, by and between the registrant and Amrit K. Das.++++ 10.13 Employment Agreement dated June 1, 2001, by and between the registrant and Jyoti Chatterjee.++++ 10.14 Employment Agreement dated June 1, 2001, by and between the registrant and Clara Y. M. Young.++++ 10.15 Employment Agreement dated June 1, 2001, by and between the registrant and Santanu Das.++++ 10.16 Standard Industrial/Commercial Single-Tenant Lease-Net dated November 30, 1999 by and between Lowenberg Corporation and the registrant.++++++ 10.17 Employee Loan Agreement and Promissory Note dated May 3, 2001 by and between the registrant and Santanu Das.++++++ 10.18 Employee Loan Agreement and Promissory Note dated November 1, 2000 by and between the registrant and Stephen Owen.++++++ 10.19 Salary Deferral Arrangement for Executives of Research Engineers (Europe) Ltd. 21.1 Subsidiaries of the registrant.+++++ 23.1 Consent of KPMG LLP. 99.1 Certifications of 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 on Form 8-K None. --------------------- * Filed as an exhibit to our Registration Statement on Form SB-2 dated May 21, 1996 or amendment thereto dated June 14, 1996 (Registration No. 333-4844-LA) and incorporated herein by reference. 40 ** Filed as an exhibit to our Form 10-KSB for the fiscal year ended March 31, 1997 that was filed with Securities and Exchange Commission on June 30, 1997, or amendment thereto filed on August 19, 1997 and incorporated herein by reference. *** Filed as an exhibit to our Form 10-QSB for the quarterly period ended December 31, 1998 that was filed with the Securities and Exchange Commission on February 11, 1999, and incorporated herein by reference. **** Filed as an exhibit to our Form 8-K dated February 26, 1999 that was filed with the Securities and Exchange Commission on March 5, 1999, and incorporated herein by reference. ***** Filed as an exhibit to our Form 8-K dated September 14, 1999 that was filed with the Securities Exchange Commission on September 29, 1999, and incorporated by reference. ****** Filed as an exhibit to our information statement that was filed with the Securities and Exchange Commission pursuant to Section 14 (c) of the Securities Act on July 27, 2000, and incorporated herein by reference. + Filed as an exhibit to our Proxy Statement that was filed with the Securities and Exchange Commission. pursuant to Section 14(a) of the Securities Act on November 12, 1998, and incorporated herein by reference. ++ Filed as an exhibit to our Form 10-KSB for March 31, 1999 that was filed with the Securities and Exchange Commission on June 30, 1999, and incorporated herein by reference. +++ Filed as an exhibit to our Form 10-KSB for March 31, 2000 that was filed with the Securities Exchange Commission on June 26, 2000 and incorporated herein by reference. ++++ Filed as an exhibit to our Form 10-KSB for March 31, 2001 that was filed with the Securities Exchange Commission on July 13, 2001, and incorporated herein by reference. +++++ Filed as an exhibit to our Form 10-KSB for March 31, 2002 that was filed with the Securities Exchange Commission on July 1, 2002, and incorporated herein by reference. ++++++ Filed as an exhibit to Amendment No. 1 to our Form 10-KSB for March 31, 2002 that was filed with the Securities and Exchange Commission on December 3, 2002, and incorporated herein by reference. 41 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. NETGURU, INC. Dated: May 5, 2003 /s/ Amrit K. Das ------------------------------------- Amrit K. Das, Chief Executive Officer In accordance with the Exchange Act, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Name Title Date --------------------------- -------------------------------------- ------------------- /s/ Amrit K. Das Chairman of the Board, Chief --------------------------- Executive Officer and Director May 5, 2003 Amrit K. Das (principal executive officer) /s/ Jyoti Chatterjee President, Chief Operating Officer, May 5, 2003 --------------------------- Director Jyoti Chatterjee /s/ Bruce K. Nelson Chief Financial Officer (principal May 5, 2003 --------------------------- financial and accounting officer) Bruce K. Nelson /s/ Santanu Das Corporate Vice President, President, May 5, 2003 --------------------------- Engineering, Collaboration and Santanu Das Animation and Director /s/ Stephen Owen Corporate Vice President, President, May 5, 2003 --------------------------- European Operations and Director Stephen Owen Director May 5, 2003 --------------------------- Stanley W. Corbett Director May 5, 2003 --------------------------- Garret Vreeland Director May 5, 2003 --------------------------- L.M. Singhvi
42 CERTIFICATIONS I, Amrit K. Das, certify that: 1. I have reviewed this amendment no. 3 to annual report on Form 10-KSB of netGuru, Inc. ("annual report"); 2. Based on my knowledge, this annual 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 annual report; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual report. Date: May 5, 2003 /s/ Amrit K. Das ------------------------------------- Amrit K. Das, Chief Executive Officer (principal executive officer) I, Bruce Nelson, certify that: 1. I have reviewed this amendment no. 3 to annual report on Form 10-KSB of netGuru, Inc. ("annual report"); 2. Based on my knowledge, this annual 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 annual report; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual report. Date: May 5, 2003 Bruce K. Nelson -------------------------------------------- Bruce K. Nelson, Chief Financial Officer (principal financial and accounting officer) 43 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS 1. Independent Auditors' Report F-2 2. Consolidated Financial Statements: Consolidated Balance Sheet as of March 31, 2002 F-3 Consolidated Statements of Operations for the years ended March 31, 2002 and 2001 F-4 Consolidated Statements of Stockholders' Equity and Comprehensive Loss for the years ended March 31, 2002 and 2001 F-5 Consolidated Statements of Cash Flows for the years ended March 31, 2002 and 2001 F-6 Notes to Consolidated Financial Statements F-8 F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors netGuru, Inc.: We have audited the consolidated financial statements of netGuru, Inc. and subsidiaries as listed in the accompanying index. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of netGuru, Inc. and subsidiaries as of March 31, 2002, and the results of their operations and their cash flows for the years ended March 31, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP Orange County, California May 30, 2002 F-2 NETGURU, INC. AND SUBSIDIARIES Consolidated Balance Sheet March 31, 2002 (In thousands, except share and per share amounts)
ASSETS Current assets: Cash and cash equivalents $ 3,466 Accounts receivable (net of allowance for doubtful accounts of $981) 3,325 Income tax receivable 305 Notes and related party loans receivable 269 Prepaid expenses and other current assets 1,543 --------- Total current assets 8,908 Property, plant and equipment, net 4,169 Goodwill (net of accumulated amortization of $4,438) 9,105 Other assets 884 --------- $ 23,066 ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 259 Current portion of capital lease obligations 417 Accounts payable 1,012 Accrued expenses 1,281 Income taxes payable 196 Deferred maintenance revenue 1,760 Deferred income taxes 60 Accrued restructuring costs 157 --------- Total current liabilities 5,142 Long-term debt, net of current portion 567 Capital lease obligations, net of current portion 1,027 Deferred income taxes, non-current 112 Deferred gain on sale-leaseback 887 --------- Total liabilities 7,735 --------- Commitments and contingencies (note 9) Stockholders' equity: Preferred stock, par value $.01; authorized 5,000,000 shares; no shares issued and outstanding -- Common stock, par value $.01; authorized 150,000,000 shares; issued and outstanding 17,265,850 shares (net of 10,965 treasury shares) 173 Additional paid-in capital 33,057 Accumulated deficit (16,805) Accumulated other comprehensive loss: Cumulative foreign currency translation adjustments (1,094) --------- Total stockholders' equity 15,331 --------- $ 23,066 ========= See accompanying notes to consolidated financial statements. F-3
NETGURU, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended March 31, 2002 and 2001 (In thousands, except share and per share amounts)
