ITEM 1.
Business
ITEM 1A.
ITEM 1A.
Risk Factors
ITEM 2.
ITEM 2.
Properties
ITEM 3.
ITEM 3.
Legal Proceedings
ITEM 4.
ITEM 4.
Submission of Matters to a Vote of Security Holders
PART II
ITEM 5.
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
ITEM 6.
ITEM 6.
Selected Consolidated Historical Financial Data
ITEM 7.
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of the financial condition and results of operations needs to be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this report. This discussion and analysis includes forward-looking statements that are subject to risks, uncertainties and other factors described under the caption “Risk Factors” beginning with Item 1A of this Annual Report. These factors could cause actual results in current and future periods to differ materially from those expressed in, or implied by, those forward-looking statements. See “Special Note Regarding Forward-Looking Statements.”
Background and History
We were incorporated in Bermuda in September 1995. Our business plan is to actively manage and grow the presence in the interactive software entertainment industry both organically and through acquisitions.
We sold our last remaining South African operations in November 2000 although we still have significant assets that are denominated in South African Rand. The assets include cash and notes receivables. Currently we do not have a financial hedging program to protect against the depreciation of the South African Rand against the United States dollar and, therefore, as long as we hold assets denominated in South African Rand we will continue to record income statement gains or losses to the extent that the South African Rand’s value fluctuates relative to the US dollar.
On April 21, 2005, we acquired Strategy First, a leading worldwide publisher of entertainment software for the PC, through the jurisdiction of the Montreal bankruptcy court. Pursuant to the approved plan of arrangement, we paid (i) 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; and (iv) assumed approximately $400,000 in existing bank debt, as well as contingent consideration based on the future profitability of Strategy First.
On December 4, 2006, we announced that we had achieved more than 90% acceptance of our offer to acquire the shares of Empire. Based on these acceptances, we announced a formal closing of the offer to Empire shareholders effective December 1, 2006. Consideration was paid to the shareholders as follows: approximately $6.8 million paid at closing and an additional $5.5 million in loan notes which were paid in full during this quarter. Additionally, further contingent consideration of approximately $3.8 million based on Empire’s EBIDTA for the 12 months ended June 30, 2007 was paid during fiscal year 2008.
Results of Operations
Due to the acquisition of Empire during fiscal year 2007 the disposal of the assets of Fantasy Sports, in fiscal year 2006 the following management discussion and analysis of financial condition and results of operations may not provide an accurate comparison between the current and past fiscal years.
The fiscal year ended June 30, 2007 includes seven months of operating results for Empire. The results for Fantasy Sports are classified as discontinued operations in the fiscal years ended June 30, 2006.
Fiscal Year 2008 Compared to Fiscal Year 2007
Revenues
Net revenues increased to approximately $25,743,000 for fiscal year 2008 as compared to approximately $19,794,000 in fiscal year 2007. This increase was due to the operations of Empire which generated revenues of approximately $23,892,000 in fiscal year 2008 versus $17,196,000 in the prior year. During fiscal year 2007 revenues were generated by the operations of Strategy First for a full year and for seven months for the operations for Empire.
Cost of Sales
Cost of sales was approximately $11,137,000 for fiscal year 2008, or 43% of total revenues. Cost of sales for Empire was approximately $10,483,000, or 43.9% of sales, while cost of sales for Strategy First was approximately $1,057,000, or 54.5% of sales. For fiscal year 2007, cost of sales was approximately $6,513,000, or 32.9% of sales. This decrease in gross margin is primarily the result of lower gross margins for console games, which make up the majority of Empire’s sales, as opposed to PC products. In fiscal year 2007 Empire’s operations were included for only seven months, therefore, the proportion of console sales for the year was lower. Additionally, a significant portion of Strategy First’s sales were generated through guaranteed foreign royalty sales, which had no associated cost of sales thereby increasing its gross margin percentage in fiscal year 2007.
Development Costs and Royalties
Development costs and royalties were approximately $2,072,000 for fiscal year 2008 as compared to approximately 2,133,000 in fiscal year 2007. Development costs and royalties for Empire totaled approximately $1,692,000 for fiscal year 2008 versus $1,527,000 for fiscal year 2007. Royalty costs for Strategy First were approximately $470,000 for fiscal year 2008 as compared to approximately $548,000 during the prior fiscal year. Royalty expenses decreased as Strategy First sold less outside products in fiscal year 2008.
