10-Q 1 doc1.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 -------------------- FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended JUNE 30, 2002. ---------------- OR [ ] Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from __________________ to __________________. Commission File Number: 001-05270 --------- SOFTNET SYSTEMS, INC. --------------------- (Exact name of registrant as specified in its charter) DELAWARE 11-1817252 --------------------------- --------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 650 TOWNSEND STREET, SUITE 225, SAN FRANCISCO, CALIFORNIA 94103 --------------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (415) 354-3900 -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT JULY 31, 2002 ----- ---------------------------- COMMON STOCK, $0.01 PAR VALUE 25,183,487 ================================================================================ SOFTNET SYSTEMS, INC. AND SUBSIDIARIES INDEX PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets as of June 30, 2002, and September 30, 2001 . . . . . . . . . . . . . . . . . . . . . . 2 Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2002 and 2001 . . . . . . . . . . . 3 Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2002 and 2001. . . . . . . . . . . . . . 4 Notes to Condensed Consolidated Financial Statements . . . . . . 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . . . . . . . . . . . . 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . 23 PART II - OTHER INFORMATION Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . 24 Item 2. Changes in Securities. . . . . . . . . . . . . . . . . . . . . . 24 Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . . . . . . 24 Item 4 Submission of Matters to a Vote of Security Holders. . . . . . . 24 Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . . . . 24 Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . 25 -1-
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SOFTNET SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share data) (Unaudited) JUNE 30, SEPTEMBER 30, 2002 2001 --------------- --------------- ASSETS Current assets: Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . $ 28,186 $ 14,960 Short-term investments, available-for-sale. . . . . . . . . . . . . . 41,117 60,494 Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . 2,336 2,018 Other current assets. . . . . . . . . . . . . . . . . . . . . . . . . 429 1,266 --------------- --------------- Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . 72,068 78,738 Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 800 Property and equipment, net of accumulated depreciation of $397 and $375, respectively. . . . . . . . . . . . . . . . . . . . . . . . 121 691 Accounts receivable, non-current portion. . . . . . . . . . . . . . . . 59 1,566 Long-term equity investments. . . . . . . . . . . . . . . . . . . . . . 1,013 1,484 Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,203 1,221 --------------- --------------- $ 75,264 $ 84,500 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 69 $ 273 Net liabilities associated with discontinued operations.. . . . . . . 3,698 2,757 Restructuring accrual . . . . . . . . . . . . . . . . . . . . . . . . 1,449 1,240 Other accrued expenses. . . . . . . . . . . . . . . . . . . . . . . . 1,249 2,340 Current portion of long-term debt . . . . . . . . . . . . . . . . . . 1,444 1,444 --------------- --------------- Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . 7,909 8,054 --------------- --------------- Commitments and contingencies Stockholders' equity: Preferred stock, $0.10 par value, 3,970,000 shares designated, no shares issued and outstanding. . . . . . . . . . . . . . . . . . - - Common stock, $0.01 par value, 100,000,000 shares authorized; 27,473,987 and 27,461,775 shares issued; 25,183,487 and 25,171,275 shares outstanding, respectively. . . . . . . . . . . . . . . . . . . . . . . . . . . . 275 275 Additional-paid-in capital. . . . . . . . . . . . . . . . . . . . . . 477,613 477,680 Deferred stock compensation . . . . . . . . . . . . . . . . . . . . . (345) (1,645) Accumulated other comprehensive loss. . . . . . . . . . . . . . . . . (22) (480) Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . (401,029) (390,247) Treasury stock, at cost, 2,290,500 and 2,290,500 shares, respectively (9,137) (9,137) --------------- --------------- Total stockholders' equity. . . . . . . . . . . . . . . . . . . . . . . 67,355 76,446 --------------- --------------- $ 75,264 $ 84,500 =============== =============== The accompanying notes are an integral part of these condensed consolidated financial statements.