2002 2001 ------------- ------------- Net revenues: Software sales, maintenance and services $ 9,313 $ 10,066 IT services 9,869 18,019 Internet, e-commerce and collaborative software solutions 5,102 3,217 ------------- ------------- Total net revenues 24,284 31,302 Cost of revenues: Software sales, maintenance and services 1,108 2,305 IT services 7,484 12,223 Internet, e-commerce and collaborative software solutions 4,230 2,214 ------------- ------------- Total cost of revenues 12,822 16,742 Gross profit 11,462 14,560 ------------- ------------- Operating expenses: Selling, general and administrative 13,001 13,815 Research and development 1,824 2,706 Amortization of goodwill 1,290 1,360 Depreciation and other amortization 1,243 798 Impairment charge 1,651 -- Restructuring 25 2,400 ------------- ------------- Total operating expenses 19,034 21,079 ------------- ------------- Operating loss (7,572) (6,519) ------------- ------------- Other expense (income): Interest, net 160 (193) Other 20 (146) ------------- ------------- Total other expense (income) 180 (339) ------------- ------------- Loss before income taxes (7,752) (6,180) Income tax expense 1,192 457 ------------- ------------- Net loss $ (8,944) $ (6,637) ============= ============= Net loss per common share: Basic $ (0.53) $ (0.45) ============= ============= Diluted $ (0.53) $ (0.45) ============= ============= Common shares used in computing net loss per common share: Basic 16,982,496 14,781,331 ============= ============= Diluted 16,982,496 14,781,331 ============= ============= See accompanying notes to consolidated financial statements. F-4
NETGURU, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity and Comprehensive Loss Years ended March 31, 2002 and 2001 (In thousands, except share amounts)
COMMON STOCK RETAINED ACCUMULATED ------------------ ADDITIONAL EARNINGS OTHER TOTAL TOTAL PREFERRED NUMBER OF PAR PAID-IN (ACCUMULATED COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE STOCK SHARES VALUE CAPITAL DEFICIT) INCOME (LOSS) EQUITY INCOME(LOSS) --------- ----------- ----- --------- ----------- ------------- ------------- ------------- Balance, March 31, 2000 -- 13,264,035 $ 133 $ 28,500 $ (1,224) $ (344) $ 27,065 --------- ----------- ----- --------- ----------- ------------ ------------- Net loss -- -- -- -- (6,637) -- (6,637) $ (6,637) Foreign currency translation -- -- -- -- -- (693) (693) (693) --------- ----------- ----- --------- ----------- ------------ ------------- ------------- Comprehensive loss for the year ended March 31, 2001 -- -- -- -- (6,637) (693) -- $ (7,330) ============= Preferred stock conversion -- 1,136,065 11 (11) -- -- -- Repurchase of preferred stock -- 400,000 4 (6,564) -- -- (6,560) Issuance of common stock in connection with acquisition -- 25,000 -- 750 -- -- 750 Issuance of common stock to private investors -- 1,870,270 19 9,302 -- -- 9,321 Exercise of stock warrants -- 80,000 1 386 -- -- 387 Exercise of stock options -- 100,199 1 198 -- -- 199 Repurchase of common stock -- (10,965) -- (76) -- -- (76) Compensation expense for stock options issued to employees below fair value -- -- -- 136 -- -- 136 --------- ----------- ----- --------- ----------- ------------ ------------- Balance, March 31, 2001 $ -- 16,864,604 $ 169 $ 32,621 $ (7,861) $ (1,037) $ 23,892 ========= =========== ===== ========= =========== ============ ============= Net loss -- -- -- -- (8,944) -- (8,944) $ (8,944) Foreign currency translation -- -- -- -- -- (57) (57) (57) --------- ----------- ----- --------- ----------- ------------ ------------- ------------- Comprehensive loss for the year ended March 31, 2002 -- -- -- -- (8,944) (57) -- $ (9,001) ============= Issuance of common stock to consultants -- 325,000 3 703 -- -- 706 Exercise of stock options -- 88,246 1 55 -- -- 56 Repurchase of common stock -- (12,000) -- (400) -- -- (400) Compensation expense for stock options issued to employees below fair value -- -- -- 78 -- -- 78 --------- ----------- ----- --------- ----------- ------------ ------------- ------------- Balance, March 31, 2002 $ -- 17,265,850 $ 173 $ 33,057 $ (16,805) $ (1,094) $ 15,331 ========= =========== ===== ========= =========== ============ ============= See accompanying notes to consolidated financial statements. F-5
NETGURU, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended March 31, 2002 and 2001 (In thousands)
2002 2001 --------- --------- Cash flows from operating activities: Net loss $ (8,944) $ (6,637) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,731 2,442 Bad debt expense 358 590 Deferred income taxes 1,334 318 Compensation expense recognized on issuance of stock options 78 136 Restructuring 25 2,400 Impairment charge 1,651 -- Consulting expense recognized on issuance of common stock 525 -- Loss on disposal of property 146 -- Changes in operating assets and liabilities (net of acquisitions): Accounts receivable 1,161 (1,419) Notes and related party loans receivable (256) 210 Income tax receivable (305) -- Deposits -- 2,381 Prepaid expenses and other current assets (761) (697) Other assets (38) (794) Accounts payable (164) 317 Accrued expenses (426) (382) Income taxes payable 29 (91) Accrued restructuring costs (177) (96) Other current liabilities 111 -- Deferred revenues (233) 731 Deferred gain on sale-leaseback (70) (70) --------- --------- Net cash used in operating activities (3,225) (661) --------- --------- Cash flows from investing activities: Purchase of property, plant and equipment (394) (4,598) Payments to acquire companies, net of cash acquired (72) (2,042) --------- --------- Net cash used in investing activities (466) (6,640) --------- --------- Cash flows from financing activities: Proceeds from issuance of bank debt 93 385 Repayment of bank debt (314) (1,147) Payment of capital lease obligations (265) (132) Issuance of common stock 79 9,907 Repurchase of preferred stock -- (6,560) Repurchase of common stock (364) (76) --------- --------- Net cash (used) provided by financing activities (771) 2,377 --------- --------- Effect of exchange rate changes on cash and cash equivalents (30) (383) --------- --------- Decrease in cash and cash equivalents (4,492) (5,307) Cash and cash equivalents, beginning of year 7,958 13,265 --------- --------- Cash and cash equivalents, end of year $ 3,466 $ 7,958 ========= ========= (Continued) F-6
NETGURU, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued
2002 2001 -------- -------- Supplemental disclosure of cash flow information: Cash paid for: Interest $ 268 $ 154 ======== ======== Income taxes 105 152 ======== ======== Supplemental disclosure of non-cash investing and financing activities: Acquisition of equipment under capital leases $ 677 $ 334 Acquisition of equipment - received in lieu of payment on accounts 70 -- receivable Write-off of assets against accrued restructure reserve -- 1,995 Issuance of common stock, warrants and options in connection with acquisitions -- 750 Acquisitions: Fair value of assets acquired, net of cash $ 72 $ 2,868 Liabilities assumed -- (76) -------- -------- Net assets acquired 72 2,792 Less: non-cash consideration given -- (750) -------- -------- Payments to acquire companies, net of cash acquired $ 72 $ 2,042 ======== ======== See accompanying notes to consolidated financial statements. F-7
NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION The Company was incorporated in 1981 in the state of New Jersey and reincorporated in the state of Delaware in 1996 under the name Research Engineers, Inc. Effective February 25, 2000, the name was changed to netGuru, Inc. (the "Company" or "netGuru"). netGuru is an integrated Internet technology and services company providing Internet and PC-based engineering software products and services, including digital media and animation services, information technology ("IT") services, and IP telephony services and Internet based phone card and travel services. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of netGuru, Inc. and its wholly owned subsidiaries. All significant transactions among the consolidated entities have been eliminated upon consolidation. