NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007, 2006 AND 2005
NOTE 1. ORGANIZATION AND PRINCIPAL ACTIVITIES OF THE
GROUP
Silverstar Holdings, Ltd. (“the Company) is the parent company of Empire Interactive,
PLC (“Empire”), a leading worldwide publisher of interactive entertainment
software for all game platforms, as well as Strategy First, Inc. (“Strategy
First”), a leading worldwide publisher of entertainment software for the Personal
Computer (PC). The Company is also a minority shareholder in Magnolia Broadband Wireless, a
development stage company which is developing mobile wireless broadband products.
On November 17, 2000, the Company acquired Fantasy Sports, Inc. (“Fantasy”).
Fantasy specializes in Internet-based subscriptions for NASCAR, college football and
basketball and other fantasy sports games. On April 7, 2006, the Company sold substantially
all the assets and transferred certain liabilities of Fantasy Sports, Inc which is
reflected as discontinued operations in the accompanying financial statements. (See Note
14.)
In April 2005, the Company acquired Strategy First Inc. (www.strategyfirst.com), a leading
developer and worldwide publisher of entertainment software for the PC. Founded in 1990,
the company publishes software games primarily for the PC platform.
On December 4, 2006, the Company announced that it had achieved more than 90% acceptance of
its offer to acquire the shares of Empire. Based on these acceptances, the Company
announced a formal closing of the offer to Empire shareholders effective December 1, 2006.
Empire develops and publishes software games for all game platforms. Some of its popular
games include the FlatOut Ford Racing franchises, Big Mutha Truckers, Taito Legends,
Starsky & Hutch, Starship Troopers, and International Cricket Captain.
The Company currently has Class A common stock shares outstanding. Holders of Class A
common stock have one vote per share on each matter submitted to a vote of the shareholders
and a ratable right to the net assets of the Company upon liquidation. Holders of the
common stock do not have preemptive rights to purchase additional shares of common stock or
other subscription rights. The Class A common stock carries no conversion rights and is not
subject to redemption or to any sinking fund provisions. All shares of Class A common stock
are entitled to share equally in dividends from legally available resources as determined
by the board of directors. Upon dissolution or liquidation of the Company, whether
voluntary or involuntary, holders of the Class A common stock are entitled to receive
assets of the Company available for distribution to the shareholders.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
The consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States and incorporate the following
significant accounting policies:
Consolidation
The consolidated financial statements include the accounts of the Company and all of its
subsidiaries in which it has a majority voting interest. Investments in affiliates are
accounted for under the cost method of accounting, where appropriate. All significant
inter-company accounts and transactions have been eliminated in the consolidated financial
statements. The entities included in these consolidated financial statements are as
follows:
F-7
|
Silverstar Holdings, Ltd.
(Parent Company)
|
|
Silverstar Holdings,
Inc.
|
|
First South Africa
Management Corp.
|
|
First South African
Holdings, Ltd. (FSAH)
|
|
Fantasy Sports, Inc.
(Dormant)
|
|
Strategy First,
Inc.
|
|
Silverstar Acquisitions
PLC
|
|
Empire Interactive Europe
Limited
|
|
Empire Interactive,
Inc
Empire Interactive Holdings
Limited
|
|
Razorworks Limited
(Dormant)
Xplosiv Limited
(Dormant)
|
|
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and all highly liquid investments with original
maturities of three months or less.
Concentrations of Credit and Market Risks
Financial instruments that potentially subject the Company to concentrations of credit and
market risk are comprised of cash and cash equivalents, accounts receivable and notes
receivable. The Company did not have a major concentration of customers for the fiscal
years ended June 30, 2007 and 2005. For the fiscal year ended June 30, 2006, Strategy First
conducted a major portion of its business with four customers, each of whom accounted for
more than 10% of total revenues. Combined sales to these customers amounted to
approximately $1,998,000 (60% of net sales) during the year ended June 30, 2006. Accounts
receivable from these customers amounted to $414,000 (65%) of total accounts receivable at
June 30, 2006.
Cash
The Company currently maintains a substantial amount of cash and cash equivalents with
financial institutions in South Africa denominated in South African Rand. Changes in the
value of the Rand compared to the U.S. dollar may still have an unfavorable impact on the
value of the cash and cash equivalents. In addition, these financial instruments are not
subject to credit insurance.
The Company maintains deposit balances at U.S. financial institutions that, from time to
time, may exceed federally insured limits. The Company maintains its cash with high quality
financial institutions, which the Company believes limits risk. As of June 30, 2007,
amounts in excess of federally insured amounts totaled approximately $4,702,000.
F-8
Accounts Receivable
We extend credit to various companies in the retail and mass merchandising industries.
Collection of trade receivables may be affected by changes in economic or other industry
conditions and may, accordingly, impact our overall credit risk. Although we generally do
not require collateral, we perform ongoing credit evaluations of our customers and maintain
reserves for potential credit losses. Significant judgment is required to estimate our
allowance for doubtful accounts in any accounting period. We analyze customer
concentrations, customer credit worthiness and current economic trends when evaluating the
adequacy of the allowance for doubtful accounts.
Notes Receivable
The Company’s notes receivable are to be settled in South African Rand by South
African companies. The Company’s ability to collect on these notes may be affected by
the financial condition of the debtor’s economic conditions in South Africa and the
value of the South African Rand, as compared to the U.S. dollar. In addition, the
Company’s ability to withdraw these funds from South Africa after collection may be
subject to approval by the South African government.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, accounts receivable, and accounts payable
approximate fair value due to the short-term nature of these instruments. The carrying
value of long-term notes receivable approximates fair values since interest rates are keyed
to the South African prime lending rate. The gross carrying value of the Company’s
convertible debenture approximates fair value since interest rates are keyed to the US
prime lending rate. The carrying value of the Company’s other debt approximates fair
value since their terms are consistent with prevailing market rates.
Inventories
Inventories are valued at the lower of
cost or market with cost determined on the first-in, first-out method. Inventory represents
mainly finished goods for resale together with some of the component materials necessary to
a completed software product. Cost represents only the purchase price of component
materials. No overheads are incorporated into the inventory value.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation is taken on property and
equipment using accelerated and straight-line methods over the expected lives of the
assets. Estimated useful lives of fixed assets are as follows:
|
Years
|
Property
|
50
|
Leasehold improvements
|
5
|
Furniture and equipment
|
4-5
|
Development equipment
|
2
|
Motor vehicles
|
4
|
Development Costs
Under SFAS No. 86 software development cost should be capitalized once technical
feasibility is achieved. In the case of Empire this would be when the product is
commercially viable (“commercial feasibility), The Company has determined to its
satisfaction that there is a clearly defined decision point quite early in development
where a product passes from concept to commercial feasibility. This decision point is
either reached with the consent of outside parties such as Sony or Microsoft or through an
internal process where management decides to move forward with a product’s
development once a game
F-9
concept has been approved. The Company also
found that there has been no material instance where concept approval has been given and a
game has not become a commercial product. The Company has, therefore, decided to capitalize
software development costs after concept approval.
Goodwill
The Company adopted Statement of Financial Accounting Standards No. 142 (SFAS 142),
Goodwill and Other Intangible Assets. Goodwill and other intangible assets with indefinite
lives must be tested for impairment on an annual basis. The Company performs this annual
impairment test at fiscal year end for goodwill.
SFAS 142 requires the Company to compare the fair value of the reporting unit to its
carrying amount on an annual basis to determine if there is potential goodwill impairment.
If the fair value of the reporting unit is less than its carrying value, an impairment loss
is recorded to the extent that the fair value of the goodwill within the reporting unit is
less than its carrying value. SFAS 142 also requires the Company to compare the fair value
of an intangible asset to its carrying amount. If the carrying amount of the intangible
asset exceeds its fair value, an impairment loss is recognized. Fair values for goodwill
and other indefinite-lived intangible assets are determined based on discounted cash flows
or market multiples as appropriate.
The Company’s goodwill represents the excess acquisition cost over the fair value of
the tangible and identified intangible net assets of Strategy First acquired in 2005. For
the years ended June 30, 2007, 2006 and 2005, the Company applied what it believes to be
the most appropriate valuation methodology for the reporting unit. If the Company had
utilized different valuation methodologies, the impairment test results could differ. There
was no impairment of goodwill for the years ended June 30, 2007, 2006 and 2005.
Intangible Assets
Intangible assets include software game titles and non-competition agreements. Intangible
assets, excluding goodwill and Empire game titles are stated on the basis of cost and are
amortized on a straight-line basis over estimated lives of three to ten years. Empire game
titles are amortized over a five-year period based on weighted average expected sales from
the date the title is launched. For titles that have not yet been launched as of June 30,
2007 a launch date was estimated to project future amortization. (See Note 11.)
Intangible assets with indefinite lives are not amortized but are evaluated for impairment
annually unless circumstances dictate otherwise. Management periodically reviews intangible
assets for impairment based on an assessment of undiscounted future cash flows, which are
compared to the carrying value of the intangible assets. Should these cash flows not equal
or exceed the carrying value of the intangible, a discounted cash flow model is used to
determine the extent of any impairment charge required.
Foreign Currency Translation
The functional currency of the Company is the United States Dollar; the functional currency
of FSAH is the South African Rand; the functional currency of Strategy First, Inc. is the
Canadian Dollar and the functional currency of Empire is the Pound Sterling. Accordingly,
the following rates of exchange have been used for translation purposes:
Assets and liabilities are translated into United States Dollars using exchange rates at
the balance sheet date. Common stock and additional paid-in capital are translated into
United States Dollars using historical rates at date of issuance. Revenue and expenses are
translated into United States Dollars using the weighted average exchange rates for each
year. The resultant translation adjustments for FSAH are reported in the statement of
operations since FSAH has sold all its operating subsidiaries. The
F-10
resultant translation adjustments for
Strategy First and Empire are reported as other comprehensive income.
Revenue Recognition
Empire and Strategy First distribute the majority of their products through third-party
software distributors to mass-merchant and major retailers and directly to certain
entertainment software retailers, all of which have traditionally sold consumer
entertainment software products. Additionally, the companies may license their products to
distributors in exchange for royalty payments. The distribution of products is governed by
purchase orders, distribution agreements or direct sale agreements, most of which allow for
product returns and price markdowns. For product shipments to these software distributors
or retailers, the companies record a provision for product returns and price markdowns as a
reduction of gross sales at the time the product passes to these distributors or
retailers.
The provision for anticipated product returns and price markdowns is primarily based upon
the company’s analysis of historical product return and price markdown results.
Should product sell-through results at retail store locations fall significantly below
anticipated levels the adequacy of this allowance may be insufficient. The companies review
the adequacy of their respective allowances for product returns and price markdowns and if
necessary make adjustments.
