10QSB 1 affinity.txt 10-QSB ENDED 3/31/01 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2001 000-30835 ---------------------- (Commission File No.) AFFINITY INTERNATIONAL TRAVEL SYSTEMS, INC. (Name of Small Business Issuer in Its Charter) NEVADA 86-0885559 ----------------------------------------- ----------------------------------- (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 100 SECOND AVENUE SOUTH, SUITE 1100S ST. PETERSBURG, FLORIDA 33701-4301 ----------------------------------------- ----------------------------------- (Address of principal executive offices) (Zip Code) (727) 896-1513 ---------------- (ISSUER'S TELEPHONE NUMBER) CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15 (D) OF THE EXCHANGE ACT DURING THE PAST 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE ISSUER WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. [X] YES [ ] NO NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AS OF May 3, 2001: 32,897,173 TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT: [ ] YES [X] NO AFFINITY INTERNATIONAL TRAVEL SYSTEMS INC. FORM 10-QSB PART I FINANCIAL INFORMATION ITEM 1 Financial Statements Condensed Consolidated Balance Sheets at March 31, 2001 (unaudited) and June 30, 2000..................................................3 Condensed Consolidated Statement of operations for the three and nine months ended March 31, 2001 and March 31, 2000 (unaudited).........4 Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2001 and March 31, 2000(unaudited).................5 ITEM 2. Management's Discussion and Analysis of Financial Condition of Results of Operations..................................9 PART II OTHER INFORMATION....................................................15 ITEM 1. Legal Proceedings....................................................15 ITEM 2. Changes in Securities and Use of Proceeds............................15 ITEM 3. Defaults Upon Senior Securities......................................16 ITEM 4. Submission of Matters to a Vote of Security Holders..................16 ITEM 5. Other Information....................................................16 ITEM 6. Exhibits and Reports on Form 8-K.....................................16 SIGNATURES...................................................................17 2
Affinity International Travel Systems, Inc. and Subsidiaries Condensed Consolidated Balance Sheets (UNAUDITED) March 31, 2001 June 30, 2000 ----------------- ------------- ASSETS CURRENT: Cash and cash equivalents $ 200 $39,526 Restricted certificates of deposit 162,346 40,269 Accounts receivable 70,568 62,354 Prepaid accommodations 140,629 127,466 ----------- ----------- TOTAL CURRENT ASSETS 373,743 269,615 ----------- ----------- RESTRICTED CERTIFICATES OF DEPOSIT -- 120,000 PROPERTY AND EQUIPMENT, net of accumulated depreciation of $715,298 and $375,454, respectively 1,509,080 1,437,457 GOODWILL, net of accumulated amortization of $7,658 and $99,516, respectively 20,900 52,262 DEPOSITS 507,386 205,231 PREPAID FEES -- 1,040,000 OTHER ASSETS 13,433 13,433 ----------- ----------- TOTAL ASSETS $ 2,424,542 $ 3,137,998 =========== =========== LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable $ 3,830,668 $ 1,997,937 Accrued expenses 2,050,296 1,460,090 Deferred revenue 439,725 416,566 Due to customers 8,808 9,821 Current portion of capital lease obligations 5,656 11,780 Convertible debentures -- 309,867 ----------- ----------- TOTAL CURRENT LIABILITIES 6,335,153 4,206,061 CAPITAL LEASE OBLIGATIONS, LESS CURRENT PORTION 7,077 12,515 ------------ ---------- TOTAL LIABILITIES 6,342,230 4,218,576 ----------- ----------- COMMON STOCK SUBJECT TO RESCISSION 5,613,000 5,613,000 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' DEFICIT Common stock, $.001 par value, shares authorized 100,000,000 issued and outstanding 29,712,175 and 20,796,408 22,943 14,027 Convertible preferred stock, $.001 par value, shares authorized 100,000,000, issued and outstanding -0- Additional paid-in capital 26,155,410 22,060,911 Accumulated deficit (35,709,041) (28,768,516) ----------- ----------- TOTAL STOCKHOLDERS' DEFICIT (9,530,688) (6,693,578) ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 2,424,542 $ 3,137,998 =========== ===========
See accompanying notes to condensed consolidated financial statements. 3
Affinity International Travel Systems, Inc. and Subsidiaries Condensed Consolidated Statements of Operations (UNAUDITED) For the three months For the nine months ended March 31, ended March 31, 2001 2000 2001 2000 ---------- ----------- ------------ ------------ NET SALES $ 422,034 $ 693,928 $ 2,645,720 $ 2,749,729 COST OF SALES 299,878 501,344 2,102,550 1,802,520 ----------- ----------- ------------ ------------ Gross profit 122,156 192,584 543,170 947,209 ----------- ----------- ------------ ------------ OPERATING EXPENSES: Selling, general and administrative 1,602,946 780,134 2,668,962 1,793,103 Salaries and wages 423,446 536,728 1,310,875 2,477,488 Consulting fees 417,074 42,425 541,835 67,948 Consulting fees to related party 2,340 40,018 40,500 120,018 Rent 90,982 55,004 253,999 213,623 ----------- ----------- ------------ ------------ TOTAL OPERATING EXPENSES 2,536,788 1,454,309 4,816,171 4,672,180 ----------- ----------- ------------ ------------ Operating loss (2,414,632) (1,261,725) (4,273,001) (3,724,971) OTHER INCOME (EXPENSE): Interest income 2,174 3,979 6,891 16,290 Interest expense (167,026) (169,856) (552,056) (509,662) Interest expense to related party -- -- (15,975) -- Gain (loss) on sale or disposal of assets -- -- (29,975) 75,000 Finance charges to related party (282) (7,964,500) (2,258,172) (10,431,000) Other, net -- (5,170) 5,000 (68,750) ----------- ----------- ------------ ------------ TOTAL OTHER INCOME (EXPENSE) (165,134) (8,135,547) (2,844,287) (10,918,122) ----------- ----------- ------------ ------------ NET LOSS BEFORE EXTRAORDINARY ITEM (2,579,766) (9,397,272) (7,117,288) (14,643,093) EXTRAORDINARY ITEM Gain on extinguishment of debt from related party (net of $0 tax expense) -- -- 176,763 -- ----------- ----------- ------------ ------------ NET LOSS $(2,579,766) $(9,397,272) $ (6,940,525) $(14,643,093) =========== =========== ============ ============ NET LOSS PER COMMON SHARE BEFORE EXTRAORDINARY ITEM, BASIC AND DILUTED $ (.09) $ (.64) $ (.28) $ (1.06) EXTRAORDINARY GAIN PER COMMON SHARE, BASIC AND DILUTED $ -- $ -- $ .01 $ -- ----------- ----------- ------------ ------------ NET LOSS PER COMMON SHARE, BASIC AND DILUTED $ (.09) $ (.64) $ (.27) $ (1.06) =========== =========== ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING, BASIC AND DILUTED 29,077,340 14,575,980 25,571,877 13,756,542 =========== =========== ============ ============
See accompanying notes to condensed consolidated financial statements. 4
Affinity International Travel Systems, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows For the Nine Months Ended March 31 (UNAUDITED) 2001 2000 ----------- ----------- Cash flows provided by (used for) operating activities $ (326,244) $(2,193,549) Cash flows used for investing activities (666,081) (1,168,693) Cash flows provided by financing activities 952,999 2,820,577 ----------- ----------- NET DECREASE IN CASH AND CASH EQUIVALENTS (39,326) (541,665) CASH and CASH EQUIVALENTS, beginning of period 39,526 1,119,796 ----------- ----------- CASH and CASH EQUIVALENTS, end of period $ 200 $ 578,131 =========== =========== Supplemental Cash Flow information: Stock issued for conversion of debentures $ 350,000 $ 25,000 Stock issued for settlement of accounts payable $ 21,000 --
See accompanying notes to condensed consolidated financial statements. 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. FINANCIAL STATEMENT PRESENTATION The unaudited condensed consolidated financial statements of Affinity International Travel Systems, Inc. ("Affinity International", "Company", "we", or "us") have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information and within the guidelines to Form 10-QSB. The financial statements do not include all information and notes required by generally accepted accounting principles for complete financial statements. These condensed consolidated interim financial statements should be read in conjunction with the Company's audited financial statements as of and for the year ended June 30, 2000, and the related notes included in the Company's Annual Report on Form 10-KSB. In the opinion of management, all adjustments, consisting of normal recurring adjustments, financing charges on warrants and an extraordinary gain on the extinguishment of debt, considered necessary for a fair presentation, have been included. The results of operations and cash flows for the three and/or nine months ended March 31, 2001 are not necessarily indicative of the results of operations and cash flows expected for the year ending June 30, 2001. The Company's consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. However, the Company has sustained recurring operating losses since its inception and, at March 31, 2001, has a working capital deficit of approximately $5,961,000 and a stockholders' deficit of approximately $9,531,000. The Company must continue to obtain outside financing to meet working capital requirements and investments in infrastructure and Website development. An inability to raise such financing raises substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern. 2. COMMON STOCK SUBJECT TO RESCISSION From July 1998 to January 1999, we sold an aggregate of 6,768,572 shares of common stock in reliance upon the exemption from registration contained in Rule 504 of Regulation D, including shares issued in the acquisition of SunStyle (an acquisition that was treated as a reverse acquisition for accounting purposes). Those sales may have been in violation of Rule 504 of Regulation D. Accordingly, stockholders who purchased shares in those transactions may have rescission rights against us; that is, such persons may have the right to compel us to repurchase the shares for an amount equal in general to the purchase price paid plus interest. Although there is no definitive answer as to whether we violated Rule 504, we have reclassified amounts previously recorded as stockholders' equity to mezzanine capital on our balance sheet. The recorded value of shares subject to rescission is $5,613,000 as of March 31, 2001 and June 30, 2000, excluding related accrued interest expense. The recission liability and the related accrued interest are reported our balance sheet under the line items "Common Stock Subject to Rescission" and "Accrued Expenses", respectively. Until the rescission issue is completely resolved, we have recorded the maximum potential known effect as of March 31, 2001. During the three and nine months ended March 31, 2001 there was $168,000 and $504,000, respectively, charged to interest expense related to the common stock subject to rescission. During the three and nine months ended March 31, 2000 there was $168,000 and $504,000, respectively, charged to interest expense related to the common stock subject to rescission. The cumulative amount of accrued interest expense related to this issue is $1,810,000 and is included in accrued expenses at March 31, 2001. 6 Although there can be no assurance that the rescission issue will be resolved in our favor, a favorable outcome, or the expiration of the statute of limitation, would result in the reversal of all, or part of, the accrued interest in future periods. 