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards ("SFAS") No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, requires management to disclose the estimated fair value of certain assets and liabilities defined by SFAS No. 107 as financial instruments. Financial instruments are generally defined by SFAS No. 107 as cash or a contractual obligation that conveys to one entity a right to receive cash or other financial instruments from another entity, as well as impose on the other entity the obligation to deliver cash or other financial instruments to the first entity. At March 31, 2002, management believes the carrying amounts of cash and cash equivalents, receivable and payable amounts, and accrued expenses approximate fair value because of the short maturity of these financial instruments. The Company also believes that the carrying amounts of its long-term debt and capital lease obligations approximate their fair value as the interest rates approximate a rate that the Company could obtain under similar terms at the balance sheet date. FOREIGN CURRENCY TRANSLATION The financial position and results of operations of the Company's foreign subsidiaries are accounted for using the local currency as the functional currency. Assets and liabilities of the subsidiaries are translated into U.S. dollars (the reporting currency) at the exchange rate in effect at the year-end. Statements of operations accounts are translated at the average rate of exchange prevailing during the respective years. Translation adjustments arising from the use of differing exchange rates from period to period are included in accumulated other comprehensive income (loss) in the consolidated statement of stockholders' equity. Gains and losses resulting from foreign currency transactions are included in operations and are not material for fiscal 2002 and 2001. F-8 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are stated at cost. Depreciation is calculated using the straight-line method over the following useful lives: Buildings 39 years Computer equipment 5 years Computer software 3 years Office equipment and furniture 3-7 years Assets held subject to capital lease agreements and leasehold improvements are amortized over the lesser of the life of the asset or the term of the lease but not in excess of 5 years. GOODWILL The Company amortizes costs in excess of the fair value of net assets of businesses acquired ("Goodwill") using the straight-line method over the estimated useful lives of the businesses acquired, usually a period of 5-15 years. Goodwill amortization was $1,290,000 and $1,360,000 for the years ended March 31, 2002 and 2001, respectively. IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF The Company applies the provisions of SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. This statement requires that long-lived assets and certain identifiable intangibles (including Goodwill) be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such asset is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. The Company applies the provisions of SFAS No. 86 (SFAS 86), "ACCOUNTING FOR THE COST OF COMPUTER SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED" for evaluating unamortized capitalized software development costs. At each balance sheet date, the Company compares the unamortized software development cost of each product to the net realizable value of the product. The amount by which the unamortized software development cost exceeds the net realizable value of the product is written off. At March 31, 2002, the Company had no write-off of unamortized software development costs. F-9 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements In fiscal 2002, the Company recorded an impairment charge of $1,651,000. Of this amount, $684,000 was related to the write-off of capitalized film production costs; $651,000 was related to the write-off of assets of Interra Global, one of the Company's subsidiaries in India; and $316,000 represented the write-down of goodwill related to the purchase of e-Destinations, the Company's travel services subsidiary. The Company wrote off capitalized film production costs, since revenues-to-date and forecasted revenues from these film assets did not support carrying value of the recorded amounts. The Company surrendered the license held by Interra Global and recorded the above-noted impairment charge related to the write-off of the assets of this subsidiary in the fourth quarter of fiscal 2002. As a result of uncertainties faced by the travel business, the Company recorded an impairment charge of $316,000 to write down the value of goodwill associated with the acquisition of its travel subsidiary, e-Destinations, Inc., which is included in the Company's Internet, e-commerce and collaborative software segment. The amount of the write down represented the excess of the carrying amount of goodwill over its fair value. The fair value of goodwill associated with the acquisition of e-Destinations was determined by calculating the present value of estimated expected future cash flows in accordance with SFAS No. 121. As of March 31, 2002, the Company had $340,000 of unamortized goodwill related to the acquisition of this subsidiary. SOFTWARE DEVELOPMENT COSTS AND PURCHASED TECHNOLOGY The Company capitalizes costs related to the development of certain software products in accordance with SFAS 86. Capitalization of costs begins when technological feasibility has been established and ends when the product is available for general release to customers. As of March 31, 2002, capitalized costs of approximately $671,000, net of accumulated amortization, were included in other assets. Approximately $303,000 of this amount represents software developed in-house and $240,000 represents the cost of software developed on the Company's behalf by third parties. The remaining $128,000 represents purchased technology. Additions to capitalized software were $545,000 and $254,000 during fiscal 2002 and 2001, respectively. The Company amortizes capitalized software development costs and purchased technology using the straight-line method over three to five years, or the ratio of actual sales to anticipated sales, whichever is greater. Amortization of software development costs and purchased technology charged to cost of revenues was approximately $198,000 and $284,000 for the years ended March 31, 2002 and 2001, respectively. Accumulated amortization on capitalized software was $1,420,000 and $966,000 as of March 31, 2002 and 2001, respectively. REVENUE RECOGNITION The Company recognizes revenue when the following criteria are met: 1. persuasive evidence of an arrangement, such as agreements, purchase orders or written or online requests, exists; 2. delivery has been completed and no significant obligations remain; 3. the Company's price to the buyer is fixed and determinable; and 4. collectibility is probable. The Company's revenues arise from the following segments: software sales, maintenance and services (including digital media products and services); information technology ("IT") services; and products and services sold via Internet portals, including ASP services, telecommunication and travel services. Revenues from providing IT services are recognized primarily on a time and materials basis, with time at a marked-up rate and materials and other reasonable expenses at cost, once the services are completed and no significant obligations remain. Certain IT services contracts are fixed price contracts where progress toward completion is measured by mutually agreed upon pre-determined milestones for which we recognize revenue upon achieving such milestones. The Company's fixed price IT contracts are typically for a short duration of one to three months. F-10 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Revenue from software sales is recognized upon shipment, provided that no significant post-contract support obligations remain outstanding and collection of the resulting receivable is probable. The Company's software sales do not provide a specific right of return. At the time of sale, the Company typically provides free 120-day initial maintenance and support to the customer. Costs relating to this initial 120-day support period, which include primarily telephone support, are not considered material. After the initial support period, customers may choose to purchase ongoing maintenance contracts that include telephone, e-mail and other methods of support, and the right to receive upgrades. Revenue from these maintenance contracts is deferred and recognized ratably over the life of the contract, usually twelve months. Revenues from digital media and animation services are recognized upon achievement of certain pre-determined milestones. In October 1997, the Accounting Standards Executive Committee ("AcSEC") of the AICPA issued Statement of Position ("SOP") 97-2, SOFTWARE REVENUE RECOGNITION. SOP 97-2 distinguishes between significant and insignificant vendor obligations as a basis for recording revenue with a requirement that each element of a software licensing arrangement be separately identified and accounted for based on relative fair values of each element. The Company adopted SOP 97-2 in the first quarter of fiscal 1999. In 1998 the AICPA issued SOP 98-9, MODIFICATION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION, WITH RESPECT TO CERTAIN TRANSACTIONS, which modifies SOP 97-2 to allow for use of the residual method of revenue recognition provided that certain criteria have been met. The Company adopted SOP 98-9 in the first quarter of fiscal 2000. The Company sells its engineering and collaborative software along with a maintenance package. This constitutes a multiple element arrangement. The price charged for maintenance portion is the same as when the maintenance is sold separately. The fair values of the maintenance contracts sold