In the case of royalty income, the companies record this income when earned based on sales
reports from its distributors. In many cases, the companies receive guaranteed royalty
income and these revenues are recorded upon signing of the royalty agreements. These
amounts are carried as accounts receivable until paid.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs for the years ending June 30,
2007, 2006 and 2005 were $1,815,837, $182,295, and $10,691, respectively.
Income Taxes
The Company accounts for its income taxes using SFAS No. 109, “
Accounting for
Income Taxes
”, which requires the recognition of deferred tax liabilities and
assets for expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred tax liabilities and assets
are determined based on the difference between the financial statement and tax bases of
assets and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
Stock-Based Compensation
In December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 123R,
“Share-Based Payment.” This standard replaced SFAS No. 123, “Accounting
for Stock-Based Compensation” and supersedes Accounting Principles Board
(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.”
The standard requires companies to recognize all share-based payments to employees,
including grants of employee stock options, in the financial statements based on their fair
values on the grant date and is effective for annual periods beginning after June 15, 2005.
In accordance with the revised statement, the Company recognized the expenses attributable
to stock options granted or vested subsequent to July 1, 2005. During the fiscal years
ended June 30, 2007 and 2006 the Company recognized expenses of $218,638 and $104,634
respectively, for employee stock options that vested during fiscal years 2007 and 2006. The
company also recognized expenses of $41,667 and $8,333 for the vesting of 37,955 restricted
shares that were granted in the fourth quarter of the fiscal year ended June 30, 2006. On
June 27, 2007 the company granted restricted stock awards to members of the Board of
Directors totaling $120,000. These awards will vest on March 29, 2008 and will be expensed
ratably until fully vested.
F-11
SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No.
123”), encouraged but did not require companies to record stock-based compensation
plans using a fair value based method. The Company chose to account for stock-based
compensation using the intrinsic value based method described in APB Opinion No. 25,
“Accounting for Stock Issued to Employees” for accounting periods ending before
July 1, 2005. Accordingly, compensation cost for stock options is measured as the excess,
if any, of the quoted market price of the Company’s common stock at the date of the
grant over the amount an employee must pay to acquire the stock.
If the Company used the fair value-based method of accounting to measure compensation
expense for options granted at the date they were granted as prescribed by SFAS No. 123
earnings (loss) per share from continuing operations for the year ended June 30, 2005 would
have changed to the pro forma amounts set forth in the table below.
|
2005
|
|
Income (Loss) from
continuing
operations as
reported
|
($ 263,798)
|
|
Less compensation expense
for options
|
|
|
awards determined by the
fair-value-
based method
|
(677,245)
|
|
Income (Loss) from
continuing
operations, pro
forma
|
($
941,043)
|
|
|
|
|
Basic:
|
|
|
As reported
|
($ 0.03)
|
|
Pro
forma
|
($ 0.10)
|
|
Assuming full
dilution:
|
|
|
As reported
|
($ 0.03)
|
|
Proforma
|
($ 0.10)
|
|
|
|
|
The weighted average grant date fair
value of options granted in 2007, 2006 and 2005 and the significant assumptions used in
determining the underlying fair value of each option grant on the date of the grant
utilizing the Black Scholes option pricing model are noted in the following table. Expected
volatility is based on historical volatility data of the Company’s stock. As a result
of the acquisition of Empire which significantly changed the size and complexity of the
Company, the volatility of options granted after March 31, 2007 were computed using the
average volatility of competitor companies in the entertainment software industry.
Historical stock prices would not be indicative of their future prices, since the Company
itself is so different from what it was historically. SFAS 123(R) requires the use of
expected volatility in the calculation of the compensation expense of a stock option. While
it allows the use of historical volatility in calculating expected volatility, it does not
require the use of historical volatility and encourages the use of other
factors.
The expected term of stock options
granted is based on historical data and represents the period of time that stock options
are expected to be outstanding. The risk-free rate of the stock options is based on the
United States Treasury rate in effect at the time of grant.
|
2007
|
2006
|
2005
|
Weighted average grant-date
fair value of options granted
|
$ 0.69
|
$ 1.08
|
$ 0.94
|
Assumptions:
|
|
|
|
Risk free interest
rate
|
4.65-4.82%
|
4.82%
|
3.19-4.01%
|
Expected life
|
0-5 years
|
5 years
|
3-5 years
|
Expected
volatility
|
42-111%
|
111%
|
126-142%
|
Expected dividend
yield
|
0.00%
|
0.00%
|
0.00
|
F-12
Based on existing unvested option agreements the Company anticipates an additional expense
of approximately $242,926 in fiscal 2008 which could increase if additional options are
granted during the fiscal year. As of June 30, 2007, $291,376 of the total unrecognized
compensation costs related to non-vested options is scheduled to be recognized over a
weighted average period of 2.58 years.
Net Income (Loss) Per
Share
Basic net income or loss per share is computed by dividing net income or loss by the
weighted average number of common shares outstanding. Diluted net income or loss per share
is computed by dividing net income or loss by the weighted average number of common shares
outstanding and dilutive potential common shares reflecting the dilutive effect of stock
options, warrants, convertible debentures and shares to be issued in connection with prior
acquisitions unless their effect is anti-dilutive. Dilutive potential common shares, stock
options, warrants and convertible debentures for all periods presented are computed
utilizing the treasury stock method. The dilutive effect of shares to be issued in
connection with the obligations related to prior acquisitions is computed using the average
market price for the quarter.
Recently Issued Accounting
Standards
On February 15, 2007, the Financial Account Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement
No. 115” (FASB 159”). This standard permits an entity to measure financial
instruments and certain other items at the estimated fair value. Most of the provisions of
SFAS No. 159 are elective; however, the amendment to FASB No. 15, “Accounting for
Certain Investments in Debt and Equity Securities,” applies to all entities that own
trading and available-for-sale securities. The fair value option created by SFAS 159
permits an entity to measure eligible items at fair value as of specified election dates.
The fair value option (a) may generally be applied instrument by instrument, (b) is
irrevocable unless a new election date occurs, and (c) must be applied to the entire
instrument and not to only a portion of the instrument. SFAS 159 is effective as of the
beginning of the first fiscal year that begins after November 15, 2007. Early adoption is
permitted as of the beginning of the previous fiscal year provided that the entity (i)
makes that choice in the first 120 days of that year, (ii) has not yet issued financial
statements for any interim period of such year, and (iii) elects to apply the provisions of
FASB 157. We are currently evaluating the impact of SFAS 159, if any, on our consolidated
financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements
in Current Year Financial Statements (“SAB 108”). SAB 108 requires that in
evaluating the effects of prior year errors on current year financial statements, SEC
registrants must consider the effect of the errors on both the current year statement of
operations and the magnitude of the errors on the current year balance sheet. As a result,
SAB 108 could require prior year financial statements to be corrected for errors that had
previously been deemed immaterial. SAB 108 is effective for fiscal years ending after
November 15, 2006. The Company has determined that the impact of adopting this standard did
not have a material effect on its financial position or results of operations.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” This
Interpretation prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. This Interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods, disclosure, and
transition. The Interpretation is effective for fiscal years beginning after
December 15, 2006. The Company is currently analyzing the effect, if any, this
interpretation may have on its financial condition, results of operations, cash flows or
disclosures.
F-13
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”
This Statement defines fair value, establishes a framework for measuring fair value and
expands disclosure about fair value measurements, and is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim periods within those
fiscal years. The Company is currently evaluating the effect that the adoption of this
Statement will have on its consolidated results of operations and financial condition.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments, an amendment of FASB Statements No. 133 and 140.” This
statement permits fair value remeasurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation, and eliminates a
restriction on the passive derivative instruments that a qualifying special-purpose entity
(SPE) may hold. The statement is effective for fiscal years beginning after September 15,
2006. The Company does not believe this standard will have a material effect on its
financial position or results of operations.
Reclassifications
Certain amounts from prior years have been reclassified to conform to the 2007
presentation.
NOTE 3. LIQUIDITY AND
PROFITABILITY
As of June 30, 2007, our Balance Sheet reflects a working capital deficit. Until recently
our operations have not generated positive operating EBITDA or earnings and there is no
guarantee that our recent profitability (See Note 21) will be sustained. However, we
believe that a combination of our cash on hand, operating cash flow and additional
financing arrangements will be sufficient to meet our short and long-term obligations.
Management’s plans to meet its ongoing cash requirement as follows:
|
·
|
Raise additional capital through the sale of equity or additional debt. To this
end the Company announced on September 7, 2007 that it had completed a $9
million private placement of common stock and warrants with institutional
investors and management. Silverstar sold a total of 6,206,890 shares at $1.45
per share. Investors also received five year warrants to purchase approximately
4,344,826 shares of common stock at $2.10 per share. The Company may seek to
raise additional debt or equity during the 2008 fiscal year.
|
|
·
|
The Company amended the terms of its Secured Convertible Debentures with DKR
Soundshore Oasis in June 2007. Under the terms of the amendment (i) the
maturity dates of the Debentures were extended to April 30, 2010; (ii) there
will be no amortization of principal under the Debentures and (iii) the
Debentures will be mandatorily convertible if the closing sale price of the
Company’s common stock equals or exceeds $3.48 per share. The mandatory
conversion will be subject to volume requirements. Furthermore, as of September
21, 2007, an amount of $2.85 million of this Convertible debenture had been
converted and the Company has issued 1,420,478 shares of Class A common
stock.
|
|
·
|
Generate short term operating earnings and cash flow primarily through its
newly acquired subsidiary Empire. Empire’s first Next Generation version
of its best selling Flat Out franchise has performed well in Europe, generating
significant cash flow and is anticipated to meet or exceed the Company’s
sales expectations in the future. Furthermore the Company anticipates that
Empire’s ongoing business which includes planned releases in the next 12
months of such high profile titles as Jackass, Hello Kitty and Pipemania, will
generate operating profits and cash flow in the short term.
|
Management believes that these actions and others to be taken by the Company will provide
the opportunity for it to improve liquidity and achieve profitability. However, there can
be no assurance that all such events will occur to realize these goals.
F-14
NOTE 4.
ACQUISITIONS
Strategy First
On April 21, 2005, the Company acquired Strategy First, Inc. (www.strategyfirst.com), a
leading worldwide publisher of entertainment software for the PC. The Company acquired
Strategy First through the jurisdiction of the Montreal bankruptcy court. Pursuant to the
approved plan of arrangement, the Company (i) paid cash consideration to the creditors of
Strategy First of $609,000; (ii) issued 377,000 shares of our common stock; (iii) issued
warrants to purchase 200,000 shares of our common stock; (iv) and assumed approximately
$400,000 in existing bank debt, as well as contingent consideration based on the future
profitability of Strategy First.
