Ealixir, Inc. 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion should be read in conjunction with the attached financial statements and notes thereto. Except for the historical information contained herein, the matters discussed below are forward-looking statements that involve certain risks and uncertainties, including, among others, the risks and uncertainties discussed below. CRITICAL ACCOUNTING POLICIES We described our critical accounting policies in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our Annual Report on Form 10-K for the year ended March 31, 2002. Our critical accounting policies are those that are most important to the portrayal of our financial condition and results of operations, and require our management's significant judgments and estimates and such consistent application fairly depicts our financial condition and results of operations for all periods presented. Critical accounting policies affecting us have not changed materially since March 31, 2002. OVERVIEW Semotus still reports four business segments: wireless services, enterprise and commerce sales, professional and related services, and logistic system sales. However, at the end of this fiscal year 2002, Semotus determined that the economy would continue in a weak recovery and that the market for technology products would stay anemic. Accordingly, the Company has centralized and consolidated its organization and its operations. Semotus has organized its operations around two core lines of businesses, while maintaining but de-emphasizing its other operations: i) financial services with the Global Market Pro and Equity Market Pro products and services and ii) workforce automation with the HiplinkXS family of products and services. These products maintain high gross and operating margins and form the core of the enterprise software marketing strategy with wireless and mobile features available in the software. Logistic systems, largely ADA's products and services, continue as part of Semotus' wireless and mobile strategy. This field force automation software provides Semotus with a unique platform for its wireless productivity enhancement tools such as Hiplink. 10 Certain professional services have been de-emphasized. As well, m-commerce initiatives have been reduced. The e-commerce economy has contracted and m-commerce is not expected to make a significant contribution in the market in the near future. Consequently, Semotus has reduced its e-commerce and m-commerce presence with the elimination of unprofitable products and services in that segment. WizShop, the remaining subsidiary in the Enterprise and Commerce Sales segment, still receives small monthly sponsorship and advertising revenue, and has one large customer loyalty software contract. Most of the operations have been largely consolidated into Semotus' other divisions and subsidiaries. At the end of June, FiveStar's operations were closed as the market for e-fulfillment is currently unprofitable, and in August, Wares on the Web was closed as the market for e-commerce and web based services remains depressed, see Note 5, "Discontinued Operations". As a result of the centralization and consolidation implementation, the net loss declined to $571,944 from $1,970,399 and to $0.03 per share from $0.11 per share in the three months ended December 31, 2002 versus 2001 and the net loss declined to $2,835,651 from $8,577,130 and to $0.16 per share from $0.51 per share in the nine months ended December 31, 2002 versus 2001. Likewise, the overall cash decline was reduced to $1,598,836 from $2,758,876 in the nine months ended December 31, 2002 versus 2001. RESULTS OF OPERATIONS FOR THE THREE MONTHS AND NINE MONTHS ENDED DECEMBER 31, 2002 AND 2001 REVENUES Revenues for the three months and nine months ended December 31, 2002 were $875,169 and $2,648,190, respectively, as compared to $935,975 and $3,459,101, respectively, for the three and nine months ended December 31, 2001. Given the continued decline in economic activity and weakened capital and consumer spending for technology products and services, Semotus experienced a decline in revenues of 6% and 23% respectively in the three months and nine months ended December 31, 2002 versus 2001. All segments of the Company's business were affected. Potential customers have delayed capital spending decisions or have kept most of the work in-house. New sales of wireless and software products and services have slowed. Further, Semotus' Centralization and Consolidation Plan has eliminated unprofitable products and services, which has largely been in the professional services and enterprise and commerce segments. The Plan has accounted for some of the revenue decline in professional services, but is the main reason for most of the decline in the enterprise and commerce segment. The e-commerce economy has contracted and is not expected to recover in the near future. Wireless Services The 2% and 5% decline in revenues in the three and nine months ended December 31, 2002 respectively, versus 2001 result from the continued decline in corporate capital spending. Both HiplinkXS and the financial service products, Global Market Pro and Equity Market Pro, have experienced a longer sale cycle, which has delayed and postponed their revenues. Enterprise and Commerce Sales The 2% and 17% decline in