in all multiple element arrangements are recognized over the terms of the maintenance contracts. The engineering and collaborative software portion is recognized when delivery is complete and no significant obligations remain. Revenues from call termination services are recognized at gross sales value with the applicable cost separately stated in the cost of revenues. Revenues from the Company's own phone card sales are deferred and recognized on the basis of usage, whereas revenues from re-sale of third-party phone cards are recognized net of returns since no significant obligations remain once product is delivered. Certain travel services, based on their nature, are recognized at the gross sales value with purchase costs stated as a separate cost of revenues in accordance with Emerging Issues Task Force Issue No. 99-19, RECORDING REVENUE GROSS AS A PRINCIPAL VERSUS NET AS AN AGENT. Other products and services sold via Internet portals, including certain travel services, where the Company is a travel discounter or an agent, are recognized net of purchase costs when the products and services are delivered and collectibility is probable. Revenues from ASP services are recognized when the services are complete and collectibility is probable. In December 1999, the staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), REVENUE RECOGNITION IN FINANCIAL STATEMENTS, as amended by Staff Accounting Bulletins No. 101 A and 101 B. These bulletins summarize certain of the staff's views about applying generally accepted accounting principles to revenue recognition in financial statements. The Company adopted SAB 101, as amended, in the fourth quarter of fiscal 2001, the implementation of which resulted in no material changes in our previous practice. F-11 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements DEFERRED REVENUES The Company defers revenues for its maintenance contracts, for its collaborative software sales and for its phone card revenues that are not considered earned. The Company defers its maintenance revenues when the maintenance contracts are sold, and then recognizes the maintenance revenues over the term of the maintenance contracts. The Company defers its collaborative software sales revenues if it invoices or receives payment prior to the completion of a project, and then recognizes these revenues upon completion of the project when no significant obligations remain. The Company defers revenues from the sales of its own phone cards when the cards are sold, and then recognizes revenues from these phone card sales based on usage. Revenues from any unused portion of phone card minutes are recognized upon expiration of the phone cards. RESEARCH AND DEVELOPMENT The Company's research and development ("R&D") costs consist mainly of developers' salaries. The major thrust of the Company's R&D efforts has been and continues to be toward developing software products for sale and toward enhancing existing software products. To a lesser extent, the Company's R&D efforts are expended toward enhancing and maintaining its Websites. The Company follows the guidance of EITF 00-2, "ACCOUNTING FOR WEB SITE DEVELOPMENT COSTS" to account for its Website development costs and the guidance of SOP 98-1, "ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE" to account for the costs of internal use software. The Company follows the provisions of SFAS No. 86, "ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED" to capitalize software development costs when technological feasibility has been established and stop capitalization when the product is available for general release to customers. The Company expenses development costs when they are related to enhancement of existing software products. INCOME TAXES The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. NET LOSS PER SHARE Basic Earnings Per Share ("EPS") is calculated by dividing net income (loss) by the weighted-average common shares outstanding during the period. Diluted EPS reflects the potential dilution to basic EPS that could occur upon conversion or exercise of securities, options, or other such items, to common shares using the treasury stock method based upon the weighted-average fair value of the Company's common shares during the period. See Note 12 "Loss Per Share" of Notes to Consolidated Financial Statements for computation of EPS. F-12 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements COMPREHENSIVE INCOME (LOSS) The Company applies the provisions of SFAS No. 130, "REPORTING COMPREHENSIVE INCOME," which establishes rules for the reporting and display of comprehensive income (loss) and its components. SFAS No. 130 requires changes in foreign currency translation adjustments, which are reported separately in stockholders' equity, to be included in other comprehensive income (loss). STOCK-BASED COMPENSATION The Company applies the provisions of SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION." As permitted by SFAS No. 123, the Company continues to follow the guidance of Accounting Principles Board ("APB") Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES." Consequently, compensation related to stock options is the difference between the grant price and the fair market value of the underlying common shares at the grant date. Generally, the Company issues stock options to employees with a grant price equal to the market value of common stock on the grant date. The Company has issued certain stock options with a grant price below the market value at the grant date. The Company recognizes compensation expense on these grants over the vesting period, generally three to four years. As required by SFAS No. 123, the Company discloses in Note 6 "STOCKHOLDERS' EQUITY" the pro forma effect on operations, as if compensation costs were recorded at the estimated fair value of the stock options granted. SEGMENT REPORTING The Company applies the provisions of SFAS No. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION." SFAS No. 131 requires segments to be determined and reported based on how management measures performance and makes decisions about allocating resources. See Note 11 "Segment and Geographic Data" of Notes to Consolidated Financial Statements for description of and disclosures regarding the Company's significant reportable segments. RECLASSIFICATIONS Certain reclassifications have been made to the 2001 consolidated financial statements to conform to the 2002 presentation. Included in amendment no. 2 and amendment no. 3 to the Form 10-KSB is a reclassification of the amortization of software development costs from "depreciation and other amortization" to "cost of revenues." (2) ACQUISITIONS The following acquisitions were accounted for using the purchase method of accounting and, accordingly, the results of operations of the acquired assets and assumed liabilities have been included in the consolidated financial statements subsequent to effective dates of the respective acquisitions. All assets acquired and liabilities assumed were recorded at their estimated fair market values at the date of acquisition in the consolidated balance sheet. Any options and warrants issued in these transactions were valued using the Black-Scholes model. ALLEGRIA SOFTWARE, INC. On April 1, 2000, we acquired all of the outstanding capital stock of Allegria Software, Inc. ("Allegria") for $1,500,000 in cash and 25,000 shares of our common stock, valued at approximately $750,000 at the date of acquisition. Allegria was a developer of Internet-based document management and collaborative software tools primarily for engineering and F-13 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements manufacturing companies. The acquisition included stand-alone software products, as well as technology. The technology is being used in the development of the Company's ASP services business. The purchase price allocation (including acquisition costs of $11,000) is summarized as follows (in thousands): Current assets $ 97 Other assets 18 Goodwill 2,222 Current liabilities (76) ---------------- $ 2,261 ================ Goodwill recorded as a result of this acquisition is being amortized over ten years. INTERRA GLOBAL, LIMITED. In May 2000, the Company acquired India-based Interra Global, Limited, an Internet service provider that had obtained the license to operate as such in India. The Company had also intended to use this license to offer Voice Over Internet Protocol ("VOIP") services when VOIP was allowed within India. The total purchase price was approximately $348,000 and substantially the entire purchase price was recorded as goodwill, which was being amortized over five years. With the deregulation of the telephony industry in India starting April 2002, the Company revised its business model for offering VOIP