The costs of the acquisition were allocated on the basis of the estimated fair values of
the assets acquired and liabilities assumed. Whereby the acquisition was accounted for
using the purchase method whereby intangible assets identified in connection with the
acquisition were recorded (and amortized where applicable) in accordance with the
provisions of SFAS No. 142.
Acquisition cost
|
$1,370,544
|
Net assets
acquired:
|
|
Current
assets
|
$297,244
|
Fixed
assets
|
82,664
|
Goodwill
|
764,089
|
Intangible assets
|
1,245,157
|
Total assets
|
$2,389,154
|
|
|
Current
liabilities
|
624,183
|
Long
term debt
|
394,397
|
Total liabilities
|
$1,018,580
|
|
|
|
$1,370,574
|
Empire Interactive
On December 4, 2006, the Company announced that it had achieved more than 90% acceptance of
its offer to acquire the shares of Empire. Based on these acceptances, the Company
announced a formal closing of the offer to Empire shareholders and took control effective
December 1, 2006.
The offer provided for either a cash payment of approximately $.13 per share (£.07
p), or an earn-out alternative, where the initial payment was approximately $.09 per share
(£.049 p), with a further $.094 per share (£.05 p) in loan notes payable in
October 2007. Additionally, there is an earn-out payable in April 2008. The earn-out was
based on a formula of Empire’s EBITDA (as defined) for the fiscal year ended June 30,
2007. The earn out has been calculated and the Company’s June 30, 2007 Balance Sheet
includes a liability of approximately £1.9 million, or $3.8 million USD based on the
June 30, 2007 foreign exchange rate of 2.0039 US dollar to the British pound.
The aggregate purchase price for Empire’s stock, was approximately $17.7 million or
£9.08 million (after adjusting for the actual earn out payable) based on the December
1, 2006 foreign exchange rate of 1.9508 US dollar to the UK pound of which amount
approximately $5.2 million are loan notes which mature October 31, 2007, and $3.8 million
are loan notes payable in April 2008 . $.7 million of the acquisition expenses were paid by
the issuance of 406,180 shares of Silverstar’s Class A common stock. Of this amount
350,000 shares were issued to a consultant to the Company as a finder’s fee for the
transaction pursuant to his consulting contract. The consultant was subsequently appointed
Chairman of the Board of Empire. Of the remaining $8.1 million of the purchase price
approximately $7.8 million has
F-15
been paid by utilizing the Company’s
internal cash resources. The remaining $.3 million has been accrued as a short-term
liability.
The purchase price was allocated on the basis of the estimated fair values of the assets
acquired and liabilities assumed. The fair value of the assets acquired and liabilities
assumed exceeded the purchase price and, therefore, the excess was allocated as a pro-rata
reduction of non-current assets, specifically intangible assets. The acquisition was
accounted for as a purchase. The intangible assets identified in connection with the
acquisition were recorded and are being amortized in accordance with the provisions of SFAS
No. 141 and 142.
Purchase price:
|
|
Net assets
acquired:
|
|
Current
assets
|
$3,226,230
|
Fixed assets
|
898,804
|
Intangible assets
|
22,816,055
|
Other assets
|
608,650
|
Total assets
|
27,549,739
|
Total liabilities
|
(9,856,885)
|
|
$17,692,854
|
The following unaudited proforma summary presents consolidated financial information as if
the acquisition of Empire had occurred effective July 1, 2006 and 2005, respectively. The
proforma information does not necessarily reflect the actual results that would have
occurred, nor is it necessarily indicative of future results of operations of the
consolidated entities.
|
Fiscal Years Ended June
30
,
|
|
2007
|
2006
|
Net revenues
|
$30,028,696
|
$26,989,382
|
Net (loss)
|
($4,287,987)
|
($12,303,801)
|
Income (loss) per
share
|
|
|
Basic and
diluted:
|
|
|
Continuing operations
|
($.44)
|
($1.47)
|
Discontinued operations
|
-
|
$0.17
|
Net loss
|
($.44)
|
($1.30)
|
NOTE 5. ACCOUNTS
RECEIVABLE
The components of accounts receivable are as follows at June 30, 2007 and 2006.
|
2007
|
2006
|
|
|
|
Accounts
receivable
|
10,632,994
|
$794,353
|
Less: allowance for
returns
|
(3,536,690)
|
(139,362)
|
Less: allowance for
doubtful accounts
|
(187,458)
|
(17,856)
|
|
|
|
|
$6,908,846
|
$637,135
|
|
|
|
NOTE 6.
INVENTORIES
Inventories consist of finished goods and component materials of $900,128 and $58,732 at
June 30, 2007 and 2006, respectively.
NOTE 7. PROPERTY, PLANT
AND EQUIPMENT
The components of property and equipment are as follows at June 30, 2007 and 2006.
F-16
|
2007
|
2006
|
|
|
|
Leasehold
improvements
|
$243,081
|
$
-
|
Furniture and
equipment
|
1,553,093
|
140,044
|
Development
equipment
|
1,646,352
|
-
|
Motor vehicles
|
40,192
|
-
|
|
|
|
|
3,482,718
|
140,044
|
Less accumulated
depreciation
|
2,994,687
|
(62,059)
|
|
|
|
|
$488,031
|
$77,985
|
|
|
|
Depreciation expense was approximately $160,000, $32,000 and $12,000 for the fiscal years
ended June 30, 2007, 2006 and 2005, respectively.
NOTE 8. SOFTWARE
DEVELOPMENT COSTS
At June 30, 2007, capitalized software costs are as follows:
|
2007
|
|
|
Capitalized Software
Costs
|
$5,524,293
|
Less accumulated
depreciation
|
(341,260)
|
|
|
|
$5,183,033
|
|
|
Software development costs are amortized over a five-year period based on weighted average
expected sales from the date commercial feasibility is reached. Amortization expense was
$337,243, $0, and $0 for the years ended June 30, 2007, 2006 and 2005, respectively
NOTE 9. INVESTMENTS
IN NON-MARKETABLE SECURITIES
A summary of the investments in non-marketable securities on the consolidated balance sheet
is presented below:
|
Effective
Percentage
|
As of and for the Year
Ended
|
Investments in
unconsolidated affiliates:
|
|
June 30,
2007
|
June 30,
2006
|
Magnolia Broadband,
Inc.
|
2.5%
|
$1,131,066
|
$1,131,066
|
Other
|
|
12,500
|
12,500
|
|
|
|
|
|
|
$1,143,566
|
$1,143,566
|
|
|
|
|
|
|
|
|
Between April 2000 and January 2006, the Company invested $3,250,000 in Magnolia through
the purchase of Series A and D Preferred Stock.
Magnolia Broadband is a development stage company established to develop and market
wireless based chips primarily for the mobile handset market.
In assessing the fair value of the Company’s investment in Magnolia, the Company
monitors their progress through monthly board meetings and additional formal and informal
communications. Magnolia, since inception, has set technical goals and timelines, which
were invariably met or surpassed. Furthermore, Magnolia excelled in hiring high level
technical staff with advanced degrees and experience in management of corporations such as
Nokia, Bell Labs, Motorola, and Anadigics. The willingness of highly qualified individuals
to leave established corporations for a start-up opportunity provided validation for our
belief in Magnolia’s potential. This promise was further validated by the significant
investments
F-17
made by leading venture capital funds in
various equity financings from 2002 through August 2006, and by positive field trials and
responses from potential customers in the United States and internationally.
Based on Magnolia’s achievements, some of which are summarized above, the Company
concluded that these positive accomplishments support the variables considered in
developing the valuations for the private placement transactions which the Company used as
a basis for concluding that its investment in Magnolia was not carried at a value in excess
of fair value on its financial statements.
The Company’s ongoing monitoring and evaluation described above continues. Over the
next twelve months, among other goals, Magnolia anticipates acceptance of its technology in
the UMTS networks and commercial sales through royalty agreements with baseband chipset
manufacturers.
In performing our analysis of the possible impairment of our investment in Magnolia as of
June 30, 2007, 2006 and 2005, we considered our investment in Magnolia in total in
accordance with paragraph 19(h) of APB No. 18.
In performing our analysis for 2005, we looked to the $13.5 million in financing Magnolia
received during the fiscal year from existing and major outside investors as well as the
progress Magnolia had made in developing its technology and meeting milestones, as
described above. The Company’s investment in Magnolia was not considered impaired at
June 30, 2005. We again computed the fair value of our holdings in Magnolia Broadband by
multiplying the number of shares we owned by the price for shares paid by investors in the
last placement round, which resulted in a fair value that was greater than the carrying
value of our investment. Additionally, we looked to an independent analysis of
Magnolia’s value performed by a leading investment bank and concluded from this, as
well, that the fair value of our holdings was greater than the carrying value of our
investment.
In performing our analysis for 2006, we looked to the $13 million in financing Magnolia
received during the fiscal year from existing investors as well as the $5 million in
financing they received from existing and outside investors in July 2006. The
Company’s investment in Magnolia was not considered impaired at June 30, 2006. We
again computed the fair value of our holdings in Magnolia Broadband by multiplying the
number of shares we owned by the price for shares paid by investors in the last placement
round, which resulted in a fair value that was greater than the carrying value of our
investment.
In performing our analysis for 2007, we looked to the $5 million in financing they received
from existing and outside investors in July 2006. The Company’s investment in
Magnolia was not considered impaired at June 30, 2007. We again computed the fair value of
our holdings in Magnolia Broadband by multiplying the number of shares we owned by the
price for shares paid by investors in the last placement round, which resulted in a fair
value that was greater than the carrying value of our investment.
NOTE 10. LONG-TERM
NOTES RECEIVABLE
In connection with the sale of our South African subsidiary in November 2000, as well as
the earlier sale of two other subsidiaries, the Company received as partial consideration
three notes receivable denominated in South African Rand. These notes are subject to
foreign currency risk and a portion of one was subject to certain performance requirements
of the debtor. The first note was for R52 million of which R20 million (plus accrued
interest) was treated as contingent consideration to be recorded when collected as it was
secured only by the debtor’s stock in Lifestyle and therefore collection was not
assured. R31.4 million of the third note, was payable as the borrower collected on junior
debt. In December 2004, the Company received a payment in the amount of R31.4 million in
partial payment of the outstanding principal and interest. The Company received R20.07
million on June 30, 2006 in payment of the note’s remaining principal balance and
accrued interest in full.