3. PREPAID FEES Prior to the current quarter ended March 31, 2001, prepaid fees consisted of amounts relating to an agreement with Juno Online Services, Inc. ("Juno") for us to provide travel packages and services via their Website. Beginning in December 2000, the amount included in prepaid fees related to this agreement was being amortized over a 12-month period following the completion of the Website integration with Juno. The prepaid balance was created through advance payments of $415,000 in cash and issuance of common stock valued at $625,000. The agreement requires three additional payments of $315,000 beginning 90 days after the completed integration. In February 2001 we notified Juno that we believed they were not in compliance with the terms of the agreement. On March 1, 2001 Juno filed a lawsuit in the United States District Court, Southern District of New York claiming non-payment of outstanding fees that we agreed to pay (see Note 10 - Legal proceedings). As a result of these current activities we have charged the total unamortized balance of these fees to administrative expenses during the three months ended March 31, 2001. 4. EXTRAORDINARY ITEM The gain on extinguishment of debt from related party of approximately $177,000 in the nine months ended March 31, 2001, consists of the settlement of approximately $195,000 in notes payable and accrued interest and fees owed to Schoemann Venture Capital, LLC, which was retired in full by a cash payment of approximately $18,000. 5. INCOME TAXES The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities. We recorded a valuation allowance for all Federal and state deferred tax assets to present such amounts at estimated realizable value. The Company does not consider the realization of such amounts to be more likely than not, due to the uncertainty related to the Company's ability to generate assets through future taxable income. 6. EQUITY TRANSACTIONS A convertible debenture was converted into 558,734 shares of common stock in settlement of $364,839 in notes outstanding and accrued interest in the six months ended December 31, 2000. During the nine months ended March 31, 2001, the Company entered agreements with third parties who would provide investor relation services in exchange for a total of 175,000 shares of common stock, issued 80,000 shares of common stock to employees, issued warrants in settlement of services and issued 69,294 common stock warrants and 173,232 shares of common stock as part of the offering costs of certain transactions. The total value of services paid through the issuance of common stock or warrants was $141,513. During the nine months ended March 31, 2001, the Company sold a total of 3,678,801 shares of its common stock for net proceeds of $764,560, after commissions of $75,580. In connection with certain offerings, 83,093 common stock warrants were issued with an exercise price of $.23 per share, approximately 125% of the common stock market value at the agreement date and 3,750 common stock warrants were issued with an exercise price of $.40 per share, approximately 200% of the common stock market value at the agreement date. 7 7. FINANCING AGREEMENT In October 2000, the Company entered into an agreement with an investment firm to facilitate the securing of outside financing. In connection with this agreement a stock subscription agreement was executed under which the investment firm advanced us approximately $245,000. During the three months ended March 31, 2001, the Company and the investment firm mutually agreed to terminate the subscription agreement. The funds advanced are recorded as liabilities as of March 31, 2001. Since no services were provided and the agreement terminated, there was no consideration given as part of the agreement and therefore no expense incurred. 8. LEGAL PROCEEDINGS On September 20, 2000, the Company filed a civil action suit against a contractor hired to perform work on the FarAway.com Website. The suit alleges that the contractor failed to deliver the work in a timely and suitable manner and the Company is seeking a rescission of the contract or a judgement for breach of contract. The contractor's $1 million countersuit in North Carolina was dismissed, and was followed with a counterclaim in the State of Florida for $689,000 alleging breach of contract. The Company believes that the counterclaim is without merit. On March 1, 2001, the company was sued by Juno Online Services, Inc. alleging that we failed to pay outstanding invoices and marketing service fees of $945,000. The Company disputes contract performance by Juno. The Company believes that the claim is without merit. We are not aware of any pending legal proceedings against us other than the two discussed above that, individually or in the aggregate, would have a material adverse effect on our business, results of operations, financial condition or cash flow. 9. RECENT ACCOUNTING PRONOUNCEMENTS During the fourth quarter of 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101 "Revenue Recognition in Financial Statements". The provisions of SAB No. 101 and subsequently issued guidance are required to be adopted no later than the fourth quarter of the fiscal year beginning after December 15, 1999. Management believes that SAB No 101 will not materially alter the Company's revenue recognition methods. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion No. 25 for (a) the definition of employee for purposes of applying Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (C) the accounting consequences of various modifications to the previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 was effective July 2, 2000. The adoption of FIN 44 did not have a material effect on the Company's financial position or results of operations. 