services within the India from becoming a direct service provider to a more cost-effective model of partnering with local companies. The Company surrendered the license held by Interra Global and recorded an impairment charge of $651,000 related to the write-off of the assets of this subsidiary in the fourth quarter of fiscal 2002. Based on the respective acquisition dates, pro forma disclosures have not been provided for the above noted acquisition, as they would not have significantly changed the actual results of operations for the fiscal years ended March 31, 2002 and 2001. (3) PROVISION FOR RESTRUCTURING OPERATIONS In March 2001, the Company announced plans to restructure its operations. As a result of this restructuring plan, the Company recorded a restructuring charge of $2,400,000 in fiscal 2001. The restructuring plan consisted of four major points: 1) refocused strategic direction of Internet service provider ("ISP") initiatives; 2) refocused strategic direction of Internet portal initiatives; 3) consolidation of the Company's technical support activities; and 4) elimination of the Company's in-house legal department. With regard to the Company's ISP initiatives in India, the Company redirected its primary focus toward communication and connectivity services targeted at the corporate market. The Company's original focus related to ISP services was that the Company planned to offer ISP services to both consumers and businesses in India. With the proposed acquisition of a 30% ownership interest in Vital Communications, Ltd., an IT communications technology company, the Company had planned to start providing ISP services for the 10,000 customers of Vital Communications as a first step toward becoming an ISP in India. The total amount charged for the refocus of ISP operations in fiscal 2001 was $1,998,000. This total charge consisted of $171,000 in contractual obligations and $1,827,000 in asset write-offs related to ISP operations in India. These charges did not include any employee costs. However, they included the write-off of $537,000 paid toward the Company's proposed acquisition of a 30% ownership interest in Vital Communications, the write-off of $346,000 related to capitalized connectivity charges for the ISP business, and the write-off of $944,000 of ISP infrastructure equipment. The ISP infrastructure equipment related to the VOIP technology. The equipment was determined to have no resale value because VOIP technology was not permitted in India and because it was not cost-effective to sell the equipment in countries where VOIP was permitted since the technology had changed. The restructuring related to the ISP operations resulted in elimination of depreciation and amortization expenses that would have resulted from the ISP related assets. F-14 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements With regard to the Internet portal business, the Company redirected its primary focus toward the telephony and travel services offered through the portal. The initial restructuring charge related to the refocus of the portal business was $194,000, of which $168,000 was related to asset write-offs, and $26,000 was related to contractual obligations. These charges did not include any employee costs. The entire $194,000 was paid in fiscal 2001. During fiscal 2002, an additional $67,000 relating to contractual obligations for the portal operations was paid. In March 2001, the Company closed its Boston technical support office as part of consolidating the Company's technical support activities. Technical support activities previously offered from the Boston office were consolidated into the California facility. The closing of this office resulted in the termination of two employees. The restructure charge related to the consolidation of technical support facilities was $166,000, of which $49,000 related to accrued severance payments for the two terminated employees and $117,000 related to contractual lease obligations for the vacated space. In fiscal 2002, the Company made cash payments totaling $58,000 toward settlement of obligations related to this activity. The employee costs related to technical support operations decreased beginning in April 2001 and the Company expects facility costs to decrease beginning in October 2003, after the termination of the lease in September 2003. The elimination of the in-house legal department primarily consisted of the termination of one employee whose position was not filled. Legal services are being obtained from the Company's continuing external legal counsel. In fiscal 2001, the Company estimated that the restructure charge related to the elimination of the in-house legal department to be $42,000. An additional charge of $41,000 was recorded in fiscal 2002 since the original estimate of severance expenses was insufficient. In fiscal 2002, the Company paid $52,000 toward this restructure charge. Activity relating to the restructuring charge is as follows (in thousands):
REFOCUS OF REFOCUS OF CONSOLIDATION ELIMINATION ISP PORTAL OF TECHNICAL OF LEGAL TOTAL OPERATIONS OPERATIONS SUPPORT DEPARTMENT ------------ ------------ ------------ ------------ ------------ March 31, 2000 -- -- -- -- -- Restructuring charge $ 1,998 $ 194 $ 166 $ 42 $ 2,400 Cash payments (1,897) (194) -- -- (2,091) ------------ ------------ ------------ ------------ ------------ March 31, 2001 $ 101 -- $ 166 $ 42 $ 309 ------------ ------------ ------------ ------------ ------------ Cash payments -- (67) (58) (52) (177) Adjustments (67) a 67 a (16) b 41 b 25 ------------ ------------ ------------ ------------ ------------ March 31, 2002 $ 34 $ -- $ 92 $ 31 $ 157 ============ ============ ============ ============ ============
a. Represents reversal of over-accrual for contractual obligations for ISP operations and additional amounts accrued for contractual obligations related to the portal operations. b. Represents reversal of over-accrual for technical support severance costs and additional amounts accrued for anticipated severance costs for the elimination of the legal department. F-15 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The balance at March 31, 2002 includes $67,000 of lease payments for vacated office space scheduled for payment through September 2003. The remaining personnel costs and contractual obligations are expected to be completed by the end of fiscal 2003. (4) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, at cost, as of March 31, 2002 consists of the following (in thousands): Land $ 24 Buildings and leasehold improvements 711 Office and computer equipment, software and furniture 5,822 Assets under capital lease 909 --------------- 7,466 Less accumulated depreciation (3,297) --------------- Net property, plant and equipment $ 4,169 =============== On December 15, 1999, the Company consummated a sale and leaseback transaction involving its Yorba Linda, California facility. The gross selling price of the property was $3,200,000, $1,689,000 of which was utilized to pay off the balance of the mortgage on the property. The Company received approximately $1,017,000 in cash proceeds, net of transaction costs, and a $250,000 short term note receivable for the sale of the property (payment on note was received prior to March 31, 2000). The proceeds were used to purchase the remaining 20% of NetGuru Systems in December 1999 and for operating purposes. Concurrent with the sale, the Company entered into a fifteen year operating lease on the facility (see Note 9). The net book value of the land and building and the related mortgage were removed from the Company's consolidated balance sheet and the lease payments are being charged to expense as incurred. The gain on the sale transaction of $1,047,000 has been deferred and is being recognized on a straight-line basis over the period of the lease as a reduction in lease expense. The deferred gain, net of accumulated amortization, was $887,000 as of March 31, 2002. (5) LONG-TERM DEBT Long-term debt, including capital lease obligations, consists of the following at March 31, 2002 (in thousands): Term loan from a bank in India, bearing interest at 3.5% over the bank's medium term prime rate (for an effective rate of 16.0% at March 31, 2002) payable monthly, principal due in quarterly installments beginning June 2000 and ending March 2005, secured by substantially all of the Company's assets located in India and guaranteed by a major shareholder $ 703 Capital lease obligations maturing at dates ranging from July 2003 to December 2006, secured by the leased assets 1,444 Other 123 -------- Total 2,270 Less current portion 676 -------- $ 1,594 ======== F-16 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The long-term debt and capital lease obligations mature in each of the following years ending March 