F-18
Two notes remain outstanding at June 30, 2007. Both require monthly payments ranging from
R50,000 to R70,000 and both bear interest at 5%.
|
2007
|
|
2006
|
|
Balance
|
|
$
471,204
|
|
$
623,218
|
|
Less current
portion
|
|
256,982
|
|
164,548
|
|
|
|
|
|
|
Long-term
portion
|
|
$
214,222
|
|
$ 458,670
|
|
|
|
|
|
|
|
NOTE 11.
INTANGIBLE ASSETS
The components of amortized intangible assets as of June 30, 2007 and 2006 are as
follows:
|
Estimated Useful
Life
|
Gross Carrying
Amount
|
Accumulated
Amortization
|
Total
|
|
|
|
|
|
Game titles - Strategy
First
|
10 years
|
1,635,552
|
(334,032)
|
1,301,520
|
Game titles –
Empire
|
5 years
|
23,437,099
|
(4,127,430)
|
19,309,669
|
Balance on June 30,
2007
|
|
$25,072,651
|
($4,461,462)
|
$20,611,189
|
|
|
|
|
|
|
Estimated Useful
Life
|
Gross Carrying
Amount
|
Accumulated
Amortization
|
Total
|
Covenant not to compete -
Strategy First
|
3 years
|
$44,638
|
($17,356)
|
$27,282
|
Game titles - Strategy
First
|
10 years
|
1,546,773
|
(161,201)
|
1,385,572
|
Balance on June 30,
2006
|
|
$1,591,411
|
($178,557)
|
$1,412,854
|
The covenant not to compete and the game titles acquired as part of the acquisition of
Strategy First are both amortized using the straight-line method. The covenant not to
compete was nullified and therefore amortized in entirety during the last quarter of the
fiscal year ending June 30, 2007.
The game titles of Empire are amortized over a five-year period based on
weighted average expected sales from the date the title is launched. For titles that have
not been launched as of June 30, 2007 a launch date was estimated to project future
amortization.
Amortization expense for intangible assets was $4,235,634, $148,797, and $21,809 for the
years ended June 30, 2007, 2006 and 2005, respectively
Estimated amortization expense for the five succeeding fiscal years is as follows:
|
2012
|
1,432,585
|
|
|
|
|
Thereafter
|
1,295,183
|
|
Total
|
$ 20,611,189
|
F-19
NOTE
12. DEBT
Lines of Credit
In June 2002, the Company obtained a secured line of credit facility for borrowings up to
$1.0 million, which is fully secured by cash balances held in the Company’s account.
This liability is due on demand and has a floating interest rate that is based on the prime
rate minus 1.75%. On June 30, 2007, the prime rate was 6.5%. The balance outstanding under
this line of credit at June 30, 2007 and June 30, 2006 was $590,990 and $647,797
respectively.
Empire has a line of credit secured by its receivables, inventory, real property and
intangible assets. As of June 30, 2007 the amount outstanding under this facility was
£1,140,018 ($2,284,482). The line of credit accrues interest at an annual rate of
8.75%.
Notes Payable
The Company owes approximately $5.5 million in notes payable to former shareholders of
Empire pursuant to the Offer made for the acquisition of Empire. This amount accrues
interest at 4% per annum and is payable on October 31, 2007.
Additionally, the Company owes approximately $3.8 million as earn out consideration based
on Empire’s EBITDA for the fiscal year ended June 30, 2007 and is payable on April
30, 2008.
Long Term Debt
At June 30, 2006 the Company had a term loan assumed pursuant to the plan of arrangement
related to the Company’s acquisition of Strategy First, payable in monthly principal
installments of Canadian $22,000 plus interest at an annual rate of prime plus 3.25% The
loan balance was $180,323 at June 30, 2006. The loan was paid off in full during the fiscal
year ending June 30, 2007.
NOTE 13.
CONVERTIBLE SECURED DEBENTURES
On October 31, 2005, the Company consummated a transaction pursuant to a Securities
Purchase Agreement, dated October 21, 2005 (the “2005 Purchase Agreement”),
with DKR SoundShore Oasis Holding Fund Ltd. (the “Purchaser”). Pursuant to the
2005 Purchase Agreement, the Company issued to the Purchaser a $5,000,000 principal amount
Variable Rate Secured Convertible Debenture due October 31, 2008 (the “2005
Debenture”) and a five year warrant to purchase 791,139 shares of the Company’s
common stock at an exercise price of $1.896 per share (the “Warrant”).
The Company pays monthly interest on the outstanding principal amount of the 2005 Debenture
at a rate per annum equal to the prime rate for the applicable interest period plus 1.5%.
The interest rate for any interest period decreases by 2% to the extent that the volume
weighted average trading price of the Company's common stock for the five consecutive
trading days immediately prior to such interest period (the “Trigger Price”)
exceeds the conversion price by 25% (and shall be decreased by an additional 2% for every
successive 25% that the Trigger Price exceeds the then applicable conversion price but in
no event shall the interest rate be less than 0%). All overdue accrued and unpaid interest
to be paid under the 2005 Debenture shall entail a late fee at a rate of 18% per annum.
The 2005 Debenture was convertible into shares of common stock of the
Company at an initial conversion rate of $1.738 per share up to a maximum of 2,876,860
shares. The 2005 Debenture and the Warrant provide for an additional 1,100,403 shares of
the Company’s common stock to be issued upon the conversion of the 2005 Debenture or
the exercise of the Warrant as a result of either conversion price adjustments or exercise
price adjustments. Based upon the closing price per share of the Company’s common
stock on the date of issuance, there was an intrinsic value associated with the
beneficial
F-20
conversion feature of $124,443, which is presented as a discount on the 2005
Debenture and amortized over the term of the 2005 Debenture.
The Company has the option, at any time, to redeem some or all of the outstanding 2005
Debenture, in cash, equal to the sum of (A) as to redemption dates before April 30, 2008,
(i) 115% of the outstanding principal amount of the Debenture or portion thereof being
redeemed, (ii) accrued but unpaid interest and (iii) all liquidated damages and other
amounts due in respect of the 2005 Debenture and (B) as to redemption dates on or after
April 30, 2008, (i) the greater of (x) 130% of the outstanding principal amount of the 2005
Debenture or portion thereof being redeemed and (y) the principal amount of the 2005
Debenture to be prepaid, plus all other accrued and unpaid interest hereon, divided by the
applicable conversion price on (a) the date the notice of redemption is delivered or (b)
the date the redemption amount is paid in full, whichever is less, multiplied by the VWAP
on (c) the date the redemption notice is delivered or otherwise due or (d) the date the
redemption amount is paid in full, whichever is greater, (ii) accrued but unpaid interest
and (iii) all liquidated damages and other amounts due in respect of the 2005 Debenture. In
May 2006, the Company repaid $1,400,000 of the outstanding principal balance along with an
early payment penalty of approximately $210,000.
The principal amount of the 2005 Debenture was to be redeemed at the rate of $185,185 per
month, plus accrued and unpaid interest, commencing on July 6, 2006 and may be paid, at the
Company’s option (i) in cash or (ii) in shares of the Company’s common stock.
The terms of the 2005 Debenture were amended in June 2006 and February 2007 and required
redemption at the rate of $180,000 per month commencing on May 1, 2007. The Company did not
pay the initial $180,000 redemption amount on May 1, 2007. The Purchaser and the Company
amended the terms of the 2005 Debenture in June 2007. Under the terms of the amendment (i)
the maturity date of the 2005 Debenture was extended to April 30, 2010; (ii) there will be
no amortization of principal under the Debenture; and (iii) the Debenture will be
mandatorily convertible if the closing sale price of the Company’s common stock
equals or exceeds $3.48 per share. This mandatory conversion is subject to volume
requirements.
The Company’s obligations under the 2005 Debenture are secured by a lien on all
assets of the Company in favor of the Purchaser pursuant to a Security Agreement, dated
October 31, 2005, among the Company, all of the subsidiaries of the Company and the
Purchaser, and guaranteed by all the subsidiaries of the Company pursuant to a Subsidiary
Guarantee, dated October 31, 2005, made by the Company’s subsidiaries in favor of the
Purchaser. In addition, the obligations of the Company under the 2005 Debenture are
personally guaranteed by Mr. George Karfunkel pursuant to a Personal Guarantee, dated
October 31, 2005, between Mr. Karfunkel and the Purchaser. Mr. Karfunkel is compensated in
the amount of 5% of the current principal outstanding per annum.
In connection with the 2005 Debenture the Company issued to the holder the Warrant. The
fair value for the Warrant was estimated at the grant date using the Black-Scholes option
pricing model using the following weighted average assumptions: risk-free interest rate of
4.50%, dividend yields of 0% and a volatility factor of the expected market price of the
Common Stock of 114.80%. Based upon the closing price per share of the Company’s
common stock on the date of issuance, the Company estimated the fair value of the warrant
and allocated $665,295 of the proceeds from the 2005 Debenture to the Warrant, which is
presented as a discount on the convertible note, net of amortization to be taken over the
three-year term of the note using the effective interest method. As a result of the June
2007 debt modification the remaining fair values of the warrant is being amortized on a
straight line method through April 30, 2010.
On October 19, 2006, the Company entered into another Securities Purchase Agreement with
the Purchaser, pursuant to which the Company issued to the Purchaser a Variable Rate
Secured Convertible Debenture in the principal amount of $1,400,000 due October 31, 2008
(the “2006 Debenture”).
The 2006 Debenture is convertible at any time after December 19, 2006, at the option of the
Purchaser, into shares of common stock at a conversion price of $1.738 per share.
F-21
The Company pays monthly interest on the outstanding principal amount of the 2006 Debenture
at a rate per annum equal to the prime rate for the applicable interest period plus 1.5%.
The interest rate for any interest period decreases by 2% to the extent that the volume
weighted average trading price of the common stock for the five consecutive trading days
immediately prior to such interest period (the “Trigger Price”) exceeds the
conversion price by 25% (and shall be decreased by an additional 2% for every successive
25% that the Trigger Price exceeds the then applicable conversion price but in no event
shall the interest rate be less than 0%). All overdue accrued and unpaid interest to be
paid under the 2006 Debenture shall entail a late fee at a rate of 18% per annum.
The principal amount of the 2006 Debenture was originally redeemable at the rate of $63,636
per month, plus accrued but unpaid interest and liquidated damages, commencing on March 1,
2007. The terms of the 2006 Debenture were amended in February 2007 to require redemption
at a rate of $63,636 per month commencing on May 1, 2007. The Company has the option, at
any time, to redeem some or all of the outstanding 2005 Debenture, in cash, equal to the
sum of (A) as to redemption dates before April 30, 2008, (i) 115% of the outstanding
principal amount of the Debenture or portion thereof being redeemed, (ii) accrued but
unpaid interest and (iii) all liquidated damages and other amounts due in respect of the
2005 Debenture and (B) as to redemption dates on or after April 30, 2008, (i) the greater
of (x) 130% of the outstanding principal amount of the 2005 Debenture or portion thereof
being redeemed and (y) the principal amount of the 2005 Debenture to be prepaid, plus all
other accrued and unpaid interest hereon, divided by the applicable conversion price on (a)
the date the notice of redemption is delivered or (b) the date the redemption amount is
paid in full, whichever is less, multiplied by the VWAP on (c) the date the redemption
notice is delivered or otherwise due or (d) the date the redemption amount is paid in full,
whichever is greater, (ii) accrued but unpaid interest and (iii) all liquidated damages and
other amounts due in respect of the 2005 Debenture.