revenues in the three month and nine month periods ended December 31, 2002 versus 2001, respectively is primarily due to the initial implementation of a customer loyalty software contract at WizShop in the quarter ended September 30, 2001. The capitalized contract costs and the commensurate deferred revenue were recognized at that time, which created large initial revenues. Since then, the contract has been amortized over its term, which ends March 31, 2003. Professional and Related Services Revenues declined 34% and 85% in the three and nine months ended December 31, 2002, respectively, versus 2001 due largely to the reduction in new professional service contracts at Simkin and also directly the result of the sale of Simkin's Kinetidex 2.0 product in June 2001 for which certain services were performed. Further, the Wares subsidiary was closed in August 2002 and since then has contributed minor amounts of revenue. Logistic System Sales The 13% and 27% decline in revenues in the three and nine month periods ended December 31, 2002 versus 2001, respectively, is a direct result of less capital spending on system integration projects and the beverage industry reducing new capital spending. ADA received fewer system integration contracts. Further, ADA is in process of upgrading its core asset tracking and management software, which has not been completed. The new software should provide further incentives for customers to upgrade and increase revenues at ADA. COST OF REVENUES AND GROSS MARGIN The overall gross profit margin increased to 65% and 61% in the three and nine months ended December 31, 2002 from 56% and 50% in the same periods ended December 31, 2001. The increase is the result of continuing changes in product mix from lower margin enterprise and commerce segment product to higher margin wireless and logistic system segment products. Further, with the elimination of unprofitable products and services and the closing of the FiveStar and Wares operations, the overall gross profit margin improved since the remaining products and services carried much higher margins. Wireless Services The gross profit margin for this segment increased to 80% from 69% in the three months ended December 31, 2002 versus 2001, and also increased to 74% from 59% in the nine months ended December 31, 2002 versus 2001. The increase in the three and nine-month gross profit margins is due to: i) increased higher margin sales of enterprise products such as Global Market Pro, ii) the introduction of a higher margin version of Hiplink, a field force automation wireless product, and iii) the reduction and discontinuance of lower margin consumer products. 11 Enterprise and Commerce Sales The gross profit margin in this segment increased to 42% and 43% in the three and nine months ended December 31, 2002 from 39% and 41% in the same periods ended December 31, 2001. This increase is due to the elimination of unprofitable products and services and the closing of the FiveStar and Wares operations. The major portion of this segment's gross margin comes from the customer loyalty software contract at WizShop. Professional and Related Services The gross profit margin in this segment declined to 77% in the three-month period ended December 31, 2002 from 89% in the three-month period ended December 31, 2001. However, the gross profit margin increased to 89% in the nine-month period ended December 31, 2002 from 52% in the nine-month period ended December 31, 2001. The decline in the three-month gross profit margin is primarily due to the decline in revenues, which has reduced the fixed cost coverage. The nine-month period increase is a direct result of the elimination of unprofitable contracts and services. The remaining professional service business carries much higher margins since the services are extensions of existing contracts that do not require as much start-up costs. Logistic System Sales The gross profit margin increased to 66% for the three months ended December 31, 2002 versus 55% for the three months ended December 31, 2001 and it increased to 58% from 50% in the nine months ended December 31, 2002 versus 2001. This is principally due to a shift in the mix of services provided in the system integration contracts. ADA experienced more demand for higher margin software and consulting services and less demand for lower margin hardware. This services shift has allowed ADA to increase the gross profit margin. OPERATING EXPENSES Operating expenses declined overall in the three month and nine month periods ended December 31, 2002 versus the same periods in the last fiscal year, due to the Centralization and Consolidation Plan, which has significantly reduced operating expenses in all areas of the firm, including research and development, sales and marketing and general and administrative cost centers. The Company categorizes operating expenses into five major categories: research and development, sales and marketing, general and administrative, depreciation and amortization, and stock, option and warrant expense. The table below summarizes the changes in these five categories of operating expenses (unaudited): THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------------- -------------------------- DESCRIPTION 2002 2001 2002 2001 --------------------------------- ------------ ------------ ------------ ------------ Research and development $ 179,969 $ 309,712 $ 695,474 $ 1,176,829 Sales and marketing 268,825 388,281 798,270 1,642,391 General and administrative 472,327 776,111 2,296,919 3,254,966 Net impairment of goodwill -- -- -- 650,000 Depreciation and amortization 329,924 830,564 1,015,745 2,661,010 Stock, option and warrant expense 1,362 95,847 24,283 386,275 ------------ ------------ ------------ ------------ Total $ 1,252,407 $ 2,400,515 $ 4,830,691 $ 9,771,471 --------------------------------- ------------ ------------ ------------ ------------ Research and development expenses are expenses incurred in developing new products and product enhancements for current products. These expenditures are charged to expense as incurred. Much of the development work for the Global Market Pro, Equity Market Pro and HiplinkXS products has been completed which has reduced research and development expenses. Remaining engineering costs are production projects for the existing products and services and engineering work on the update to ADA's asset tracking and management software. Sales and marketing expenses consist of costs incurred to develop and implement marketing and sales programs for the Company's product lines. These include costs required to staff the marketing department and develop a sales and marketing strategy, participation in trade shows, media development and advertising, and web site development and maintenance. These costs also include the expenses of hiring sales personnel and maintaining a customer support call center. These costs have declined principally due to the reduction in general advertising and non-sales supported marketing. There has also been a reduction in marketing personnel as the Company has shifted to emphasizing marketing and sales support for its existing products. General and administrative expenses include senior management, accounting, legal and consulting. This category also includes the costs associated with being a publicly traded company, including the costs of the AMEX listings, investor and public relations, rent, administrative personnel, and other overhead related costs. These costs declined during the three months and nine months ended December 31, 2002 as personnel and offices were reduced and operating functions were consolidated. The net impairment of goodwill is related to an impairment charge to goodwill related to Simkin for $650,000. As noted in Note 5 of Semotus' Form 10K for the year ended March 31, 2002, "Sale of Technology and Net Impairment of Goodwill", Semotus elected to sell the royalty rights and software of Kinetidex 2.0 to Micromedex, Inc., the joint developer and exclusive distributor of the product. Semotus received $350,000 for the product and all future royalty rights. Semotus considered a variety of factors for a potential impairment of goodwill, which included the sale of the technology, future prospects of Simkin's business, and importantly, the consideration paid for Simkin, which was substantially all 12 common stock. Subsequent to the acquisition, the price of the common stock of Semotus had declined from $14.375 to $1.59 as of June 30, 2001. Consequently, Semotus elected to take a goodwill impairment charge of $650,000. Depreciation and amortization expense includes depreciation of computers and other related hardware and certain fixtures. Amortization includes goodwill costs for periods prior to April 1, 2002 and certain intellectual property costs. The decrease in this expense is primarily the result of the adoption of SFAS 142, "Goodwill and Other Intangible Assets" in which goodwill is no longer amortized. Further, Semotus elected to take an impairment charge of $3,541,017 for intangible assets at March 31, 2002 which has reduced the asset value of intangible assets other than goodwill to $1,000,000 at March 31, 2002. This impairment charge has reduced the amortization associated with the intangible assets. The non-cash charges for compensation consists mainly of grants of stock, options and warrants for services provided to the Company. Such services include financial, marketing and public relations consulting. Additionally, common stock was issued for certain accrued liabilities. The decline in non-cash charges for compensation is due mainly to the termination of contracts with service providers, which called for stock or warrant compensation, as well as the decline in the stock and option grants to service providers, in the three months and nine months ended December 31, 2002. The common stock issued was valued at its fair market value at the time of issuance, or in the instance of common stock purchase warrants, in accordance with the Black-Scholes pricing guidelines. Certain employee stock options, which have been repriced, are subject to the variable plan requirements of FIN No. 44, that requires the Company to record compensation expense for changes in the fair value of the Company's common stock. While no compensation expense was required to be recognized in the three months and nine months ended December 31, 2002 or 2001, expense will be recognized in the future if the stock price increases above the revised exercise price of the options. NON-OPERATING INCOME AND EXPENSES Non-operating income and expenses for the three and nine months ended December 31, 2002 and 2001 are primarily