31 (in thousands): LONG-TERM CAPITAL LEASE DEBT OBLIGATIONS --------- ------------- 2003 $ 259 $ 548 2004 366 506 2005 176 370 2006 8 189 2007 7 133 Thereafter 10 -- --------- --------- Total minimum payments $ 826 1,746 ======== Less amount representing interest (302) --------- Present value of minimum capital lease payments 1,444 ========== (6) STOCKHOLDERS' EQUITY In September 1999, the Company issued warrants to purchase 170,000 shares of its common stock at exercise prices ranging from $4.71 to $4.84 per share to third parties related to the acquisition of NetGuru systems. Each warrant is convertible into one share of common stock. Through March 31, 2002, 135,000 of these warrants had been converted into common stock. The remaining 35,000 warrants expire between September 2002 and September 2004. In February 2000, the Company issued warrants to purchase 200,000 shares of common stock at an exercise price of $38.00 per share to an investor in consideration for the holder's decision to exercise previously issued warrants for cash rather than via a cashless exercise. These warrants expire February 2005. In March 2000, in a private transaction not involving a public offering, the Company issued 12,000 shares of Series B 5% Cumulative Convertible Preferred Stock (which were later repurchased and retired in November 29, 2000) and warrants to purchase 102,000 shares of the Company's common stock at an exercise price of $28.50 per share for approximately $11,380,000, net of offering costs. These warrants expire between March 2003 and March 2005. In April 2000, the Company issued 25,000 shares of common stock as a portion of the purchase price for the acquisition of Allegria Software, Inc ("Allegria"). The recipients of these shares were given the right to demand the Company to repurchase these shares at a price of $28.60 per share at the end of one year. In April 2001, each of the former owners exercised this right. The total repurchase price is $715,000. Agreements were reached with all parties to extend cash payment for this repurchase over a twelve-month period. As of March 31, 2002, the Company had paid $146,000 to one of the former owners for the repurchase of 6,000 shares. The remaining $26,000 is to be paid by November 30, 2002, and has been accrued under "accrued expenses." The repurchase of 6,000 shares from another former owner was settled for a total of $100,000. As of March 31, 2002, $90,000 was paid and the remaining $10,000 has been accrued under "accrued expenses." The owner of the remaining 13,000 shares is holding F-17 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements the stock certificates until full payment is received for these shares. The total cash to be paid for this repurchase was $372,000, of which $128,000 has been paid as of March 31, 2002. Due to a dispute as a result of an apparent breach of the purchase agreement by the former owner, the Company believes that it is probable that the balance of $244,000 will not be paid and therefore has not accrued this amount as a liability. On June 22, 2000, the Company closed a private equity financing to issue to two investors, in a private transaction not involving a public offering. As part of this transaction, the Company issued warrants to purchase 60,000 shares of its common stock at an exercise price of $19.00 per share. These warrants expire in June 2005. The Company issued additional warrants to purchase 53,300 shares of its common stock at exercise prices ranging from $16.50 to $23.46 per share to third parties related to this financing transaction. These warrants expire between May and June 2003. On November 29, 2000, the Company issued warrants to purchase an aggregate of 200,000 shares of the Company's common stock at an exercise price of $3.93 per share to a third party in a transaction involving the purchase and retirement of all of its outstanding preferred stock. These warrants expire in November 2005. On January 2, 2002, in a private transaction not involving a public offering, the Company issued 300,000 shares of its common stock to three consultants (100,000 shares each) for $0.25 per share. The shares were issued as consideration for consulting services to be provided by the consultants for a period of three years ending January 2, 2005, but were fully earned when issued with no additional conditions to be satisfied. The Company recorded an expense of $525,000 for this transaction. On March 19, 2002, in a private transaction not involving a public offering, the Company issued 25,000 shares of its common stock to its external legal counsel as consideration for services provided and as a retainer. WARRANTS The following table summarizes the fair value of warrant issuances detailed above and the assumptions used in determining fair value.
Exercise Estimated Fair value of Number of price per life (in Risk-free warrants Grant date warrants share years) Volatility rate ($)(a) ---------- -------- ----- ------ ---------- ---- ------ September 1999 170,000 $4.71 - $4.84 3 - 5 93% 6.72% 541,500 February 2000 200,000 $38.00 5 93% 6.72% 4,666,000 March 2000 102,000 $28.50 3 - 5 93% 6.72% 4,302,780 June 2000 60,000 $19.00 5 146% 4.87% 979,200 May-June 2000 53,300 $16.50 - $23.46 3 146% 4.87% 716,896 November 2000 200,000 $3.93 5 146% 4.87% 1,188,000
F-18 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (a) Fair value was determined using the Black-Scholes option-pricing model. The following table summarizes the warrant activity (in thousands, except dollar amounts): Weighted Number of average warrants exercise price ----------- ----------------- Outstanding at March 31, 2000 417 $ 26.53 Issued 313 $ 9.03 Exercised (80) $ 4.84 ----------- ----------------- Outstanding at March 31, 2001 650 $ 20.76 Issued - $ - Exercised - $ - ----------- ----------------- Outstanding at March 31, 2002 650 $ 20.76 =========== ================= STOCK OPTION PLANS The Company has adopted the following employee stock option plans:
SHARES ADOPTED TERMINATES AUTHORIZED -------------------- ---------------------- --------------- NetGuru, Inc. 2000 Stock Option Plan (the "2000 Plan") December, 2000 November, 2010 1,000,000 Research Engineers, Inc. 1998 Stock Option Plan (the "1998 Plan") December, 1998 November, 2008 1,000,000 Research Engineers, Inc. 1997 Stock Option Plan (the "1997 Plan") February, 1997 February, 2007 600,000 Research Engineers, Inc. 1996 Stock Option Plan (the "1996 Plan") April, 1996 April, 2006 588,000
Each plan provides for the granting of shares as either Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NQOs). Options under all plans generally vest over 3 years, though the vesting periods may vary from person to person, and are exercisable subject to continued employment and other conditions. As of March 31, 2002, there were 563,000 options available for grant and 131,000 options exercisable under the 2000 Plan, 137,000 options available for grant and 722,000 options exercisable under the 1998 Plan, 34,000 options available for grant and 354,000 options exercisable under the 1997 Plan, and 21,000 options available for grant and 395,000 options exercisable under the 1996 Plan. F-19 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The following is a summary of activity related to all outstanding stock options (number of shares in thousands):
WEIGHTED AVERAGE NUMBER OF EXERCISE PRICE SHARES PER OPTION ---------------- ----------------- Outstanding at March 31, 2000 2,000 $2.71 Granted 534 4.11 Exercised (100) 2.06 Forfeited (176) 4.49 ---------------- Outstanding at March 31, 2001 2,258 $2.93 Granted 54 1.35 Exercised (145) 1.42 Forfeited (134) 5.61 ---------------- Outstanding at March 31, 2002 2,033 $2.81 ================