The Company did not pay the initial $63,636 redemption amount on May 1, 2007. The Purchaser
and the Company amended the terms of the 2006 Debenture in June 2007. Under the terms of
the amendment (i) the maturity date of the 2005 Debenture was extended to April 30, 2010;
(ii) there will be no amortization of principal under the Debenture; and (iii) the
Debenture will be mandatorily convertible if the closing sale price of the Company’s
common stock equals or exceeds $3.48 per share. This mandatory conversion is subject to
volume requirements.
The Company’s obligations under the 2006 Debenture are secured by a lien on all
assets of the Company in favor of the Purchaser, and guaranteed by all the subsidiaries of
the Company. In addition, the obligations of the Company under the 2006 Debenture are
personally guaranteed by Mr. George Karfunkel. Mr. Karfunkel is compensated in the amount
of 5% of the current principal outstanding amount of the 2006 Debenture per annum.
As consideration, the Company reduced the exercise price of the Warrant $.10 to $1.7986 per
share. The fair value for the reduction in the exercise price of the Warrant was estimated
at the grant date using the Black-Scholes option pricing model using the following weighted
average assumptions: risk-free interest rate of 4.37%, dividend yields of 0% and a
volatility factor of the expected market price of the Company’s common stock of
106.66%. Based upon the closing price per share of the Company’s common stock on the
date of issuance, the Company estimated the fair value of the exercise price reduction and
allocated $10,490 of the proceeds from the 2005 Debenture to the Warrant, which is
presented as a discount on the 2005 Debenture, net of amortization to be taken over term of
the 2005 Debenture using the effective interest method. As a result of the June 2007 debt
modification the remaining fair values of the warrant is being amortized on a straight line
method through April 30, 2010.
F-22
The balance of the notes as of June 30, 2007 and June 30, 2006, net of unamortized
discounts was as follows:
|
June
30
,
2007
|
June 30,
2006
|
Principal amount of
notes
|
$
5,000,000
|
$3,600,000
|
Discounts for beneficial
conversion features
|
(58,765)
|
(60,122)
|
Discounts for fair value of
warrants and options
|
(150,456
)
|
(321,423)
|
Balance , net of
unamortized discounts
|
$4,790,779
|
$3,218,455
|
Less current
portion-
|
-
|
(900,000)
|
Long-term
portion
|
$4,790,779
|
$2,318,455
|
Scheduled maturities of the convertible debentures as of June 30, 2007 are as follows:
|
June 30,
2007
|
1 Year or less
|
$
-
|
1-3
Years
|
5,000,000
|
Total
|
$5,000,000
|
Interest expense related to the notes amounted to $429,504 and $491,381 during the years
ended June 30, 2007 and 2006 respectively. Interest expense incurred during the year ended
June 30 includes a $210,000 penalty that was applied when the company paid $1,400,000
toward principal in May 2006.
Amortization of discounts for the beneficial conversion features and warrant resulted in
charges to Amortization of Convertible Debt Discounts and Issuance Costs totaling $235,192
and $408,193 during the fiscal years ended June 30, 2007 and 2006. The Company also
incurred loan costs of $1,199,119 directly related to securing these notes, which included
$500,000, ($250,000 annually) paid for a personal guarantee on the outstanding balances.
The loan costs were originally amortized over the term of the notes. As a result of the
June 2007 debt modification the remaining loan issuance costs are being amortized on a
straight line method through April 30, 2010.
The guarantee fees of $500,000 are being amortized at the rate of $250,000 per year.
Amortization expenses for the guarantee and debt issuance costs totaled $357,213 and
$361,372 for the fiscal years ending June 30, 2007 and 2006 are included in Amortization of
Convertible Debt Discounts and Issuance Costs.
Estimated amortization expense related to the warrants beneficial conversion feature and
costs related to securing these notes through debt maturities is as follows:
2008
|
$297,365
|
2009
|
214,032
|
2010
|
178,360
|
Total
|
$689,757
|
F-23
NOTE 14. INCOME
TAXES
The components of the
Company’s provision (benefit) for income taxes were as follows:
|
2007
|
|
2006
|
|
2005
|
|
Current:
|
|
|
|
|
|
|
|
Federal
|
|
($11,918
|
)
|
$ -
|
|
$ -
|
|
Foreign
|
|
-
|
|
-
|
|
-
|
|
State
|
|
|
|
|
|
|
|
|
Tax benefit:
|
|
($11,918
|
)
|
-
|
|
-
|
|
|
|
|
|
|
|
|
Deferred:
|
|
Federal
|
|
-
|
|
-
|
|
-
|
|
Foreign
|
|
-
|
|
-
|
|
-
|
|
State
|
|
-
|
|
-
|
|
-
|
|
A reconciliation of income tax
computed at the statutory rates to income tax expense (benefit) is as follows:
|
2007
|
|
2006
|
|
2005
|
|
Tax expense at the
statutory rate
|
|
($818,251
|
)
|
($707,528
|
)
|
$49,432
|
|
Tax effect on income (loss) of non-US
operations
|
|
665,447
|
|
1,254,175
|
|
61,768
|
|
State and provincial income taxes, net
of federal
|
|
income
tax
|
|
(73,215
|
)
|
88,872
|
|
15,669
|
|
Change in effective tax
rate
|
|
-
|
|
-
|
|
(128,330
|
)
|
Permanent difference-
Amortization
|
|
1,216,615
|
|
Permanent differences-
Other
|
|
156,870
|
|
6,641
|
|
3,851
|
|
Deferred Balance
adjustment
|
|
(332,176
|
)
|
-
|
|
-
|
|
Adjustment for prior years' R&D
expense
|
|
-
|
|
(1,150,304
|
)
|
-
|
|
Valuation allowance
|
|
(827,208
|
)
|
508,144
|
|
(2,390
|
)
|
|
|
|
|
|
|
|
Provision (benefit) for
Taxes
|
|
($11,918
|
)
|
$ -
|
|
$ -
|
|
|
|
|
|
|
|
|
At June 30, 2007, the Company
has available US net operating loss carrying forwards of approximately $3,501,000 which
expire through 2027, Canadian net operating loss carry forwards of approximately $3,430,000
which expire through 2017, and United Kingdom operating losses of approximately $25,900,000
which can be carried forward indefinitely.
In addition to the net
operating loss carrying forward, the Company has deferred tax assets which relate primarily
to depreciation of fixed assets recorded at different rates for tax and book purposes,
certain research and development costs incurred in Canada expensed for book purposes, not
deducted for tax purposes, and available to offset future income taxable in Canada, and
differences in recording bad debts for book and U.K. tax purposes. As of June 30, 2007 a
valuation allowance has been established against a significant portion of the deferred tax
asset since the Company believes it is more likely than not that that the amounts will not
be realized in full; the Company has not established a valuation allowance against the
portion of the deferred tax asset it believes will be realized in future periods due to
expected taxable profits. As of June 30, 2006, a valuation allowance was established
against the entire deferred tax asset.
F-24
The components of the deferred
tax assets (liabilities) were as follows at June 30, 2007 and 2006:
Current:
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Net operating
losses
|
|
10,198,654
|
|
$2,087,040
|
|
|
|
|
|
|
Bad
Debts
|
|
196,478
|
|
-
|
|
R&D
Expenses
|
|
1,436,816
|
|
1,264,300
|
|
|
|
|
|
|
|
|
11,831,948
|
|
3,351,340
|
|
Long term:
|
|
|
|
|
|
|
Depreciation
|
|
515,440
|
|
47,887
|
|
|
|
|
|
|
|
|
515,440
|
|
47,887
|
|
|
|
|
|
|
|
|
12,347,388
|
|
3,399,227
|
|
Total valuation allowance
|
|
(11,722,171
|
)
|
(3,399,227
|
)
|
|
|
|
|
|
|
|
|
Deferred tax asset
|
|
$625,217
|
|
$ -
|
|
|
|
|
|
|
The Silverstar Holdings
Limited is a Bermuda registered corporation where there are no income tax laws applicable.
FSAH, a South African registered corporation, incurred no income tax charges for fiscal
years 2007, 2006, and 2005.
First South Africa Management
Corp. and Fantasy Sports, Inc. are US registered corporations and did not incur any income
tax provision for fiscal years 2007, 2006 and 2005.
Silverstar Acquisitions, PLC
is a United Kingdom based registered company and did not incur any income tax charges for
the seven months ending June 30, 2007 (since inception).
Empire Interactive, PLC is a
United Kingdom based registered company and did not incur any income tax charges for the
seven months ending June 30, 2007(since acquisition).
Empire Interactive Europe,
Limited is a United Kingdom based registered company and did not incur any income tax
charges for the seven months ending June 30, 2007 (since acquisition).
Empire Interactive, Inc is a
US registered corporation and recognized a tax benefit of $11,918 for the seven months
ending June 30, 2007 (since acquisition).
Empire Interactive Holdings,
Limited is a United Kingdom based registered company and did not incur any income tax
charges for the for the seven months ending June 30, 2007 (since acquisition).
NOTE
15. DISCONTINUED OPERATIONS
Fantasy Sports, Inc.
On April 7, 2006, the Company sold substantially all the assets and transferred certain
liabilities of Fantasy Sports, Inc. for total cash consideration of $3.85 million. The
purchaser assumed liabilities in the amount of $.79 million
A summary of the calculation of the gain on disposition is as follows:
Cash received
|
$
3,850,000
|
Expenses of sale
|
(156,622)
|
Net proceeds of
sale
|
3,693,378
|
Net book value
transferred
|
(2,212,668)
|
Gain on
disposition
|
($1,480,710)
|
In accordance with accounting
principles generally accepted in the United States of America, the net income and net
assets related to Fantasy Sports, Inc. have been included in discontinued operations in the
Company’s consolidated statements of operations and consolidated balance
sheets.