Development expenditures capitalized during fiscal year 2008 were approximately $7,091,000 as compared to $5,524,000 in fiscal year 2007. Development costs are incurred by Empire only as Strategy First does not develop products. To date, Strategy First has outsourced development in exchange for future distribution rights. Amortization of development costs during fiscal year 2008 was approximately $4,022,000 as compared to $337,000 in fiscal year 2007 which reflected amortization for a full fiscal year.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for fiscal year 2008 were approximately $14,184,000. Selling, general and administrative expenses for Empire Interactive were approximately $9,945,000 while selling, general and administrative expenses for Strategy First were approximately $1,413,000 Corporate overhead was approximately $2,598,000. For fiscal year 2007, selling general and administrative expenses were approximately $8,084,000 of which empire accounted for approximately $5,138,000, Strategy First accounted for approximately $1,787,000 with corporate overhead accounting for approximately $1,144,000. The increase in selling, general and administrative costs for Empire is primarily the result of including a full year of operations versus only seven months in the prior year. The increase in corporate overhead was primarily the result of increased staff, professional fees and stock based compensation expense during fiscal year 2008 reflecting the greatly increased size of the Company’s operations. The decrease in Strategy First sales, general and administrative expenses were primarily due to staff reductions.
Amortization and Depreciation
Amortization of acquired intangible assets increased to approximately $6,642,000 during fiscal year 2008 as compared to approximately $4,236,000 in the prior fiscal year. This increase of approximately $2,420,000 is primarily due to the full year’s amortization of intangible assets acquired in the Empire transaction as opposed to seven months in fiscal year 2007. Amortization of development costs are $4,022,000 versus $337,000 in the prior year. This is due primarily to the first full year of amortizing capitalized development costs due to a new accounting policy adopted when the Company acquired Empire. Depreciation expenses were approximately $260,000 for fiscal year 2008 and approximately $158,000 in the same period in the prior fiscal year. The increase is primarily attributable to the inclusion of Empire for 12 months versus seven months in the prior year.
Impairment Loss
The Company incurred a non-cash impairment loss on certain acquired intangible assets of $8,605,517. This impairment was due to an updated third party valuation of the expected value of the acquired intangible assets of Empire consisting of individual game titles. Although in total, the value of all game titles approximates its carrying value, certain individual game titles were impaired due to lower than projected sales and an increase in the imputed cost of capital. There was no impairment charge in the prior year.
Foreign Currency Gains (Losses)
Foreign currency losses during the fiscal year 2008 were approximately $158,000 versus gains last year of approximately $247,000. Empire realized foreign currency gains of approximately $99,000 and Strategy First realized foreign currency losses of approximately $3,000. Additionally, First South Africa Holding incurred a loss of approximately $231,000 primarily due to the devaluation assets held in South Africa. Foreign currency gains during the fiscal year 2007 were approximately $247,000. Empire realized foreign currency gains of approximately $205,000 and Strategy First realized foreign currency gains of approximately $42,000.
Amortization of Convertible Debt Discounts and Issuance Costs
Amortization of convertible debt discounts and issuance costs were approximately $896,000 in fiscal year 2008 as compared to approximately $592,000 in fiscal year 2007. The Company began amortizing convertible debt discounts and amortization costs during the second quarter of fiscal year 2006. Amortization expenses were higher in the current fiscal year as compared to fiscal year 2007 as a result of the issuance of $7,500,000 million in convertible debentures in March 2008.
Interest Expense
Interest expense of approximately $702,000 was recorded during fiscal year 2008 as compared to approximately $884,000 in fiscal year 2007. Interest expense decreased as a result of average lower aggregate debt obligations during the current fiscal year as compared to the prior year.
Interest Income
Interest income of approximately $226,000 was recorded during fiscal year 2008 as compared to interest income of approximately $484,000 in the prior fiscal year. The decrease of approximately $264,000 is primarily the result of the Company’s decrease in the average cash balances held during fiscal year 2008 as compared to the prior fiscal year.
Provision for Income Taxes
The Company is registered in Bermuda, where no income tax laws are applicable. Two subsidiaries are subject to US income taxes, four subsidiaries are subject to United Kingdom income taxes, one subsidiary is subject to Canadian income taxes and one of the subsidiaries is subject to South African income taxes. For the year ended June 30, 2008, 2007 and 2006, the Company had a provision for income taxes of $615,893, a benefit of $11,918, and $0, respectively. The deferred tax asset generated by the tax losses and temporary differences has been fully reserved including those of Empire in the United Kingdom.