10. EQUITY LINE OF CREDIT On January 29, 2001, the Company entered into an Equity Financing Facility agreement (the "Agreement") with Ailouros Ltd, an institutional money management fund, to provide up to $10 million of financing over a three-year period through the periodic sales of the Company's common stock. The Company may access funds under this Agreement after a registration statement for common stock to be issued under this Agreement has been declared effective by the Securities and Exchange Commission and for a 36-month period thereafter. During the term of the Agreement, the Company may sell up to $1,500,000 of common stock during sequential 90-day periods, subject to certain trading volume and price requirements. There is no assurance that the Company will be able to access funds available through the Facility, due to the market price and trading volume requirements for the Company's common stock. The price per share for common stock sold under this Agreement is equal to 88% of the three lowest bid prices for the common stock over a 7-day trading period immediately preceding the sale. 8 The Company was assisted in structuring the transaction by Comergent Capital Ltd. ("Comergent"). In exchange for Ailouros's commitment to provide the $10 million Equity Financing Facility and for the assistance of Comergent, the Company issued 500,000 warrants to each of them with an exercise price of $.3125 per share. These warrants were valued at $380,000 using the Black Scholes Valuation Model and charged to consulting fees during the three months ended March 31, 2001. If the Company does not obtain at least $5 million of equity financing over the 3-year period of the agreement, an additional 500,000 warrants at an exercise price of $.3125 will be issued to Ailouros. ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING INFORMATION This quarterly report on Form 10-QSB may contain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and is subject to the relevant safe harbors created. The words "plan," "intend," "anticipate" "project," estimate," "expect," "may," "might," "believe," "potential," "could," "should," "would", and similar statements are intended to be among the statements that are forward-looking statements. Investors are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to the to certain risks and uncertainties, including, without limitation, the ability of the Company to obtain adequate financing to continue its current operations; the ability of the Company to successfully enter into strategic relationships and agreements with additional suppliers and marketers; the ability of the Company to retain and possibly increase its employees; the ability of the Company to continue as a going concern; risks associated with the Company's ability to continue as a going concern; risks associated with the Company's Web site, www.FarAway.com; the Company's history of operating losses; dependence on senior management; risks inherent in the travel and internet industries and the Company's ability to manage anticipated growth. The forward-looking statements contained in this report should not be regarded as a representation by the Company, or any other person, that the objectives or plans of the Company will be achieved. The Company cautions readers not to place undue reliance on the forward-looking statements. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2001 ("2001") COMPARED WITH THE THREE MONTHS ENDED MARCH 31, 2000 ("2000") REVENUE Total revenue of $422,000 for the three months ended March 31, 2001 consists primarily of revenue from wholesale operations, and is a decrease of $272,000 (39.2%) from the prior year period. For the three months ended March 31, 2000 total revenue of $694,000 included $64,000 of retail commissions. The reduction in retail commissions between the three months ended March 31, 2001 and March 31, 2000 is the result of the sale of our Prestige retail operation in December 1999. Comparable wholesale revenues in the three months ended March 31, 2001 were $416,000 a decrease of $190,000 (31.3%) from $606,000 in the three months ended March 31, 2000. The majority of the wholesale revenue decrease is a result of the discontinuation of reservations from the termination of the agreement to provide product and services to Travel Navigator. As of January 3, 2001 Travel navigator was not renewed as a contractor for Yahoo Travel. A small portion of the decrease can be attributed to the discontinuance of fulfillment for Juno and the website down time in March of 2001 associated with the Company's installation of the new FarAway.com website and testing of its new instant vacation quote software. Although we do not expect a material improvement in the next fiscal quarter, the Company believes that new search engine marketing programs being implemented will show results in approximately 90 days and will replace the loss of revenue from Travel Navigator. 9 GROSS PROFIT Gross profit of $122,000 for the three months ended March 31, 2001 is a decrease of $70,000 (36.6%) from the prior year, due to the reduction in the amount of retail travel operations. Gross profit of $193,000 in the three months ended March 31, 2000, included retail revenue commissions earned, as noted above. The gross profit percentage of 28.9% for the three months ended March 31, 2001 increased from 27.8% in the prior year three-month period. This increase was directly related to the reduction of retail operations, which record net commissions as revenue, with relatively minimal cost of sales. At present, the Company expects to continue to produce future gross profit margins comparable to the three months ended March 31, 2001. However, future gross margins for our wholesale business could be adversely affected by revenue sharing arrangements or promotions used to increase revenue. The decrease in retail revenue and related gross profit was primarily the result of the sale of our Prestige retail operation