F-26
The following summarizes the results of Fantasy Sports, discontinued operations:
|
Nine Months Ended April 7,
2006
|
Year Ended June 30,
2005
|
Revenues
|
$1,490,855
|
$1,945,911
|
Total operating
expenses
|
(1,318,555)
|
(1,502,298)
|
Operating income
|
172,700
|
436,613
|
Other expense
|
(10,947)
|
(13,977)
|
Net income
|
$161,753
|
$422,636
|
NOTE
16. CASH FLOWS
Changes in operating assets and liabilities consist of the following:
|
2007
|
2006
|
2005
|
(Increase) decrease in
accounts receivable
|
|
|
|
($3,699,503
|
)
|
|
($483,814
|
)
|
|
$34,083
|
|
Increase in prepaid
expenses and current assets
|
|
|
|
(298,109
|
)
|
|
(115,857
|
)
|
|
(10,166
|
)
|
(Increase) decrease in
inventories
|
|
|
|
36,247
|
|
|
(52,354
|
)
|
|
-
|
|
Software development costs
capitalized
|
|
|
|
(5,524,293
|
)
|
|
|
|
|
|
|
Increase (decrease) in
accounts payable
|
|
|
|
3,218,57
2
|
|
|
41,356
|
|
|
(13,246
|
)
|
Increase in refundable
deposits
|
|
|
|
630,403
|
|
|
|
|
|
|
|
Increase (decrease) in
accrued expenses
|
|
|
|
1,108,723
|
|
|
477,577
|
|
|
(39,656
|
|
|
|
|
|
|
|
|
|
|
|
($4,527,960
|
)
|
|
($133,092
|
)
|
|
($ 28,985
|
)
|
|
|
|
|
|
|
Changes in net assets and
liabilities of discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and
amortization
|
|
|
|
-
|
|
|
5,563
|
|
|
10,681
|
|
Changes in operating accounts
|
|
|
|
-
|
|
|
(228,122
|
)
|
|
(122,092
|
)
|
Loss on disposal of fixed assets
|
|
|
|
-
|
|
|
2,762
|
|
|
-
|
|
Decrease in other assets
|
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Changes in cash (included in) from net assets
and from discontinued operations
|
|
|
|
-
|
|
|
(612
)
|
|
|
(3,344
|
)
|
|
|
|
|
|
|
Changes in net assets and liabilities of discontinued
Operations
|
|
|
|
(-
|
)
|
|
($220,409
|
)
|
|
($114,755
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities - discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
Short-term borrowings
(repayments), net
|
|
|
|
|
|
|
-
|
|
|
(237,971
|
)
|
|
|
|
|
|
|
|
Non cash investing and
financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of class B shares to common shares
|
|
|
|
|
|
|
-
|
|
|
$613
|
|
Issuance of shares of common stock
|
|
|
|
|
|
|
$49,995
|
|
|
-
|
|
Warrants issued for acquisition
|
|
|
|
|
|
|
-
|
|
|
$167,400
|
|
Cashless exercise of options
|
|
|
|
$973
|
|
|
|
|
|
|
|
Issuance of notes payable to former Empire
shareholders contingent
on
earn out targets
achieved
|
|
|
|
$3,847,446
|
|
|
|
|
|
|
|
Stock
issued for acquisition
|
|
|
|
$723,000
|
|
|
-
|
|
|
$517,676
|
|
Issuance
of debt for acquisition
|
|
|
|
$5,475,179
|
|
|
-
|
|
|
$394,395
|
|
F-27
NOTE 17. BUSINESS
SEGMENT INFORMATION
As a result of the sale of all the assets and transfer of certain liabilities of Fantasy
Sports on April 7, 2006, the Company no longer operates in the Internet fantasy sports
games segment and now only operates in one segment -- entertainment software.
NOTE 18. STOCK
OPTION PLAN
1995 Stock Option Plan:
The Board of Directors has adopted the Company's 1995 Stock Option Plan. The Stock Option
Plan provides for the grant of (i) options that are intended to qualify as incentive stock
options ("Incentive Stock Options") within the meaning of Section 422 of the Internal
Revenue Code to key employees and (ii) options not so intended to qualify ("Nonqualified
Stock Options") to key employees (including directors and officers who are employees of the
Company and to directors).
The Stock Option Plan is administered by the Compensation Committee of the Board of
Directors. The committee shall determine the terms of the options exercised, including the
exercise price, the number of shares subject to the option and the terms and conditions of
exercise. No options granted under the Stock Option Plan are transferable by the optionee
other than by the will or the laws of descent and distribution.
The exercise price of Incentive Stock Options granted under the plan must be at least equal
to the fair market value of such shares on the date of the grant (110% of fair market value
in the case of an optionee who owns or is deemed to own more than 10% of the voting rights
of the outstanding capital stock of the Company or any of its subsidiaries). The maximum
term for each Incentive Stock Option granted is ten years (five years in the case of an
optionee who owns or is deemed to own more than 10% of the voting rights of the outstanding
capital stock of the Company or any of its subsidiaries). Options shall be exercisable at
such times and in such installments as the committee shall provide in the terms of each
individual option. The maximum number of shares for which options may be granted to any
individual in any fiscal year is 210,000.
The Stock Option Plan also contains an automatic option grant program for the Directors.
Each person who is director of the Company following an annual meeting of shareholders will
automatically be granted an option for an additional 15,000 shares of common stock. Each
grant will have an exercise price per share equal to the fair market value of the common
stock on the grant date and will have a term of five years measured from the grant date,
subject to earlier termination if an optionee's service as a board member is terminated for
cause.
2004 Stock Incentive Plan
The Company's board of directors has adopted and the Company's shareholders approved the
Company's 2004 Stock Incentive Plan (the "2004 Plan"). The 2004 Plan is intended to provide
an incentive to employees (including executive officers), and directors of and consultants
to the Company and its affiliates, and is intended to be the successor plan to the 1995
Stock Option Plan (which terminated in November 2005). The 2004 Plan authorizes the
issuance of a maximum of 1,000,000 shares of the Company's common stock (subject to
adjustment as described in the 2004 Plan) pursuant to stock grants or options to purchase
common stock to employees (including officers and directors who are employees) and
non-employee directors of, and consultants to the Company.
The 2004 Plan provides for the grant of (i.) "incentive stock options" ("ISOs") within the
meaning of Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code"),
(ii.) non-qualified stock options (which are stock options that do not qualify as ISOs),
and (iii.) stock awards.
The 2004 Plan will be administered by our board of directors or a committee of the
Company's board of directors consisting of at least two members of the Company's board,
each of whom is a "non-employee
F-28
director" within the meaning of Rule 16b-3 promulgated under the Securities
Exchange Act
of 1934. It is also intended that each member of any
such committee will be an "outside director" within the meaning of Section 162(m) of the
Code.
Options granted under the 2004 Plan
will be subject to, among other things, the following terms and conditions:
• The exercise price of each
option will be determined by the administrator; provided, however, that the exercise price
of an ISO may not be less than the fair market value of our common stock on the date of
grant (110% of such fair market value if the optionee owns (or is deemed to own) more than
10% of our voting power).
• Options may be granted for terms
determined by the administrator; provided, however, that the term of an ISO may not exceed
10 years (5 years if the optionee owns (or is deemed to own) more than 10% of our voting
power).
• The maximum number of shares of
the Company's common stock for which options may be granted to an employee in any calendar
year is 230,000. In addition, the aggregate fair market value of shares with respect to
which ISOs may be granted to an employee which are exercisable for the first time during
any calendar year may not exceed $100,000.
• The exercise price of each
option is payable in full upon exercise or, if the applicable stock option contract entered
into by us with an optionee permits, in installments.
• Options may not be transferred
other than by will or by the laws of descent and distribution, and may be exercised during
the optionee's lifetime only by the optionee or his or her legal
representatives.
• Except as may otherwise be
provided in the applicable option contract, if the optionee's relationship with the Company
as an employee or consultant is terminated for any reason (other than the death or
disability of the optionee), the option may be exercised, to the extent exercisable at the
time of termination of such relationship, within three months thereafter, but in no event
after the expiration of the term of the option.
• The Company may withhold cash
and/or shares of the Company's common stock having an aggregate value equal to the amount
which we determine is necessary to meet its obligations to withhold any federal, state
and/or local taxes or other amounts incurred by reason of the grant or exercise of an
option, its disposition or the disposition of shares acquired upon the exercise of the
option. Alternatively, the Company may require the optionee to pay us such amount, in cash,
promptly upon demand.
2007 Stock Incentive Plan:
The Company's board of directors has adopted and the Company's shareholders approved the
Company's 2007 Stock Incentive Plan (the "2007 Plan"). The 2007 Plan is intended to provide
an incentive to employees (including executive officers), and directors of and consultants
to the Company and its affiliates, and is intended to be the successor plan to the 2004
Stock Option Plan The 2007 Plan authorizes the issuance of a maximum of 2,000,000 shares of
the Company's common stock (subject to adjustment as described in the 2007 Plan) pursuant
to stock grants or options to purchase common stock to employees (including officers and
directors who are employees) and non-employee directors of, and consultants to the
Company.
The 2007 Plan provides for grant of “incentive
stock options” (“ISOs”) within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended, non-qualified stock options (“NQSOs”), and
stock awards (“Stock Awards”) ;
F-29
The 2007 Plan will be administered by our board of directors or a committee of the
Company's board of directors consisting of at least two members of the Company's board,
each of whom is a "non-employee director" within the meaning of Rule 16b-3 promulgated
under the Securities Exchange Act of 1934. It is also intended that each member of any such
committee will be an "outside director" within the meaning of Section 162(m) of the
Code.
Options granted under the 2007 Plan
will be subject to, among other things, the following terms and conditions:
• The exercise price of each
option will be determined by the administrator; provided, however, that the exercise price
of an ISO may not be less than the fair market value of our common stock on the date of
grant (110% of such fair market value if the optionee owns (or is deemed to own) more than
10% of our voting power).
• Options may be granted for terms
determined by the administrator; provided, however, that the term of an ISO may not exceed
10 years (5 years if the optionee owns (or is deemed to own) more than 10% of our voting
power).
• The maximum number of shares of the
Company’s common stock for which options may be granted to an employee in any
calendar year is 210,00. In addition, the aggregate fair market value of shares with
respect to which ISOs may be granted to an employee which are exercisable for the first
time during any calendar year may not exceed $100,000
.
• The exercise price of each
option is payable in full upon exercise or, if the applicable stock option contract entered
into by us with an optionee permits, in installments.
• Options may not be transferred
other than by will or by the laws of descent and distribution, and may be exercised during
the optionee's lifetime only by the optionee or his or her legal
representatives.
• Except as may otherwise be
provided in the applicable option contract, if the optionee's relationship with the Company
as an employee or consultant is terminated for any reason (other than the death or
disability of the optionee), the option may be exercised, to the extent exercisable at the
time of termination of such relationship, within
one year
thereafter, but in no event after the expiration of the
term of the option.