interest income from invested cash, interest expense from notes payable, amortization of advances from technology sales received in previous periods, and the owner's fees and offsetting interest income recognized, related to the technology sales. See the Consolidated Statement of Operations and Comprehensive Loss and Notes to the Financial Statements in our Annual Report on Form 10-K for the year ended March 31, 2002. Net interest income declined as less cash was available for investment during the three and nine month periods ended December 31, 2002 versus 2001 as Semotus continues with operating losses. Amortization of technology advances decreased somewhat in the three months ended December 31, 2002, due to the application of accelerated amortization on the balances. COMPREHENSIVE LOSS The comprehensive loss of $574,024 or $0.03 per share and $2,835,444 or $0.16 per share for the three months and nine months ended December 31, 2002, respectively, compared to $1,977,143 or $0.11 per share and $8,614,394 or $0.51 per share for the three months and nine months ended December 31, 2001, respectively, is a direct result of the implementation of cost reduction programs which have consolidated and centralized Semotus' operating units and the elimination of unprofitable products and services. SEGMENT RESULTS Semotus' business has evolved into four segments: wireless services, enterprise and commerce sales, professional and related services and logistic system sales. (See Note 8, "Segment Information" for further information about each of the segments.) Specific results of the segments are discussed under "Revenues" and "Cost of Revenues and Gross Margin" in this section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations". All segment financial information presented is unaudited. WIRELESS ENTERPRISE AND PROFESSIONAL AND LOGISTIC CORPORATE SERVICES COMMERCE SALES RELATED SERVICES SYSTEM SALES AND OTHER TOTAL ----------- ----------- ----------- ----------- ----------- ----------- AS OF AND FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 ----------------------------------- Revenue $ 338,970 $ 250,212 $ 11,475 $ 274,512 $ -- $ 875,169 Gross Profit 270,810 105,972 8,888 180,983 -- 566,653 Operating loss* (16,330) 89,950 (496) 6,188 (765,066) (685,754) Depreciation and amortization 28,922 43,471 -- 7,531 250,000 329,924 Capital expenditures 2,567 -- -- -- -- 2,567 Total assets, December 31, 2002* 3,614,285 713,951 263,530 134,168 1,628,812 6,354,746 13 NINE MONTHS ENDED DECEMBER 31, 2002 ----------------------------------- Revenue $ 962,773 $ 766,775 $ 51,744 $ 866,898 $ -- $ 2,648,190 Gross Profit 716,643 332,880 45,886 507,054 -- 1,602,463 Operating Loss* (830,801) 255,358 22,830 (41,772) (2,633,843) (3,228,228) Depreciation and amortization 193,951 45,964 1,880 23,950 750,000 1,015,745 Capital expenditures 22,083 -- -- -- -- 22,083 Total assets, December 31, 2002* 3,614,285 713,951 263,530 134,168 1,628,812 6,354,746 AS OF AND FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 ----------------------------------- Revenue $ 346,421 $ 255,380 $ 17,512 $ 316,662 $ -- $ 935,975 Gross Profit 237,636 100,243 15,640 175,095 -- 528,614 Operating loss* (122,550) 45,551 4,148 (119,979) (1,679,071) (1,871,901) Depreciation and amortization 73,742 21,744 7,486 8,393 719,199 830,564 Capital expenditures 4,172 -- -- -- -- 4,172 Total assets, December 31, 2001* 8,797,980 4,802,917 828,350 1,417,831 4,153,816 20,000,894 NINE MONTHS ENDED DECEMBER 31, 2001 ----------------------------------- Revenue $ 1,017,190 $ 921,334 $ 334,274 $ 1,186,303 $ -- $ 3,459,101 Gross Profit 597,159 378,085 172,736 589,054 -- 1,737,034 Operating Loss* (638,934) (177,929) (443,143) (133,640) (6,640,791) (8,034,437) Depreciation and amortization 233,873 66,842 71,354 21,402 2,267,539 2,661,010 Capital expenditures 14,992 -- -- 5,715 -- 20,707 Total assets, December 31, 2001* 8,797,980 4,802,917 828,350 1,417,831 4,153,816 20,000,894 * Certain corporate marketing, research and development and general and administrative costs have not been allocated to the segments and have been included in "Corporate and other". Further, the selected profit and loss items in the three and nine month periods ended December 31, 2002 and 2001 and total assets at December 31, 2002 and 2001 respectively, have been adjusted for the discontinued operations of FiveStar and Wares on the Web, which are categorized in the Enterprise and Commerce Sales segment. See Note 5, "Discontinued Operations". LIQUIDITY AND CAPITAL RESOURCES The overall decrease in the cash position of Semotus is due to the continued operating losses at the Company. Cash continued to be spent on operating resources and upgrading and maintaining certain wireless and logistic system products although a cash management and cost reduction program has been implemented and has reduced the overall cash loss by 42% for the nine month period ended December 31, 2002 versus 2001. The sources and uses of cash are summarized as follows (unaudited): NINE MONTHS ENDED DECEMBER 31, ----------------------------------------------------------------------------- 2002 2001 ------------ ------------ Cash used in operating activities $ (1,656,049) $ (4,084,588) Cash provided by investing activities 188,856 1,425,765 Cash used in financing activities (161,809) (188,625) Net cash