In April 2006, the 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 $280,000 as of August 31, 2007. The Company believes its remaining liability to SARS is lower than this amount, however, in the event its arguments are unsuccessful, it may be forced to increase this liability.
Net Loss
The Company has recognized an operating EBITDA loss of approximately $1.820 million during fiscal year 2008 compared to an operating EBITDA gain of approximately $3.06 million for the prior fiscal year. The operating loss for fiscal year 2008 was approximately $12.52 million as compared to approximately $1.67 million for the prior fiscal year. During fiscal year 2008 the Company incurred amortization expenses for software development and acquired intangibles of approximately $10.66 million as compared to $4.57 million in the prior fiscal year. A net loss was incurred of approximately $22.4 million as compared to approximately $2.4 million in the previous fiscal year. The increase in the net loss was primarily caused by increases in the depreciation and amortization of software development costs and acquired intangibles of approximately $10.66 million in fiscal year 2008 as well as a non-cash impairment charge of approximately $8.6 million as opposed to $4.4 million in fiscal year 2007 with no impairment charges. Additionally, selling general and administrative costs increased by $5.8 million from fiscal year 2007 due in part to including Empire for a full fiscal year versus only for seven months in fiscal year 2007.
The calculation used to compute operating EBITDA for the fiscal years ended June 30, 2008 and 2007 was computed as follows:
For fiscal year 2008, net loss includes non-cash foreign currency losses of approximately $158,000, as compared to gains of approximately $247,000 in the prior fiscal year; and approximately $895,000 of amortization costs related to debt as compared to approximately $592,000 during the year ended June 30, 2007. Non-cash stock-based compensation expense totaled $$772,461 during fiscal year 2008 as compared to $260,305 for the prior fiscal year.
Fiscal Year 2007 Compared to Fiscal Year 2006
Revenues
Net revenues increased to approximately $19,800,000 for fiscal year 2007 as compared to approximately $3,316,000 in fiscal year 2006. This increase was due to the operations of Empire which generated revenues of approximately $17,196,000. During fiscal year 2006 revenues were generated by the operations of Strategy First alone.
Cost of Sales
Cost of sales was approximately $6,513,000 for fiscal 2007, or 32.9% of total revenues. Cost of sales for Empire was approximately $5,841.000, or 39.8% of related sales, while cost of sales for Strategy First was approximately $672,000, or 25.9% of related sales. For fiscal year 2006, cost of sales was approximately $555,000, or 16.7% of sales. This decrease in gross margin is primarily the result of lower gross margins for console games, which make up the majority of Empire’s sales, as opposed to PC products. In fiscal year 2006 a significant portion of Strategy First’s sales were generated through foreign royalty sales, which had no associated cost of sales.
Development Costs and Royalties
Development costs and royalties were approximately $2,133,000 for fiscal year 2007. Development costs and royalties for Empire totaled approximately $1,527,000 for fiscal year 2007. Royalty costs for Strategy First were approximately $548,000 for fiscal year 2007 as compared to approximately $943,000 during the prior fiscal year. Royalty expenses decreased as Strategy First sold less outside products in fiscal year 2007. Development expenditures capitalized during fiscal year 2007 were approximately $5,524,000 Development costs are incurred by Empire. To date Strategy First has outsourced development in exchange for future distribution rights. Amortization of development costs during fiscal year 2007 was approximately $337,000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for fiscal year 2007 were approximately $8,084,000. Selling, general and administrative expenses for Empire Interactive were approximately $5,138,000 while selling, general and administrative expenses for Strategy First were approximately $1,604,000. Corporate overhead was approximately $1,383,000. For fiscal year 2006, selling general and administrative expenses were approximately $2,931,000 of which Strategy First accounted for approximately $1,787,000 with corporate overhead accounting for approximately $1,144,000. The increase in corporate overhead was primarily the result of increased professional fees and stock based compensation expense during the fiscal year 2007.
Amortization and Depreciation
Amortization of acquired intangible assets increased to approximately $4,236,000 during fiscal year 2007 as compared to approximately $149,000 in the prior fiscal year. This increase is primarily due to the amortization of intangible assets acquired in the Empire transaction of approximately $3,970,000. Depreciation expenses were approximately $160,000 for fiscal year 2007 and approximately $32,000 in the same period in the prior fiscal year. Depreciation expense for Empire was approximately $129,000 for fiscal year 2007.