• The Company may withhold cash
and/or shares of the Company's common stock having an aggregate value equal to the amount
which we determine is necessary to meet its obligations to withhold any federal, state
and/or local taxes or other amounts incurred by reason of the grant or exercise of an
option, its disposition or the disposition of shares acquired upon the exercise of the
option. Alternatively, the Company may require the optionee to pay us such amount, in cash,
promptly upon demand.
The Company, through June 30, 2007, has granted options to purchase 2,111,666 shares of
common stock under the Plans, of which 255,000 options have been exercised and 175,000
options expired unexercised.
F-30
The following table represents stock option activity for the years ended June 30, 2005,
2006, and 2007:
|
Shares Subject to
Options
Outstanding
|
Weighted Average
Exercise Price
Per Option
|
Balance at June 30,
2004
|
1,193,333
|
3.68
|
Granted options:
|
|
|
Granted non-plan options
|
450,000
|
2.00
|
Granted-plan options
|
390,000
|
1.37
|
Exercised
options:
|
(15,000)
|
0.43
|
Expired - plan options
|
(40,000)
|
5.13
|
Expired - non-plan options
|
(433,333
)
|
4.08
|
|
|
|
Balance at June 30,
2005
|
1,545,000
|
2.49
|
|
|
|
|
|
|
Granted options:
|
|
|
Granted-plan options
|
57,405
|
1.33
|
Exercised
options:
|
(30,000)
|
0.75
|
Expired plan options
|
(10,000)
|
0.75
|
Expired non-plan options
|
(200,000)
|
5.00
|
Terminated plan options
|
(75,000
)
|
1.35
|
|
|
|
Balance at June 30,
2006
|
1,287,405
|
2.17
|
|
|
|
|
|
|
Granted options:
|
|
|
Granted plan options
|
682,595
|
1.76
|
Exercised
options:
|
(65,000)
|
0.87
|
Expired plan options
|
(25,000)
|
0.42
|
Expired non-plan options
|
(320,000)
|
3.93
|
Terminated plan options
|
(50,000)
|
1.35
|
|
|
|
Balance at June 30,
2007
|
1,510,000
|
1,72
|
|
|
|
450,000 options granted during the year end June 30, 2005 were subject to a lock-up
agreement and therefore could not be exercised until such lock-up agreement was released.
The lock-up agreement was released during the fiscal year ending June 30, 2007 when
granting of these options was approved by a vote of the Company’s stockholders, which
was required by the terms and conditions of the Company’s NASDAQ listing
agreement.
The following summarizes information related to options outstanding and exercisable as of
June 30, 2007.
|
|
Options
Outstanding
|
|
Options
Exercisable
|
Range of
Exercise
Prices
|
Shares
|
Weighted Average
Exercise
Price
|
Weighted Average
Remaining in
Years
|
Shares
|
Weighted Average
Exercise
Price
|
Weighted Average
Remaining in
Years
|
Less than $1.00
|
30,000
|
$0.16
|
0.50
|
30,000
|
$0.16
|
0.50
|
$1.06 to 2.00
|
1,480,000
|
$1.75
|
2.59
|
905,833
|
$1.74
|
2.43
|
|
|
|
|
|
|
1,510,000
|
|
|
935,833
|
|
|
2,184,810 shares were available for future stock option grants to employees and directors
under the existing plans as of June 30, 2007. As of June 30, 2007 the aggregate intrinsic
value of shares outstanding and exercisable was $135,975. Total intrinsic value of options
exercised was $92,000, $10,900 and $16,500 for the years ended June 30, 2007, 2006 and
2005, respectively.
F-31
The following table summarizes our nonvested stock option activity for the year ended June
30, 2007.
|
Shares
|
Weighted Average
Fair Value on the
Grant
Date
|
|
|
|
Nonvested as of June 30,
2006
|
75,000
|
$1.03
|
Granted during
2007
|
682,593
|
$0.69
|
Vested during
2007
|
(133,429)
|
$0.84
|
Forfeited
|
(50,000
)
|
$1.03
|
|
|
Nonvested as of June 30,
2007
|
574,166
|
$0.66
|
|
|
NOTE 19. WARRANTS
OUTSTANDING
In consideration for the capital raising activities undertaken during 2000, the Company
issued warrants to purchase 150,000 shares of common stock at an exercise price of $6.00
per share.
In July 2004, 180,000 warrants to purchase one share of Class A common stock at an exercise
price of $0.81 per share were granted to a consultant for services to be rendered. These
warrants were valued at $115,210 using a Black-Scholes pricing model with the following
assumptions: expected volatility of 142%; a risk-free interest rate of 3.19% and an
expected life of three years. An expense has been recognized for the fair value of these
warrants granted to such non-employees in the amount of $32,000 for fiscal year 2005.
Effective May 1, 2005, the consultant was appointed to the Board of Directors at Strategy
First and the remainder of his options valued at $83,210 vested immediately. These options
were included in compensation expense deducted from income from continuing operations as
prescribed by Accounting Principles Board Opinion #25. These options were exercised in a
cashless transaction in June of 2007 which resulted in the issuance of 93,728 shares.
In April 2005, 200,000 warrants to
purchase one share of Class A common stock at an exercise price of $2.50 per share were
granted to former shareholders of Strategy First as part of the consideration paid in
connection with the acquisition of that company. These warrants were valued at $167,400
using a Black-Scholes pricing model with the following assumptions: expected volatility of
126%; a risk-free interest rate of 3.77% and an expected life of three years. These
warrants vest immediately.
On October 31, 2005, the Company issued
warrants to purchase 791,139 shares of Class A common stock at an exercise price of $1.896
per share to DKR SoundShore Oasis Holding Fund Ltd. in connection with the Company’s
sale of a $5 million convertible debenture. These warrants were valued at $665,295 using a
Black-Scholes pricing model with the following assumptions: expected volatility of 114.80%;
a risk-free interest rate of 4.50% and an expected life of five years On October 19, 2006,
the Company entered into another Securities Purchase Agreement with the Purchaser, pursuant
to which the Company issued to the Purchaser a Variable Rate Secured Convertible Debenture
in the principal amount of $1,400,000 due October 31, 2008.As consideration, the Company
reduced the exercise price of the Warrant $.10 to $1.7986 per share. The fair value for the
reduction in the exercise price of the Warrant was estimated at the grant date using the
Black-Scholes option pricing model using the following weighted average assumptions:
risk-free interest rate of 4.37%, dividend yields of 0% and a volatility factor of the
expected market price of the Company’s common stock of 106.66%. Based upon the
closing price per share of the Company’s common stock on the date of issuance, the
Company estimated the fair value of the exercise price reduction and allocated $10,490 of
the proceeds from the 2005 Debenture to the Warrant, which is presented as a discount on
the 2005 Debenture, net of amortization to be taken over term of the 2005
Debenture.
F-32
Warrants outstanding at June 30, 2007 were as follows:
Warrant
|
Number
o
f
Warrants
|
Exercise
Price
|
Expiration
Date
|
Entitlement
|
Debenture warrants
2001
|
52,189
|
$6.00
|
July 31, 2007
|
One share of common
stock
|
Capital raising
warrants
|
150,000
|
$6.00
|
July 31, 2007
|
One share of common
stock
|
Warrants issued for
acquisition
|
200,000
|
$2.50
|
April 21, 2008
|
One share of common
stock
|
Warrants issued for
convertible debenture
|
791,139
|
$1.79
|
October 31, 2010
|
One share of common
stock
|
|
|
|
|
|
NOTE 20. COMMITMENTS, CONTINGENCIES AND OTHER
MATTERS
Leases
The Company leases office facilities and some equipment under non-cancelable operating
leases. Office facility and equipment rental expenses included in continuing operations for
the fiscal years ended June 30, 2007, 2006 and 2005 were approximately $259,000, $109,000
and $60,000, respectively.
Approximate future minimum lease payments under non-cancelable office and equipment lease
agreements are as follows:
Fiscal Year End June
30:
|
|
2008
|
$ 259,000
|
2009
|
176,000
|
2010
|
98,000
|
Total
|
$ 533,000
|
Litigation and Other Contingencies
Other than as set forth below we are not currently a party to any material legal
proceedings. We may become from time to time involved in legal proceedings in the ordinary
course of business. We may not be successful in defending these or other claims. Regardless
of the outcome, litigation can result in substantial expense and could divert the efforts
of our management.
In April 2006, our First South African subsidiary received a letter from the South African
Revenue Service (“SARS”) challenging certain tax treatment of dividends and
operating loss carry forwards for the years 2002 through 2004. Subsequently SARS issued two
tax assessments for approximately $2.9 million. The Company had contended that its South
African tax filings were in full compliance with all applicable laws and had vigorously
defended its position in this regard. The Company had retained an amount of cash equal to
the assessments in South Africa to satisfy any potential liability that may arise.
In May, 2007, the Company through an arbitration procedure with SARS reached an agreement
whereby SARS agreed in principle to drop the larger of its two assessments. The Company
conceded the principle of SARS second assessment. On August 31, 2007, the Company paid
approximately $300,000 to SARS in regard to this assessment. The Company is vigorously
disputing a further amount of approximately $770,000 and believes it has strong arguments
in this regard based on among other factors, computational errors made by SARS in its
assessment. Based on its payments to SARS, the Company has reduced its estimated liability
to approximately $313,000. The Company believes its remaining liability
F-33
to SARS is lower than this amount, however, in the event its arguments are
unsuccessful, it may be forced to increase this liability
.
In June 2006, Empire commenced litigation against Take Two Interactive Inc. (“Take
Two”) in regard to the accounting and reporting of sales of various products by Take
Two. Through March 31, 2007 Empire had received payments of approximately $1,632,000 from
Take Two, including $216,000 received during the third quarter of fiscal 2007. On
May 10, 2007, Empire settled this litigation for a final payment of $350,000 plus
expense reimbursements of $140,000.
During the first quarter of fiscal year 2006, the Company entered into agreements with two
of Strategy First’s game developers to guarantee certain of their royalty payments.
The guarantee is limited to $100,000. Royalties owed to these developers as of June 30,
2007 were less than $31,000. (Strategy First paid these royalties when due after the fiscal
year ended.)
The Company anticipates that Strategy First will pay the royalties due to its developers
when earned and does not anticipate having to make any payments under these guarantees.
On March 29, 2006, Strategy First entered into an agreement to acquire certain intellectual
property rights for $200,000 in cash and the issuance of options to acquire 100,000 shares
of the Company’s common stock at an exercise price of $1.50. The options vest when
net sales, as defined in the purchase agreement, exceed $750,000 and expire on December 31,
2008. The agreement also provides for commissions of twenty-five percent of net revenues in
the event they exceed $500,000 through December 31, 2008. As of June 30, 2007 net revenues
earned under this agreement were approximately $335,000.