in December 1999. OPERATING EXPENSES SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses ("SG&A") were $ 1,603,000 in the three months ended March 31, 2001, an increase of $823,000 from the three months ended March 31, 2000. This increase is the result of fully expensing to SG&A $859,000 of fee expenses for our Juno Online Services, Inc. ("Juno") business partnership. We are currently in dispute with Juno concerning their contract performance. There were no expenses related to Juno in the three months ended March 31, 2000. SALARIES AND WAGES Salaries and wages of $423,000 decreased $113,000 (21.1%) from the third quarter of 2000, primarily as a result of the reduction in senior management and the closing of the work force in our Atlanta operations center that was closed at year-end June 30, 2000. CONSULTING FEES AND RENT Consulting fees of $417,000 in the three months ended March 31, 2001 increased $375,000 from the three months ended March 31, 2000 due to the valuation of warrants issued in connection with an equity line of credit. Consulting fees to related party of $2,000 in the three months ended March 31, 2001 decreased $38,000 (94.2%) from the prior year period and consist of agreements with a significant stockholder for investment and financial related assistance. Rent of $91,000 for the three months ended March 31, 2001 increased $36,000 from the prior year amount of $55,000 in the three months ended March 31, 2000. This increase is primarily due to a sublease entered into with Transaction Tracking Technologies for additional space adjacent to the Company's primary facility. OTHER INCOME AND EXPENSE Interest expense includes $168,000 in accrued interest related to rescission for the three months ended March 31, 2001 and is comparable to the expense for the three months ended March 31, 2000. Finance charges of $7,965,000 in the three months ended March 31, 2000 consist of $7,140,000 charged for the re-pricing of common stock warrants in connection with a financing transaction and $825,000 for the issuance of common stock for failure to meet certain provisions of certain financing and consulting agreements. 10 INCOME TAXES The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities. We recorded a valuation allowance for all Federal and state deferred tax assets to present such amounts at estimated realizable value. The Company does not consider the realization of such amounts to be more likely than not, due to the uncertainty related to the Company's ability to generate assets through future taxable income. NINE MONTHS ENDED MARCH 31, 2001 ("2001") COMPARED WITH NINE MONTHS ENDED MARCH 31, 2000 ("2000") REVENUE Total revenue of $2,646,000 decreased $104,000 (3.8%) for the nine months ended March 31, 2001 compared to $2,750,000 in the nine months ended March 31, 2000. Revenue in the nine months ended March 31, 2001 included $85,000 of retail commissions, while the prior year nine months included $886,000 of retail commissions. The decrease is due primarily to our Prestige retail operations, which were sold in December 1999. Comparable wholesale revenues were $2,518,000 for the nine months ended March 31, 2000, an increase of $736,000 or 41.3% from the prior year. GROSS PROFIT Gross profit of $543,000 in the nine months ended March 31, 2001, decreased $404,000 (42.7%) from the nine months ended March 31, 2000. Gross profit percentage of 20.5% decreased from gross profit percentage of 34.4% in the nine months March 31, 2000. The decrease in both gross profit dollars and percentage is due to the inclusion of $886,000 in retail commissions in the nine months ended March 31, 2000 for which there are relatively low offsetting cost of goods. OPERATING EXPENSES SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses ("SG&A") were $2,669,000 in the nine months ended March 31, 2001, an increase of $876,000 from the nine months ended March 31, 2000. This increase is the result of fully expensing during the current quarter to SG&A $859,000 of fee expenses for our Juno Online Services, Inc. business partnership. We are currently in dispute with Juno concerning their contract performance. There were no expenses related to Juno in the nine months ended March 31, 2000. SALARIES AND WAGES Salaries and Wages of $1,311,000 in the nine months ended March 31, 2001 decreased $1,167,000 (47.1%) from $2,477,000 in the same period of the prior year. The decrease is primarily related to a $750,000 charge for stock options granted at below market prices in the prior year. Other decreases in salaries and wages from the reduction of retail operations were partially offset by $67,000 of expense for the issuance of common stock to employees and some personnel increases to support the growth of the wholesale business. CONSULTING FEES AND RENT Consulting fees of $542,000 in the nine months ended March 31, 2001, increased $474,000 from the same period of the prior year. The increase in consulting fees in the nine months ended March 31, 2001 is due to the valuation of warrants issued in connection with an equity line of credit. 