Foreign Currency Gains (Losses)
Foreign currency gains during the fiscal year 2007 were approximately $247,000. Empire realized foreign currency gains of approximately $205,000 and Strategy First realized foreign currency gains of approximately $42,000. The foreign currency losses during fiscal year 2006 were approximately $750,000, consisting of foreign currency losses of approximately $832,000 related to the remaining assets from the sale of discontinued South African operations, approximately $66,000 in gains recognized by Strategy First and approximately $16,000 in gains recognized by the parent company.
Acquisition Costs Incurred
During fiscal year 2006 the Company incurred approximately $321,000 in direct costs plus additional costs in related to securing financing for an unsuccessful acquisition of and subsequent litigation against a European software company. The Company is seeking damages for breach of contract from this European software company. The case has been concluded and the ruling was against the Company and the Company is not seeking any further redress.
Amortization of Convertible Debt Discounts and Issuance Costs
Amortization of convertible debt discounts and issuance costs were approximately $592,000 in fiscal year 2007 as compared to approximately $770,000 in fiscal year 2006. The Company began amortizing convertible debt discounts and amortization costs during the second quarter of fiscal year 2006. Amortization expenses were lower as compared to fiscal year 2006 as a result of the extending the maturity date of the debentures to April 30, 2010 during the current fiscal year.
Interest Expense
Interest expense of approximately $884,000 was recorded during fiscal year 2007 as compared to approximately $561,000 in fiscal year 2006. Interest expense increased as a result of significant increases in debt obligations that occurred during fiscal year 2007 as compared to the prior year. This increase is partially attributable to the Empire line of credit which stood at approximately $2,284,000 at June 30, 2007.
Interest Income
Interest income of approximately $484,000 was recorded during the fiscal year 2007 as compared to interest income of approximately $633,000 in the prior fiscal year. The decrease of approximately $149,000 is primarily the result of the Company’s decrease in the average cash balances held during fiscal year 2007 as compared to the prior fiscal year.
Provision for Income Taxes
The Company is registered in Bermuda, where no income tax laws are applicable to us. Two of its subsidiaries are subject to US income taxes, four subsidiaries are subject to United Kingdom income taxes, one subsidiary is subject to Canadian income taxes and one of its subsidiaries is subject to South African income taxes. None of them has had taxable income because each of them has incurred losses for tax purposes. The deferred tax asset generated by the tax losses and temporary differences has been fully reserved with the exception of approximately $625,000 carried as a long-term asset that will be offset against future taxable earnings of Empire in the United Kingdom.
In April 2006, the Company’s 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 $316,000 as of August 31, 2007. The Company believes its remaining liability to SARS is lower than this amount, however, in the event its arguments are unsuccessful, it may be forced to increase this liability.
Discontinued Operations
During fiscal year 2006, the Company recognized income of approximately $162,000 from the discontinued operations of Fantasy Sports, Inc. On April 7, 2006, the Company sold all the assets and certain liabilities of Fantasy Sports, Inc. to FUN Technologies, LLC which resulted in a recognized gain of approximately $1,481.000. In fiscal year 2007, the Company had no discontinued operations.
Net Loss
The Company has recognized an operating EBITDA gain of approximately $3.06 million during fiscal year 2007 compared to an operating EBITDA loss of approximately $1.11 million for the prior fiscal year. The company’s operating loss for the fiscal year 2007 was approximately $1.67 million as compared to approximately $1.29 million for the prior fiscal year. During fiscal year 2007 the Company incurred amortization expenses for software development and acquired intangibles of approximately $4.57 million as compared to $150,000 in prior fiscal year. The Company incurred a net loss of approximately $2.4 million as compared to approximately $1.98 million in the previous fiscal year. The increase in the net loss was primarily caused by increases in the depreciation and amortization of software development costs and acquired intangibles of approximately $4.4 million in fiscal year 2007 as well decreases in income recognized from discontinued operations of approximately $1,642,000 as compared to the prior fiscal year.
The calculation used to compute operating EBITDA for the fiscal years ended June 30, 2007 and 2006 was computed as follows:
For fiscal year 2006, net loss includes non-cash foreign currency losses of approximately $616,000, as compared to gains of approximately $247,000 in the current fiscal year; $600,000 expensed for an estimated foreign tax liability as compared to $0 in the current fiscal year; approximately $321,000 incurred for abandoned acquisition costs as compared to $0 in the current fiscal year; and approximately $770,000 of amortization costs related to the issuance of the Company’s $5,000,000 convertible debt as compared to approximately $592,000 during the year ended June 30, 2007.