On June 30, 2007, Empire owed approximately $1,173,000 for United Kingdom payroll taxes of
which approximately $985,000 was past due. Payroll liabilities totaling approximately
$394,000 for the months of May and June 2007 were paid in July with the agreement of the
tax authorities and were not subject to penalties. A payment schedule for the remaining
past due balance of $779,000 has been finalized and the Company anticipates that this
amount will be paid in full in October 2007. As of June 30, 2007, the interest rate in
effect for late tax payments was 7.50%. Interest is automatically be charged for the period
following April 19, 2007 on the amount that was still due at that date. In addition, the
United Kingdom tax authorities have the power to charge this rate of interest on overdue
payroll taxes in respect to periods prior to April 19, 2007; however in practice, this is
rare.
In August 2007, Empire was served with a lawsuit brought by a former distributor in
Portugal. The lawsuit claims that Empire had no right to utilize other distributors in
Portugal and seeks 630,000 euros in damages. Empire believes this claim has no merit as its
distribution agreements are tailored for individual products only and do not give blanket
distribution rights to outside distributors. Empire will move to dismiss the claim.
Employment Agreements
Silverstar Holdings Ltd.
On January 29, 2005, the Company’s Board of Directors approved an Employment
Agreement with Clive Kabatznik (the “Employment Agreement”). Pursuant to the
Employment Agreement, Mr. Kabatznik will serve as the Chief Executive Officer, President
and Chief Financial Officer of the Company beginning as of January 1, 2005 and continuing
through and until December 31, 2009. As compensation for his services, Mr. Kabatznik will
received an annual base salary of $325,000 which increased by $10,000 in 2006 and
increasing to $350,000 per annum from the beginning of 2007 to the end of 2009. During the
term of the agreement, the employee shall be entitled to an annual bonus in an amount to be
determined by the Company’s Board of Directors and Compensation Committee based on
results of operations of the Company for each fiscal year starting in the fiscal year ended
June 30, 2006. Such bonus will be
F-34
dependent on the Company’s income from operations achieving a rate of
return on equity of not less than 20% annually.
Mr. Kabatznik also received options to purchase 500,000 shares of the Company’s
common stock at $2.00 per share for a term of five years. 450,000 of these options are
subject to a lock-up agreement.
Empire Interactive, PLC
On December 1, 2006, Empire Interactive entered into employment agreements with Ian Higgins
and Simon Jeffrey. The agreements terminate on January 1, 2008 and shall then continue
until terminated by either party giving to the other not less than six months notice. The
agreements call for basic annual salary of £132,000 for each executive as well as a
£12,000 car allowance and a pension contribution equal to 15% of the basic annual
salary. Additionally, each executive received 100,000 two-year options to acquire shares of
Silverstar stock at $1.79. These options vest on December 31, 2007. Mr. Higgins serves as
the Chief Executive Officer of the company and Mr. Jeffrey as Managing Director in charge
of product development and acquisition.
Strategy First, Inc.
On April 21, 2005, Strategy First, Inc. entered into employment agreements with Don
McFatridge, Brian Clarke and Richard Therrien. The employment agreements are on an at-will
basis and call for salaries of Canadian $180,000, 160,000 and 75,000, respectively. Each
employee is entitled to a bonus of up to 30% of their salary at the discretion of
Silverstar. Mr. McFatridge served as Chief Executive Officer of Strategy First and received
options to acquire 75,000 shares of Silverstar’s common stock (25.000 of these
options are vested). Mr. McFatridge’s contract was terminated during the fiscal year
ended June 30, 2007. These options vest annually over a three-year period. Mr. Clarke, who
died in June 2006, served as Chief Operating Officer of Strategy First and received options
to acquire 75,000 shares of Silverstar’s common stock which terminated upon his
death. Mr. Therrien serves as Chief Technology Officer of Strategy First and received
options to acquire 25,000 shares of Silverstar’s common stock. These options vest
annually over a three-year period.
On October 3, 2005, the Company entered into an employment agreement with Sheldon Reinhart
to serve as Vice President of Finance. The employment agreement is on an at-will basis and
calls for an annual salary of Canadian $120,000.00 and entitles the employee to a bonus of
up to 30% of his salary at the discretion of Silverstar Holdings. Mr. Reinhardt will also
receive stock options to acquire 20,000 shares of the Company’s common stock at the
completion of fiscal year 2007 which will vest annually over a three-year period.
NOTE 21. QUARTERLY INFORMATION
(UNAUDITED)
Quarter
Ended
|
September 30,
|
December 31,
|
March 31,
|
June 30,
|
|
|
|
2006
|
2006
|
2007
|
2007
|
Total
|
Revenues
|
$278,745
|
$2,960,789
|
$4,603,017
|
$11,951,733
|
$19,794,284
|
Income (loss) from
continuing operations
|
(941,438)
|
(1,301,671)
|
(2,751,028)
|
2,587,516
|
(2,406,621)
|
Net income
(loss)
|
(941,438)
|
(1,301,671)
|
(2,751,028)
|
2,587,516
|
(2,406,621)
|
Net Income (loss) per
share:
|
|
|
|
|
|
Basic
|
($.10)
|
($.14)
|
($.27)
|
$.25
|
($.25)
|
Diluted
|
($.10)
|
($.14)
|
($.27)
|
$.25
|
($.25)
|
Weighted average common
stock:
|
|
|
|
|
|
Basic
|
9,149,034
|
9,431,657
|
10,119,834
|
10,205,553
|
9,726,520
|
Diluted
|
9,149,034
|
9,431,657
|
10,119,834
|
10,635,564
|
9,726,520
|
F-35
|
Quarter Ended
|
|
September 30,
2005
|
December 31,
2005
|
March 31,
2006
|
June 30,
2006
|
Total
|
Revenues
|
|
|
|
$370,709
|
|
|
$983,434
|
|
|
$1,494,991
|
|
|
$467,295
|
|
|
$3,316,429
|
|
Loss from continuing
operations
|
|
|
|
(286,528
|
)
|
|
(574,356
|
)
|
|
(401,300
|
)
|
|
(2,359,469
|
)
|
|
(3,621,653
|
)
|
Net loss
|
|
|
|
(48,298
|
)
|
|
(454,963
|
)
|
|
(608,112
|
)
|
|
(867,817
|
)
|
|
(1,978,990
|
)
|
Net (loss) per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
(0.01
|
)
|
|
(0.05
|
)
|
|
(0.07
|
)
|
|
(0.09
|
)
|
|
(.22
|
)
|
Weighted average common
stock outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
9,068,584
|
|
|
9,076,518
|
|
|
9,098,584
|
|
|
9,151,177
|
|
|
9,102,286
|
|
|
|
|
|
|
|
NOTE 22. SUBSEQUENT
EVENTS
Pursuant to a purchase agreement, dated July 2, 2007, by and among us and the purchasers
named therein. Pursuant to the purchase agreement, we sold aggregate of 6,206,891 shares
(the “Shares”) of our common stock and warrants (the “Warrants”) to
purchase up to 4,344,826 shares of our common stock at an exercise price of $2.10 per
share, at a price per unit of $1.45 (the “July Private Placement”).
The sale an issuance of the Shares and Warrants was structured to close in two closings.
The first closing was completed on July 5, 2007, pursuant to which we sold and issued an
aggregate of 2,057,495 Shares and Warrants to purchase up to an aggregate of 1,440,234
shares of our common stock. The second closing was completed on September 6, 2007, pursuant
to which we sold and issued an aggregate of 4,149,396 shares of our common stock and
warrants to purchase up to 2,904,592 shares of our common stock at the second closing.
As of September 21, 2007, DKR Oasis had converted an aggregate amount of $2.85 million of
their 2005 Debenture and we have issued 1,420,478 shares of Class A common stock.
On September 17, 2007, the Company announced a change in its executive management team. In
connection with such change, the Company’s current Chief Financial Officer ("CFO"),
Clive Kabaztink, resigned from that position, and Lawrence R. Litowitz was engaged as the
new CFO. Mr. Kabatznik will continue to serve as the Company’s President and Chief
Executive Officer. Additionally, Mr. Kabatznik has retained responsibility as the
Company’s Principal Financial and Accounting Officer to complete the Company’s
Form 10-K for the year ended June 30, 2007.
Pursuant to an Employment Letter Agreement, dated September 17, 2007 (the “Employment
Agreement”), between the Company and Lawrence R. Litowitz Mr. Litowitz shall work
approximately three full days per work week for an initial salary of $1,900 per day
("Salary"), of which $1,582.70, or 83.3%, shall be paid directly to Mr. Litowitz and
$317.30, or 16.7%, shall be paid directly to Tatum LLC (“Tatum”); provided
however, that in no event shall Mr. Litowitz and Tatum be paid a Salary in excess of the
aggregate amount of $24,166 per calendar month. Any cash bonus to be paid to Mr. Litowitz
shall be determined by the Board of Directors of the Company in its sole discretion. After
allocation of 20% of any cash bonus payable to Mr. Litowitz to Tatum, Mr. Litowitz will be
paid 80% of any cash bonus. In addition, Mr. Litowitz will share with Tatum 20% of any cash
proceeds realized from any equity bonus that Mr. Litowitz may be granted by the
Company’s Board of Directors.
Pursuant to the Employment Agreement, the Company granted Mr. Litowitz 180,000 options to
purchase common stock of the Company and 5,000 of the options will vest each month
commencing on October 17, 2007. The options were granted under the Company’s 2007
Stock Incentive Plan. The exercise price for each option is $2.15 (the closing price of the
Common Stock on September 17, 2007). At the option of
The Employment Agreement is terminable by either party on 30 days' prior written notice, or
immediately for Cause (as defined in the Employment
F-36
Agreement) or Good Reason (as defined in the Employment Agreement). In the
event that the Company elects to terminate Mr. Litowitz without Cause or if Mr. Litowitz
elects to terminate the Employment Agreement for Good Reason, in each case prior to
September 16, 2008, then Mr. Litowitz will be entitled to receive a payment as severance
(“Severance Payment”) equal to three months of the Salary paid to Mr. Litowitz
during the three months immediately preceding such termination (a portion of which shall be
paid to Tatum. In the event that the Company elects to terminate Mr. Litowitz without Cause
or Mr. Litowitz elects to terminate the Employment Agreement for Good Reason, in each case
after September 16, 2008 but prior to September 16, 2010, Mr. Litowitz will be entitled to
receive a Severance Payment equal to six months of the Salary paid to Mr. Litowitz during
the six months immediately preceding such termination (a portion of which shall be paid to
Tatum).
F-37