11 Consultant fees to a related party of $41,000 in the nine months ended March 31, 2001 decreased $80,000 (66.3%) from the prior year period and consist of agreements with a significant stockholder for investment and financial related assistance. Rent of $254,000 in the nine months ended March 31, 2001, increased $40,000 (18.9%) from the same prior year period, with increases in primary office space exceeding decreases from reductions in retail operations. OTHER INCOME AND EXPENSE Interest expense includes primarily interest being accrued related to common stock subject to rescission which totaled $504,000 in both the nine months ended March 31, 2001 and 2000. Finance charges of $2,258,000 in the nine months ended March 31, 2001 relate primarily to the repricing of warrants in August 2000 to a significant shareholder. Finance charges of $10,431,000 in the nine months ended March 31, 2000 consist of $9,222,000 for the issuance of new common stock warrants and the repricing of existing common stock warrants in connection with a financing transaction and $1,209,000 related to the issuance of common stock for failure to meet certain provisions of certain financing and consulting agreements. INCOME TAXES The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities. We recorded a valuation allowance for all Federal and state deferred tax assets to present such amounts at estimated realizable value. The Company does not consider the realization or such amounts to be more likely than not, due to the uncertainty related to the Company's ability to generate assets through future taxable income. EXTRAORDINARY ITEM Gain on extinguishment of debt from related party of $177,000 in the nine months ended March 31, 2001, consists of the settlement of $195,000 in notes payable and accrued interest and fees owed to Schoemann Venture Capital, LLC, which was retired in full by a cash payment of $18,000. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2001 we had a working capital deficit of $5,961,000, total stockholders' deficit of $9,531,000 and a total of 29,712,175 shares outstanding. For the three months ended March 31, 2001 we had net losses of $2,580,000 and $6,941,000 for the respective three and nine months ended March 31, 2001. The nine months ended March 31, 2001 included $2,253,000 in non-cash financing charges and $380,000 of non-cash consulting fees related to the new equity facility. During the nine month period ended March 31, 2001, our principal source of cash was $953,000 provided from financing activities, including $765,000 in proceeds from the sale of common stock and $200,000 in proceeds from the exercise of common stock warrants. We have been experiencing and expect to continue to experience significant negative cash flow. For the nine months ended March 31, 2001 our operations used $326,000 in cash primarily through an increase of $1,833,000 in accounts payable and a $590,000 increase in accrued expenses offset by a net loss of $2,200,000 reduced by non-cash charges. The Company's investing activities used $666,000 in cash, including $362,000 used for fixed asset purchases and $302,000 in additional deposits. We have no line of credit or loans for working capital and we have relied upon proceeds from the sale of our equity securities and debentures to fund negative cash flow from 12 operations and to fund our capital expenditures related to the implementation of our Internet business strategy. The newly established Equity Financing Facility is expected to be utilized for obtaining up to $10 million over a three-year period. The Company may access funds under this Facility only after a registration statement covering common stock to be issued under this Facility, has been declared effective by the Securities and Exchange Commission and for a 36-month period thereafter. There is no assurance that the Company will be able to access funds available through the Facility, due to certain market price and trading volume requirements for the Company's common stock (see note 10 of notes to financial statements). From July 1998 to January 1999, we sold an aggregate of 6,768,572 shares of common stock in reliance upon the exemption from registration contained in Rule 504 of Regulation D, including shares issued in the acquisition of SunStyle (an acquisition that was treated as a reverse acquisition for accounting purposes). Those sales may have been in violation of Rule 504 of Regulation D. Accordingly, stockholders who purchased shares in those transactions may have rescission rights against us; that is, such persons may have the right to compel us to repurchase the shares for an amount equal in general to the purchase price paid plus interest. If all or a portion of the purchasers of the common stock in those transactions exercise any rescission right they may have, we may be subject to substantial liability, in which case, there would be a severe impact on our financial condition and ability to continue as a going concern. We do not have sufficient cash reserves to repurchase the shares of our common stock that are subject to possible rescission. While we believe that the issue will eventually be resolved in our favor with minimal financial effect, if any, there is no assurance that this will occur. In addition, our ability to raise additional capital may be severely restricted, as investors may be hesitant to invest in us because of this potential liability. Our inability to raise capital when needed would have an adverse effect on our ability to continue as a going concern. Although there is no definitive answer as to whether we violated Rule 504, we have reclassified amounts previously recorded as stockholders' equity to mezzanine capital on our balance sheet. The recorded amount of shares subject to rescission is $5,613,000 as of March 31, 2001 and 2000, excluding related accrued interest which has been charged to interest expense. We believe that our total exposure to the rescission, if any, will be much less than the maximum indicated since approximately 5,394,000 shares, or 80% of the amounts isolated as potentially subject to rescission are owned by 3 significant shareholders, or shareholder groups (owners of more than 5% of our common stock). One portion of this amount or 2,850,000 shares (42% of the amounts potentially subject to rescission) are owned by Daniel G. Brandano, Jr. our Chairman, CEO and one of our directors, and/or Joan Brandano our Secretary and one of our directors. Until the rescission issue is completely resolved, we have recorded