As discussed in Note 1, the Company accounts for our stock options issued to employees based on the intrinsic value of a grant as of the date of the grant in accordance with APB No. 25. Generally, the Company issues stock options to employees with a grant price equal to the market value of common stock on the grant date. The Company has, in prior fiscal years, issued certain stock options with a grant price below the market value at the grant date. Compensation expense on these grants is recognized over the vesting period, generally three to four years. Compensation expense recognized in the Company's consolidated financial statements for these grants for fiscal years 2002 and 2001 was $78,000 and $136,000, respectively. As required by SFAS No. 123, the Company discloses below the pro forma and assumption information for stock options using the fair value method (dollars in thousands, except amounts per share): For the fiscal years ended March 31, 2002 2001 ------------ ------------ Net loss - as reported $ (8,944) $ (6,637) Net loss - pro forma (11,504) (9,181) ============ ============ Basic net loss per share - as reported $ (0.53) $ (0.45) pro forma (0.68) (0.60) Diluted net loss per share - as reported (0.53) (0.45) pro forma (0.68) (0.60) ============ ============ Weighted average fair value of options granted $ 1.35 $ 3.41 ============ ============ Black-Scholes option pricing model assumptions: Dividend yield -- -- Expected volatility 120% 146% Risk-free interest rate 5.07% 4.87% Expected option lives (in years) 7.0 7.5 F-20 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The following table summarizes options outstanding and exercisable by price range at March 31, 2002.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE Weighted- Average Remaining Weighted- Weighted- Range Of Exercise Number Of Contractual Average Exercisable At Average Prices Options Life Exercise Price March 31, 2002 Exercise Price ------ ------- ---- -------------- -------------- -------------- $ 0.00 - $ 3.80 1,893,632 6.3 $2.21 1,568,466 $2.04 $ 3.80 - $ 7.60 10,200 7.5 $4.25 10,200 $4.25 $ 7.60 - $ 11.40 114,000 6.9 $10.36 80,666 $10.32 $ 11.40 - $ 19.00 8,000 8.3 $18.06 2,667 $18.06 $ 19.00 - $ 22.80 7,000 - $21.68 7,000 $21.68
At March 31, 2002, the range of exercise prices and the weighted average remaining contractual life of outstanding options were $1.35 - $21.68 and 6.3 years, respectively. (7) RELATED PARTY TRANSACTIONS The Company has previously provided digital media production services to Ruby Pictures, Inc. ("Ruby"). Ruby is a movie production house owned and operated by the Purabi Das Foundation, Inc., a charitable organization founded by Amrit Das, the Company's Chairman and CEO. In fiscal 2001, the Company entered into an agreement with Ruby to purchase the rights to a digital film produced by Ruby for $500,000, net of any un-reimbursed costs incurred by the Company in the production of this film. The outstanding receivable balance due from Ruby was offset against the purchase price, and a net payment was made in April 2001. In fiscal 2002, the Company recorded an impairment charge of $684,000 related to the write-off of capitalized film production costs. On May 3, 2001, the Company entered into an interest bearing secured loan agreement and promissory note with Mr. Santanu Das, an officer and director of the Company, in the amount of $70,000 at an annual interest rate of 6%. The loan was payable through payroll withholdings commencing on August 24, 2001 through August 4, 2006. Shares of netGuru common stock owned by Mr. Das as well as all vested but unexercised options granted him secured the loan. At March 31, 2002, the total outstanding balance on this loan was $64,000, which is included in notes and related party receivable. In April 2002, Mr. Das paid-off the outstanding balance of this loan in full. In November 2000, the Company entered into a non-interest bearing secured loan agreement and promissory note with Mr. Stephen Owen, an officer and director of the Company, in the amount of $85,000. The loan is secured by Mr. Owen's pledge of the proceeds from the exercise and sale of his vested options. As of March 31, 2002, the entire amount of the loan is outstanding and is included in notes and related party receivable. In April 2002, Mr. Owen repaid $7,030 toward this loan. F-21 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (8) RETIREMENT PLANS The Company and certain of its subsidiaries have adopted qualified cash or deferred 401(k) retirement savings plans. The domestic plan covers substantially all domestic employees who have attained age 21 and have had one year of service. Employees may contribute up to 14% of their compensation. The Company makes matching contributions to the plan of 75% to 100% of the employees' elective contributions for the first 6% of compensation. For the years ended March 31, 2002 and 2001, Company contributions to the retirement plans were $231,000 and $218,000, respectively. The international employees are not covered by any retire- ment plans. However, the Company's subsidiary in the United Kingdom allows executives to defer a portion of their salary on a pretax basis to a retirement account of their choice. The Company does not match these contributions. (9) COMMITMENTS AND CONTINGENCIES The Company leases certain facilities and equipment under non-cancelable operating leases. The facility leases include options to extend the lease terms and provisions for payment of property taxes, insurance and maintenance expenses. At March 31, 2002, future minimum annual rental commitments under these lease obligations were as follows (in thousands): Year ending March 31: 2003 $ 590 2004 455 2005 382 2006 374 2007 316 Thereafter 2,366 --------------- $ 4,483 =============== Rent expense was $708,000 and $738,000 for the years ended March 31, 2002 and 2001, respectively. The Company has entered into a renewable firm purchase commitment in the amount of $800,000 to purchase airline tickets it sells as a ticket consolidator for a period of six months ending in August 15, 2002. If the Company is unable to meet this commitment during this period, the Company will owe the airlines the difference between commitment amount and the amounts received by the airlines from the Company's ticket sales during this period, subject to certain conditions. The Company is a party to various litigation arising in the normal course of business. Management believes the disposition of these matters will not have a material adverse effect on our results of operations or financial condition. F-22 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (10) INCOME TAXES The components of loss before income taxes are as follows for the year ended March 31, (in thousands): 2002 2001 ------------ ------------ United States $ (6,176) $ (5,914) Foreign (1,576) (266) ------------ ------------ Total (7,752) (6,180) ============ ============ The provision (benefit) for income taxes is comprised of the following for the year ended March 31, (in thousands): 2002 2001 ------------- ------------- Current: Federal $ (167) $ -- State 2 4 Foreign 70 136 ------------- ------------- (95) 140 Deferred: Federal 1,066 271 State 228 46 Foreign (7) -- ------------- ------------- 1,287 317 ------------- ------------- Total $ 1,192 $ 457 ============= ============= The reported provision (benefit) for income taxes differs from the amount computed by applying the statutory federal income tax rate of 34% to loss before income taxes as follows for the year ended March 31, (in thousands): 2002 2001 ------------ ----------- Income tax benefit at statutory rate $ (2,636) $ (2,101) State taxes, net of federal benefits (36) (255) Foreign income tax rate differential 649 123 Change in valuation allowance 2,529 2,564 Tax portion intangible asset write-off 424 -- Rate differential on net operating loss carry back benefit 100 -- Research and development credits (25) (18) Nondeductible amortization 58 83 Other 129 61 ------------ ----------- Total $ 1,192 $ 457 ============ =========== F-23 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The Company provides deferred income taxes for temporary differences between assets and liabilities recognized for financial reporting and income tax purposes. The tax effects of temporary differences at March 31, 2002 are as follows (in thousands): Deferred tax assets: Accrued vacation $ 127 Allowance for doubtful accounts 267 Amortization of intangibles 571 Net operating loss carryforwards 3,469 Foreign tax credit carryforwards 133 Research and development credit carryforwards 167 Gain on sale of property 367 Restructuring reserve 62 Other 1 Total deferred tax assets 5,164 Less: valuation allowance (5,164) Net deferred tax assets - Deferred tax liabilities: Depreciation (116) Cash to accrual adjustment (56) --------------- Total deferred tax liabilities $ (172) =============== At March 31, 2002, the Company had tax net operating loss carryforwards of approximately $9,321,000 for federal and $5,133,000 for state income tax purposes, which expire at varying dates beginning in 2019 and 2004, respectively. Due to the "change in ownership" provisions of the Tax Reform Act of 1986, the Company's net operating loss carryforwards may be subject to an annual limitation on the utilization of these carryforwards against taxable income in future periods if a cumulative change in ownership of more than 50% occurs within any three-year period. In addition to the net operating loss carryforwards, the Company has, for federal income tax purposes, $108,000 of research and development credit carryforwards and $133,000 of foreign tax credit carryforwards, which expire at varying dates beginning in 2013 and 2003, respectively. Additionally, the Company has, for state income tax purposes, $90,000 of research and development credit, which carries forward