provided by discontinued operations 30,166 88,573 ------------ ------------ Net decrease in cash and cash equivalents $ (1,598,836) $ (2,758,875) ============ ============ 14 Cash used in operating activities from continuing operations consisted principally of a net loss of $2,835,651 offset somewhat by non-cash charges of $1,015,745, of depreciation and amortization, $574,647 of amortization of notes receivable, $165,215 of settlement of liabilities and $24,283 of stock based compensation. Additionally, the loss from the discontinued operations contributed $125,860. Other operating activities that contributed to offsetting the use of cash were $202,775 in the net change of current assets and current liabilities. This largely resulted from decreases in accrued liabilities and accounts payable of $189,041 and $97,186 respectively and increases in accounts receivable of $116,828, offset somewhat by increases in deferred revenue of $127,788. Cash provided by investing activities consisted principally of the continuing investment in ADA of $210,379, by the 49% owner of ADA, Global Beverage Group. This was offset somewhat by capital expenditures of $22,083. Cash flows from financing activities produced a net decrease in cash of $161,809, which resulted primarily from the repurchase by the Company of its preferred stock for $100,000 in cash as part of the consideration (see Note 6, "Repurchase of Preferred Stock"), as well as from repayments on notes payable and capital leases. As of December 31, 2002, the Company had cash and cash equivalents amounting to $2,505,467, a decrease of $2,292,122 from the balance at March 31, 2002. Working capital decreased to $1,252,372 at December 31, 2002 from $2,064,396 at the fiscal 2002 year end. The decrease in working capital is from the resources used in the operations of Semotus as explained above. The Company has not yet generated sufficient revenues to cover the costs of continued product development and support, sales and marketing efforts and general and administrative expenses. There are no material commitments for capital expenditures at December 31, 2002. Management believes that it has adequate working capital for the next 12 months. RECENT PRONOUNCEMENTS: In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities" ("SFAS 146"). SFAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accconted for under EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity (including Certain Costs Incurred in a Restructuring)." The scope of SFAS 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. The Company's adoption of SFAS 146 on January 1, 2003 had no impact on the Company's financial position or results of operations. In November 2002, the FASB issued FASB Interpretation NO. 45 ("FIN 45"), "GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS, AN INTERPRETATION OF FASB STATEMENTS NO. 5, 57, AND 107 AND RESCISSION OF FASB INTERPRETATION NO. 34." FIN 45 clarifies the requirements of FASB Statement No. 5, "ACCOUNTING FOR CONTINGENCIES" relating to to the guarantor's accounting for, and disclosure of the issuance of certain types of guarantees. The disclosure provisions of the Interpretation are effective for financial statements of interim or annual reports that end after December 15, 2002, irrespective of the guarantor's year-end. The Company's adoption of FIN 45 did not have a material impact in the Company's financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 amends SFAS No. 123 and requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and is effective for interim periods beginning after December 15, 2002. The Company's adoption of SFAS NO. 148 on January 1, 2003 did not have a material effect on the Company's financial position or results of operations. FORWARD LOOKING STATEMENTS AND RISK FACTORS This report includes forward-looking statements relating to, among other things, projections of future results of operations, our plans, objectives and expectations regarding our future services and operations and our acquisitions of Cross, Simkin, Wares, Five Star, Tech-ni-comm, WizShop and Application Design Associates and general industry and business conditions applicable to us. We have based these forward-looking statements on our current expectations and projections about future events. You can find many of these forward-looking statements by looking for words such as "may", "should", "believes", "expects", "anticipates", "estimates", "intends", "projects", "goals", "objectives", or similar expressions in this document or in documents incorporated herein. These forward-looking statements are subject to a number of risks, uncertainties and assumptions about us that could cause actual results to differ materially from those in such forward-looking statements. Such risks, uncertainties and assumptions include, but are not limited to, our limited operating history, our historical losses, the infancy of the wireless data industry where there is no established market for our products and services, our ability to adapt to rapid technological changes, our dependence on wireless networks owned and controlled by others, and the other factors that we describe in the section entitled "Risk Factors" in the Form 10K for the year ended March 31, 2002. Semotus Solutions claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. 15