the maximum potential known effect as of March 31, 2001. Accrued interest of $1,810,000 is recorded as part of accrued expenses at March 31, 2001. The Company is evaluating whether to address this issue with the SEC or allow the Statute of Limitations to expire. Although there can be no assurance that the rescission issue will be resolved in our favor, a favorable decision would result in the reversal of all or part of the accrued interest in future periods. We expect net losses and negative cash flow to continue for the foreseeable future and anticipate our losses and the use of cash will increase from current levels because we expect to incur significant expenses and capital expenditures related to: o brand development, advertising, marketing and promotional activities, including product discounts and revenue sharing agreements; o continued development of our Web site, transaction-processing systems, fulfillment capabilities and network infrastructure, most of which are capital expenditures; o expansion of our supplier/distributor relationships; o expansion of our order fulfillment infrastructure; o expansion of our product offerings and Web site content; and o employment of additional personnel as our business expands With our intended increase in expenditures on marketing and promotional activities, there are no assurances these efforts will be effective in attracting customers to our 13 on-line method of shopping for travel products and services via our Web site. In addition, we may be obligated to pay commissions, based on a percentage of revenue, to companies with whom we have online marketing relationships. These costs will increase as our revenues increase. If we do achieve profitability, we cannot be certain that we will be able to sustain or increase profitability on a quarterly or annual basis in the future. Our ability to achieve profitability depends on our ability to secure additional financing, to generate and sustain substantially higher revenues and control the growth in operating costs. We anticipate incurring capital expenditures of approximately $1.0 million during fiscal 2001, dependent on our ability to obtain access to additional funding or positive cash flow from operations, to complete the development of travel booking engines and the primary Website, and other improvements in software and technology. In order to fund our operations and continue the implementation of our Internet business strategy, we anticipate the need to raise at least $1.0 million in additional capital during the fiscal year ending June 30, 2001 and a total of $3.0 million December 31, 2001. For the nine months ending March 31, 2001, we have raised $765,000 through the private sale of the Company's common stock and $200,000 in proceeds from the exercise of common stock warrants. We will continue to need to raise a portion of the remaining capital immediately to fund negative cash flow from operations and fund capital expenditures related to the implementation of our Internet business strategy. If we raise additional funds through the issuance of equity or debt securities, those securities may have rights senior to those of our current stockholders, and our stockholders may experience additional dilution. We cannot be certain that additional financing will be available to us on favorable terms when required, or at all. There can be no assurance that we will be able to successfully secure the anticipated financing which is necessary for the implementation of our Internet business strategy, complete our plans for growing revenue through existing projects, support our working capital needs and to provide available capital for potential acquisitions. Our failure to obtain sufficient additional funds, either through additional financing or continuing operations, would have a material adverse effect on our business and financial condition, our ability to implement our Internet business strategies and our ability to continue our operations. Our auditor's report on our financial statements for the year ended June 30, 2000 and included in our Form 10-KSB, indicated that certain factors raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is contingent upon the following: o We may be subject to substantial liability in connection with sales of our common stock which may have been made in violation of Rule 504 of Regulation D, and our ability to raise additional capital may be severely restricted, as investors may be hesitant to invest in us because of this potential liability. o Anticipated additional periods of negative cash flow, regardless of any potential liability in violation of Rule 504 of Regulation D, will require us to continue to raise additional capital. Any reduction or delay in our ability to raise capital could severely delay our planned technology investments, and would adversely affect our operations, since we do not anticipate generating sufficient cash from existing operations to internally finance our business for the next 12 months. o We cannot assure you that we will be able to generate positive cash flow internally or raise sufficient funds to continue our operations. Our failure to raise sufficient additional funds, either through additional financing or continuing operations, will have a material adverse effect on our business and financial condition and on our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our possible inability to continue our operations. 