indefinitely. In assessing the realizability of the net deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon either the generation of future taxable income during the periods in which those temporary differences become deductible or the carryback of losses to recover income taxes previously paid during the carryback period. As of March 31, 2002, the Company had provided a valuation allowance of $5,164,000 to reduce the net deferred tax assets due in part to the potential expiration of certain tax credit and net operating loss carryforwards prior to their utilization. F-24 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Undistributed earnings of certain of the Company's foreign subsidiaries in the cumulative amount of $1,436,000 are considered to be indefinitely reinvested and, accordingly, no provision for United States federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both federal income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. (11) SEGMENT AND GEOGRAPHIC DATA The Company is an integrated Internet and IT technology and services company operating in three primary business segments: 1) engineering software products, maintenance and services, including digital media products and animation services; 2) IT services; and 3) Internet content and e-commerce focused on telecommunication and travel services, and collaborative software solutions. The Company has provided computer-aided engineering software solutions to customers for over 21 years. During the past 19 years, the Company has supported the engineering software business with India-based software programming and IT resources. In addition, based upon the Company's knowledge and understanding of the engineering software market, combined with the Company's Internet technology resources and experience, the Company launched Web4engineers.com, an engineering applications service provider ("ASP") portal hosting the Company's engineering software applications online and providing ASP services to engineering software providers and their licensees worldwide. With the acquisitions of R-Cube Technologies in February 1999 and NetGuru Systems completed in December 1999, the Company further expanded its IT resources and capabilities and its presence in the IT services industry, providing expertise in data-mining and embedded technologies, Internet/Intranet design and development and systems and software integration and implementation to companies in North America. The Company has expanded its IT services business into Europe and intends to further expand its services in India and Southeast Asia. With the Company's experience in India and understanding of the global Indian community, it began offering online Internet portal services in 1999. In fiscal 2001, the Company's portal offerings were refocused primarily on telecommunication and travel services Asian expatriates. The Company continues to provide digital media services, including computer animation, and has used this expertise to enhance its Internet portal offerings. F-25 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The significant components of worldwide operations by reportable operating segment (in thousands) are:
FOR THE YEAR ENDED MARCH 31 --------------------------- 2002 2001 --------- --------- (IN THOUSANDS) NET REVENUE Software sales, maintenance and services $ 9,313 $ 10,066 IT services 9,869 18,019 Internet, e-commerce and collaborative software solutions 5,102 3,217 --------- --------- Consolidated $ 24,284 $ 31,302 ========= ========= GROSS PROFIT Software sales, maintenance and services $ 8,205 $ 7,761 IT services 2,385 5,796 Internet, e-commerce and collaborative software solutions 872 1,003 --------- --------- Consolidated $ 11,462 $ 14,560 ========= ========= OPERATING (LOSS)/INCOME Software sales, maintenance and services $ (4,021) $ (3,773) IT services (749) 1,994 Internet, e-commerce and collaborative software solutions (2,802) (4,740) --------- --------- Consolidated $ (7,572) $ (6,519) ========= ========= AMORTIZATION OF GOODWILL Software sales, maintenance and services $ 290 $ 489 IT Services 550 549 Internet, e-commerce, collaborative software solutions 450 322 --------- --------- Consolidated $ 1,290 $ 1,360 ========= ========= AMORTIZATION EXPENSE CHARGED TO COST OF REVENUES Software sales, maintenance and services $ 118 $ 248 IT Services -- -- Internet, e-commerce, collaborative software solutions 80 36 --------- --------- Consolidated $ 198 $ 284 ========= ========= DEPRECIATION & AMORTIZATION EXPENSE CHARGED TO OPERATIONS Software sales, maintenance and services $ 1,164 $ 764 IT Services 60 32 Internet, e-commerce, collaborative software solutions 19 2 --------- --------- Consolidated $ 1,243 $ 798 ========= ========= RESTRUCTURE CHARGE Software sales, maintenance and services $ 25 $ 208 IT Services -- -- Internet, e-commerce, collaborative software solutions -- 2,192 --------- --------- Consolidated $ 25 $ 2,400 ========= ========= F-26
FOR THE YEAR ENDED MARCH 31 ----------------------------- 2002 2001 ------------- ------------- (IN THOUSANDS) IMPAIRMENT CHARGE Software sales, maintenance and services $ 684 $ - IT Services - - Internet, e-commerce, collaborative software solutions 967 - ------------- ------------- Consolidated $ 1,651 $ - ============= ============= EXPENDITURES FOR ADDITIONS TO LONG-LIVED ASSETS Software sales, maintenance and services $ 374 $ 1,837 IT Services 6 4 Internet, e-commerce, collaborative software solutions 14 2,757 ------------- ------------- Consolidated $ 394 $ 4,598 ============= ============= The Company's operations are based worldwide through foreign and domestic subsidiaries and branch offices in the United States, Germany, India, the United Kingdom, and Asia-Pacific. The following are significant components of worldwide operations by geographic location: FOR THE YEAR ENDED MARCH 31 ----------------------------- 2002 2001 ------------ ------------- (IN THOUSANDS) NET REVENUE United States $ 18,260 $ 25,316 The Americas (other than U.S.) 574 728 Europe 2,757 2,755 Asia-Pacific 2,693 2,503 ------------- ------------- Consolidated $ 24,284 $ 31,302 ============= ============= EXPORT SALES United States $ 615 $ 1,078 ============= ============= LONG-LIVED ASSETS United States $ 12,434 $ 14,621 Europe 284 324 Asia-Pacific 1,440 2,710 ------------- ------------- Consolidated $ 14,158 $ 17,655 ============= ============= F-27 NETGURU, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (12) LOSS PER SHARE The following table illustrates the computation of basic and diluted net loss per share for the years ended March 31, (in thousands): 2002 2001 ---------- ---------- Numerator: Net loss -- numerator for basic and diluted net loss per share $ (8,944) $ (6,637) Denominator: Denominator for basic net loss per share - average number of common shares outstanding during the year 16,982 14,781 Incremental common shares attributable to exercise of outstanding options and warrants -- -- ---------- ---------- Denominator for diluted net loss per share 16,982 14,781 ========== ========== Basic net loss per share $ (0.53) $ (0.45) ========== ========== Diluted net loss per share $ (0.53) $ (0.45) ========== ========== Options, warrants and other common stock equivalents amounting to 485,000 and 1,700,000 potential common shares were excluded from the computation of diluted EPS for fiscal 2002 and 2001, respectively, because the Company reported a net loss and, therefore, the effect would be antidilutive. (13) LIQUIDITY The Company incurred net losses of $8,944,000 and $6,637,000 and has used cash in operations of $3,225,000 and $661,000 in fiscal years 2002 and 2001, respectively. The Company's future capital requirements will depend upon many factors, including sales and marketing efforts, the development of new products and services, possible future strategic acquisitions, the progress of research and development efforts, and the status of competitive products and services. The Company believes it will be able to generate cash from operations or through additional sources of debt and equity financing. The Company has continued its program to reduce costs and expenses. If adequate funds are not available, the Company may be required to delay, scale back, or eliminate its research and development programs and its marketing efforts or to obtain funds through arrangements with partners or others who may require the Company to relinquish rights to certain of its technologies or potential products or assets. F-28 INDEX TO EXHIBITS FILED WITH THIS AMENDMENT NO. 3 TO FORM 10-KSB EXHIBIT NO. DESCRIPTION ----------- ----------- 10.19 Salary deferral arrangement for executives of Research Engineers (Europe) Ltd. 23.1 Consent of KPMG LLP. 99.1 Certifications of 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 44