Financial Condition, Liquidity and Capital Resources
Cash decreased by approximately $1,478,000 from $3,693,000 at June 30, 2007 to approximately $2,215,000 at June 30, 2008. This decrease is primarily the result of the investments in software development. The cash balances are being held for acquisitions and working capital purposes. Included in this amount is $700,000 which is classified as restricted. This amount relates to cash used to secure borrowings of the Company’s subsidiary, Strategy First, as well as money retained in South Africa to satisfy any potential liability that may result from the tax dispute with the South African Revenue.
Working capital increased by approximately $7,417,000 from approximately a deficit of $12,700,000 at June 30, 2007 to a deficit of approximately $5,453,000 on June 30, 2008. The decrease is primarily due to the ability of the Company to refinance the short term debt due to the acquisition of Empire, which resulted in significant decreases to the cash balance and significant increases in current liabilities. Current liabilities acquired as part of the acquisition of Empire exceeded current assets acquired by $6,631,000. Current notes payable to Empire shareholders totaled approximately $ 3,000 as of June 30, 2008.
On June 30, 2008, Empire owed approximately $795,000 for United Kingdom payroll taxes of which approximately $ 602,000 was past due.
At June 30, 2008 the Company had borrowings of approximately $1,618,000 which consisted of advances against the Empire’s line of credit, secured by the Company’s cash. Additionally, there are two outstanding debentures issued to DKR Soundshore Oasis, with a combined face value of $8,900,000. The Company currently incurs monthly interest on this amount at a rate of approximately 8.5%.
As shown in the consolidated financial statements (refer to ITEM 8), the Company has incurred recurring losses from operations, negative cash flows from operation, and as of June 30, 2008, the Company’s current liabilities exceeded its current assets by $5,681,513. These factors raise substantial doubt about the Company’s ability to continue as a going concern.
Management plans to meet its ongoing cash requirement as follows:
•
Generate significant short term operating earnings and cash flow primarily through its Empire subsidiary. Empire’s title release schedule for the next 12 months includes several multi-platform games most notably Hello Kitty and PipeMania. The company anticipates that the launch of these games, along with Empire’s ongoing business will generate operating profits and cash flow in the short term. Empire continues to explore US distribution agreements with major entertainment publishers which would provide significant short term cash flow.
•
On September 9, 2008, the Company and Empire Interactive entered into a term sheet with a fund whereby Empire would be provided a senior secured revolving loan of up to $8 million. The loan will be secured by all of the assets of Empire and is subject to borrowing base availability which consists of accounts receivable inventory and intellectual property. The loan proceeds will be used to repay the outstanding balance of the current Barclays Commercial line of credit, finance the development and marketing of existing and new games and for working capital purposes. Based on the current due diligence and legal documentation, the Company anticipates this loan to close in early November.
•
Raise additional capital through the sale of certain intellectual property. The Company has had preliminary discussions with a third party to sell certain of its intellectual property and would entertain the sale of such intellectual property should the sales price justify a transaction.
•
The Company has approximately $677,000 of restricted cash set aside to match its current South African tax assessment. The Company believes that it has strong arguments to set aside this assessment. If this assessment is set aside, this cash would be available for operations.
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. In addition, the Company believes that if they close on the $8 million loan in November, they would be able to sustain operations through fiscal year 2009. The accompanying financial statements do not include any adjustments that might be necessary if the company is unable to continue as a going concern.
Contractual Obligations
The following table is a summary of contractual obligations as of June 30, 2008:
Future Commitments
Through June 30, 2008, Strategy First has sustained operating losses. The Company anticipates that this situation will be remedied through a combination of increased revenues through sustained new game releases as well as a reduction in expenses. Strategy First and Empire are projecting an operating profit for the coming twelve months. There are no assurances that these expectations will be met. In this event, it may need to continue to support the operations of the subsidiaries.
Off-Balance Sheet Arrangements
The Company has not created, and is not a party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating the business. There are no arrangements or relationships with entities that are not consolidated into the financial statements.
Critical Accounting Policies
The following is a discussion of the accounting policies that the Company believes are critical to the operations:
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 Company records 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.