14 PART II OTHER INFORMATION ITEM 1. Legal proceedings Affinity International Travel Systems, Inc. v. Information Architects Corporation ("IAC"), Circuit Court of the Sixth Judicial Circuit in and for Pinellas County Civil division, Case No. 00-6491-CI-19. On September 20, 2000, we filed a civil action suit against IAC, a contractor hired to perform work on the FarAway.com Web site. We have alleged that IAC failed to deliver the work in a timely and suitable manner, and we are seeking rescission of the contract and/or to obtain a declaratory judgment for breach of contract. Information Architects Corporation v. Affinity International Travel Systems, Inc., United States District Court Western District of North Carolina, Charlotte Division, Case No. 3:00CV474-H. On September 22, 2000, IAC filed suit against us separately in North Carolina alleging breach of the contract discussed above and seeking damages in excess of $1,000,000. IAC's action in the State of North Carolina was dismissed; however, IAC has counterclaimed for $689,000 in the State of Florida action alleging breach of contract. Juno Online Services, Inc. v. Affinity International Travel Systems, Inc., United States District Court Southern District of New York, Case No. 01 CIV. 1821 (GEL). On March 1, 2001, Juno filed suit against us alleging that we failed to pay outstanding invoices and marketing service fees of $945,000. We are not aware of any pending legal proceedings against us other than the ones discussed above that, individually or in the aggregate, would have a material adverse effect on our business, results of operations, financial condition or cash flow. Also we may in the future be party to litigation arising in the course of our business. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. ITEM 2. Changes in Securities and Use of Proceeds RECENT SALE OF UNREGISTERED SECURITIES Set forth below, in chronological order, is information regarding the numbers of shares of common stock sold, the number of options and warrants granted and the principal amount of debt instruments issued by us from October 1, 2000 to December 31, 2000 and the consideration received by us for such shares, options, warrants and debt instruments. None of these securities was registered under the Securities Act. In our opinion, all offers and sales of our securities were exempt from registration by virtue of Section 4(2) of the Securities Act and the rules promulgated therewith. All purchasers of our securities represented their intention to acquire our securities for investment purposes only and not with a view to or for sale in connection with any distribution thereof. Appropriate legends were affixed to the certificates representing the securities issued in such transactions. All purchasers of our securities had adequate access to information about us and were "accredited investors" as defined in Section 501 of Regulation D promulgated under the Securities Act. Except as otherwise indicated, no sales or issuance of securities involved the use of an underwriter and no commissions were paid in connection with the sale of any securities. In November 2000, the Company issued 3,500 shares of its common stock to employees with a market value of $2,000, at the time of issuance. In December 2000, 16,375 shares of common stock were issued for settlement of accrued interest payable. The market value of the common stock was $15,000. 15 On December 1, 2000 the Company entered into an agreement with a third party who would provide investor relations services over a twelve-month period for a total of 150,000 shares of common stock. The market value of the common stock at the agreement date was $.1875 per share. On December 1, 2000 the Company entered into an agreement with a third party who would provide investor relations services over a three-month period for a total of 25,000 shares of common stock. The market value of the common stock at the agreement date was $.1875 per share. On December 13, 2000 the Company sold 617,600 shares of its common stock for proceeds of $92,640 or an average price of $.15, per share. Also, on December 13, 2000 the Company sold 213,333 shares of its common stock for proceeds of $32,000 or an average price of $.15 per share. In connection with these offerings, commissions of $15,580 are to be paid, and 83,093 common stock warrants were issued at an exercise price of $.23 per share, which expire three years from the date of grant. On December 21, 2000 the Company sold 555,555 shares of its common stock for proceeds of $100,000 or an average price of $.18 per share, prior to commissions of $10,000. On January 19, 2001 the Company sold 625,000 shares of its common stock for proceeds of $125,000 or an average price of $.20 per share, prior to commissions of approximately $7,500. On February 8, 2001 the Company sold 1,096,439 shares of its common stock for proceeds of $189,404 or an average price of $.17 per share, prior to commissions of approximately $10,000. On February 8, 2001 69,294 common stock warrants and approximately 173,232 shares of common stock were issued as part of the offering costs of certain transactions. ITEM 3. Defaults Upon Senior Securities none ITEM 4. Submission of Matters to a Vote of Security Holders none ITEM 5. Other Information none ITEM 6. Exhibits and Reports on Form 8-K On February 2, 2000, the Company filed a Form 8-K regarding the completion of an Equity Financing Facility with Ailouros Ltd., an institutional money management fund. The Facility provides up to $10 million of financing over a three-year period through the periodic sales of the Company's common stock. The Facility requires an effective registration statement being filed with the Securities and Exchange Commission, and certain trading volume and price requirements along with other conditions. 16 SIGNATURES Pursuant to the requirements of Section 13 and 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. Dated: May 21, 2001 AFFINITY INTERNATIONAL TRAVEL SYSTEMS, INC. ------------------------------------------- (Registrant) By: /s/ Daniel G. Brandano, Jr. ---------------------------- Daniel G. Brandano, Jr. Chief Executive Officer 17