Development Costs
In the past, Empire has incurred significant software development costs in connection with the production of their products. 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”). Empire’s management had taken the position that commercial feasibility is reached very late in the development process and therefore had not capitalized any development costs in regard to their products. As reported in the Company’s Form 10-Q/A for the quarter ended December 31, 2006, the Company was in the process of evaluating the appropriateness of this position by performing its own analysis to determine as to when commercial feasibility is reached. This analysis was completed during the quarter ending March 31, 2007. Based on this analysis, the Company 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 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.
During the quarter ended December 31, 2006, $693,268 (£353,209 based on the December, 2006 foreign exchange rate of $1.96277 US dollars to the UK pound) of software development costs were expensed. This had the effect of reducing the March 31, 2007 quarter’s loss by $690,242 (£353,209 based on the quarter ended March 31, 2007 foreign exchange rate of 1.95449 US dollars to the UK pound) and represents the amount of software development cost expensed during the quarter ended December 31, 2006, capitalized during the current quarter ended March 31, 2007. The table sets forth below the effect on the quarterly earnings had the Company capitalized its software development costs starting on Decemb er 1, 2006.
Goodwill Valuation
Goodwill represents the excess of the purchase price over the fair market value of net assets acquired. The process of determining goodwill requires judgment. Evaluating goodwill for impairment involves the determination of the fair value of the reporting units. Inherent in such fair value determinations are certain judgments and estimates, including the interpretation of current economic indicators and market valuations, and the strategic plans with regard to the operations. To the extent additional information arises or the strategies change, it is possible that the conclusion regarding goodwill impairment could change, which could have a material effect on the financial position and results of operations. For those reasons, the Company believes that the accounting estimate related to goodwill impairment is a critical accounting estimate.
The Company reviews goodwill annually (or more frequently under certain conditions) for impairment in accordance with SFAS No. 142, goodwill and other intangible assets. The Company performed its annual impairment test of goodwill as of June 30, 2008 and determined that goodwill was impaired which resulted in the Company writing down to zero the Goodwill that was recognized as a component of the Strategy First acquisition.
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, 2008 a launch date was estimated to project future amortization.
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.
ITEM 7A.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
ITEM 9A.
Controls and Procedures
Not applicable.
ITEM 9A(T).
Controls and Procedures
As of the end of the period covered by this annual report, management of the Company, with the participation of the Company’s Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as defined in Rule 13a-15(e) under the Exchange Act. Disclosure controls and procedures are defined as the controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act are recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act are accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, management of the Company, including the Company’s principal executive officer and principal financial officer, concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2008.
Management’s Annual Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management of the Company, including the Company’s principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2008 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Management believes that this evaluation provides a reasonable basis for its opinion. Based on that evaluation, management of the Company, including the Company’s principal executive officer and principal financial officer, have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting during the fiscal quarter ended June 30, 2008, that has materially affected, or is reasonably likely to materially effect our internal controls over financial reporting
ITEM 9B.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth, as of September 29, 2008, certain information as to the beneficial ownership of the common stock by:
•
each person known by us to own more than five percent (5%) of the outstanding shares of common stock;
•
each of the named executive officers in the Summary Compensation Table under “Executive Compensation;”
•
each of the directors; and
•
all of the executive officers and directors as a group.
Unless otherwise specified, the address of each of the persons set forth below is in care of Silverstar Holdings, Ltd, Clarendon House, Church Street, Hamilton HM CX Bermuda:
___________________
(1)
Beneficial ownership is calculated in accordance with Rule 13d-3 under the Securities Exchange Act of 1934. Shares subject to stock options, for purposes of this table, are considered beneficially owned only to the extent currently exercisable or exercisable within 60 days after August 31, 2002.
(2)
Includes 60,000 shares of common stock issuable upon exercise of options that are immediately exercisable and 21,186 shares of restricted stock.
(3)
Includes 750,000 shares of common stock issuable upon exercise of options 500,000 of which are immediately exercisable and 18,181 shares of restricted stock.
(4)
Includes 40,000 shares of common stock issuable upon the exercise of options that are immediately exercisable and 21,186 shares of restricted stock.
(5)
Includes 30,000 shares of common stock issuable upon exercise of options that are immediately exercisable and 13,227 shares of restricted stock.
(6)
Consists of 21,186 shares of restricted stock.
(7)
Includes 850,000 shares of common stock issuable upon exercise of options: 600,000 shares of which are exercisable immediately; 102,925 shares of restricted stock. Does not include 48,276 and 96,552 warrants owned by Mr. Levy and Mr. Kabatznik, respectively.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
(a)
Related Party Transactions.
(b)
Independent Directors.
Michael Levy, Edward Roffman, Cornelius J. Roodt and Edward L. Bernstein are independent directors as defined by the Nasdaq Marketplace Rules.
ITEM 14.
ITEM 14.
Principal Accountant Fees and Services
Audit Fees
Audit fees billed to the Company by Rachlin, LLP for its audit of the Company’s financial statements and for its review of the financial statements included in the Company’s Quarterly Reports on Form 10-Q filed with the Securities and Exchange Commission for fiscal years 2008 and 2007 totaled approximately $170,000 and approximately $154,000, respectively.
Tax Fees
Tax fees billed to the Company by Rachlin, LLP for its tax returns for the fiscal years 2008 and 2007 were $0 and approximately $3,600, respectively.
Other Fees
No other fees were billed to the Company by Rachlin, LLP for all other non-audit or tax services rendered to the Company for the fiscal years 2008 and 2007, respectively.
Audit Committee Pre-Approval Policies
The Audit Committee has adopted a procedure under which all arrangements to render services by Rachlin, LLP must be pre-approved by the Audit Committee, subject to certain permitted statutory de minimus exceptions.
Part IV
ITEM 15.
ITEM 15.
Exhibits and Financial Statement Schedules.
(a)
The following financial statements and exhibits are filed as part of this report.
Report of Independent registered Public Accounting Firm
Consolidated Balance Sheets at June 30, 2008 and 2007
Consolidated Statements of Operations for the years ended June 30, 2008, 2007 and 2006
Consolidated Statements of Cash Flows for the years ended June 30, 2008, 2007 and 2006
Consolidated Statement of stockholders’ equity and Comprehensive loss for the years ended June 30, 2008, 2007 and 2006
Notes to the Consolidated Financial Statements for the years ended June 30, 2008, 2007, and 2006
(2)
Financial Statement Schedules:
All schedules have been omitted because the required information is included in the consolidated financial statements or notes thereto.
(b)
Exhibits
10.9
Subscription Agreement, dated February 24, 2005, between the Company and Strategy First Inc.(12)
10.10
1995 Stock Option Plan.(2)
10.11
2004 Stock Incentive Plan.(12)
10.12
2007 Stock Incentive Plan.(13)
10.13
Securities Purchase Agreement, dated as of July 2, 2007, among the Company and the purchasers named therein.(8)
10.14
Securities Purchase Agreement, dated as of March 19, 2008, among the Company and the purchasers named therein.(7)
10.15
Form of Warrant.(8)
10.16
Form of Warrant issued in connection with the 9% Secured Convertible Debenture.(7)
10.17
Amendment and Waiver Agreement, dated as of June 28, 2007, by and among the Company and each of the investors signatory thereto.(11)
10.18
Security Agreement, dated as of March 19, 2008, among the Company and certain subsidiaries of the Company and the holders of the Company’s 9% Secured Convertible Debentures due March 19, 2012.(7)
10.19
Subsidiary Guarantee, dated as of March 19, 2008 made by certain of the Company’s subsidiaries in favor of the holders of the Company’s 9% Secured Convertible Debentures due March 19, 2012.(7)
10.20
Personal Guarantee, dated as of March 19, 2008 in favor of the holders of the Company’s 9% Secured Convertible Debentures due March 19, 2012.(7)
10.21
Waiver dated March, 19, 2010 between the Company and the holder of the Company’s Amended and Restated Variable Rate Secured Convertible Debenture due October 31, 2008.(7)
10.22
Waiver of Registration Rights Agreement, dated September 18, 2008, among the Company and the purchasers of the Amended and Restated 9% Secured Convertible Debenture due October 31, 2008.(14)
21.1
Subsidiaries of the Company *
23.1
Consent of Rachlin, LLP.*
31.1
Rule 13a-14(a) Certification of Clive Kabatznik, Principal Executive Officer of the Company.*
31.2
Rule 13a-14(a) Certification of Lawrence R. Litowitz, Principal Financial Officer of the Company.*
Section 1350 Certification of Principal Executive Officer and Principal Financial Officer.*
_________________
* Filed herewith
# Management Contract
(1)
Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (No. 33-99180) filed on November 9, 1995, as amended on Form S-1/A No. 1, Form S-1/A No. 2, Form S-1/A No. 3 filed on December 27, 1995, January 16, 1996 and January 24, 1996, respectively and Form 10-Q for the fiscal quarter ended March 31, 2000.
(2)
Incorporated by reference to the Company’s Current Report on Form 8-K filed September 9, 2007.
(3)
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed September 10, 1997.
(4)
Incorporated by reference is the Registrant’s Registration Statement on Form S-1 (No. 333-33561) filed on August 13, 1997 as amended on Form S-1/A No. 1, Form S-1/A No. 2 and For S-1/A No. 3 filed on December 9, 1997, January 22, 1998 and February 11, 1998, respectively.
(5)
Incorporated by reference to the Company’s Current Report on Form 8-K filed October 24, 2006 and July 3, 2007.
(6)
Incorporated by reference to the Company’s Current Report on Form 8-K filed November 4, 2005 and July 3, 2007.
(7)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on March 20, 2008.
(8)
Incorporated by reference to the Company’s Current Report on Form 8-K filed July 3, 2007.
(9)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on October 12, 2000.
(10)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on April 26, 2005.
(11)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on September 21, 2007.
(12)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on March 2, 2005.
(13)
Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended June 30, 2007.
(14)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on September 24, 2008.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Boca Raton, State of Florida, on the 14th day of October, 2008.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the date indicated.
Signature
Title
Date
/s/ Michael Levy
Chairman of the Board of Directors
October 14, 2008
Michael Levy
/s/ Clive Kabatznik
President, Vice Chairman, Chief
October 14, 2008
Clive Kabatznik
Executive Officer and Director (Principal Executive Officer)
/s/ Larry R. Litowitz
Chief Financial Officer (Principal Financial and
October 13, 2008
Larry R. Litowitz
Accounting Officer)
/s/ Cornelius J. Roodt
Director
October 14, 2008
Cornelius Roodt
/s/ Edward L. Bernstein
Director
October 14, 2008
Edward L. Bernstein
/s/ Edward Roffman
Director
October 14, 2008
Edward Roffman
EXHIBIT INDEX
10.21
Waiver dated March, 19, 2010 between the Company and the holder of the Company’s Amended and Restated Variable Rate Secured Convertible Debenture due October 31, 2008.(7)
10.22
Waiver of Registration Rights Agreement, dated September 18, 2008, among the Company and the purchasers of the Amended and Restated 9% Secured Convertible Debenture due October 31, 2008.(14)
21.1
Subsidiaries of the Company *
23.1
Consent of Rachlin, LLP.*
31.1
Rule 13a-14(a) Certification of Clive Kabatznik, Principal Executive Officer of the Company.*
31.2
Rule 13a-14(a) Certification of Lawrence R. Litowitz, Principal Financial Officer of the Company.*
Section 1350 Certification of Principal Executive Officer and Principal Financial Officer.*
_________________
* Filed herewith
# Management Contract
(1)
Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (No. 33-99180) filed on November 9, 1995, as amended on Form S-1/A No. 1, Form S-1/A No. 2, Form S-1/A No. 3 filed on December 27, 1995, January 16, 1996 and January 24, 1996, respectively and Form 10-Q for the fiscal quarter ended March 31, 2000.
(2)
Incorporated by reference to the Company’s Current Report on Form 8-K filed September 9, 2007.
(3)
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed September 10, 1997.
(4)
Incorporated by reference is the Registrant’s Registration Statement on Form S-1 (No. 333-33561) filed on August 13, 1997 as amended on Form S-1/A No. 1, Form S-1/A No. 2 and For S-1/A No. 3 filed on December 9, 1997, January 22, 1998 and February 11, 1998, respectively.
(5)
Incorporated by reference to the Company’s Current Report on Form 8-K filed October 24, 2006 and July 3, 2007.
(6)
Incorporated by reference to the Company’s Current Report on Form 8-K filed November 4, 2005 and July 3, 2007.
(7)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on March 20, 2008.
(8)
Incorporated by reference to the Company’s Current Report on Form 8-K filed July 3, 2007.
(9)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on October 12, 2000.
(10)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on April 26, 2005.
(11)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on September 21, 2007.
(12)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on March 2, 2005.
(13)
Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended June 30, 2007.
(14)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on September 24, 2008.