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SOFTNET SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited) THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30, ---------------------------- ---------------------------- 2002 2001 2002 2001 ------------- ------------- ------------- ------------- Operating expenses: Selling and marketing. . . . . . . . . . . . . . . . $ - $ 9 $ - $ 196 Engineering. . . . . . . . . . . . . . . . . . . . . - 71 - 529 General and administrative, exclusive of non-cash compensation expense (benefit) of $400, $483, $1,200 and $(1,087), respectively . . . . . . . . . . . . 1,265 1,612 4,347 6,403 Depreciation . . . . . . . . . . . . . . . . . . . . 34 78 160 282 Non-cash compensation expense (benefit) related to stock options. . . . . . . . . . . . . . . . . . . 400 483 1,200 (1,087) Provision for impaired assets. . . . . . . . . . . . - - 352 - Restructuring expense. . . . . . . . . . . . . . . . - - 502 3,900 ------------- ------------- ------------- ------------- Total operating expenses . . . . . . . . . . . . . . . 1,699 2,253 6,561 10,223 ------------- ------------- ------------- ------------- Loss from continuing operations before other income (expense), income taxes, discontinued operations and extraordinary item . . . . . . . . . . . . . . . . . (1,699) (2,253) (6,561) (10,223) Other income (expense): Interest income. . . . . . . . . . . . . . . . . . . 391 1,223 1,423 5,533 Interest expense . . . . . . . . . . . . . . . . . . (18) (4) (54) (89) Loss on disposition of equity investments, net . . . - (3,684) (701) (17,445) Equity in net losses of investee companies . . . . . - - - (394) Miscellaneous income (expense), net. . . . . . . . . 3 (50) - (153) ------------- ------------- ------------- ------------- Loss from continuing operations before income taxes, discontinued operations and extraordinary item . . . (1,323) (4,768) (5,893) (22,771) Provision for income taxes . . . . . . . . . . . . . . - - - - ------------- ------------- ------------- ------------- Loss from continuing operations before discontinued operations and extraordinary item. . . . . . . . . . (1,323) (4,768) (5,893) (22,771) Discontinued operations: Loss from operations . . . . . . . . . . . . . . . . - (3,913) (1,829) (26,625) Loss on disposition, net . . . . . . . . . . . . . . (70) (4,100) (3,060) (6,828) Extraordinary item: Gain on settlements of outstanding obligations . . . - - - 1,326 ------------- ------------- ------------- ------------- Net loss . . . . . . . . . . . . . . . . . . . . . . . $ (1,393) $ (12,781) $ (10,782) $ (54,898) ============= ============= ============= ============= Basic and diluted loss per common share: Loss from continuing operations. . . . . . . . . . . $ (0.05) $ (0.19) $ (0.23) $ (0.91) Discontinued operations. . . . . . . . . . . . . . . - (0.32) (0.19) (1.34) Extraordinary item . . . . . . . . . . . . . . . . . - - - 0.05 ------------- ------------- ------------- ------------- Net loss . . . . . . . . . . . . . . . . . . . . . . $ (0.05) $ (0.51) $ (0.42) $ (2.20) ============= ============= ============= ============= Shares used to compute basic and diluted loss per common share. . . . . . . . . . 25,183 25,157 25,178 24,974 ============= ============= ============= ============= The accompanying notes are an integral part of these condensed consolidated financial statements.
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SOFTNET SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) NINE MONTHS ENDED JUNE 30, ------------- ------------- 2002 2001 ------------- ------------- Cash flows from operating activities: Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (10,782) $ (54,898) Adjustments to reconcile net loss to net cash used in operating activities: Loss from discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . 1,829 26,625 Loss on disposition of discontinued operations. . . . . . . . . . . . . . . . . . . . 3,060 6,828 Extraordinary item - gain on settlements of outstanding obligations . . . . . . . . . - (1,326) Provision for impaired assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352 - Provision for restructuring costs . . . . . . . . . . . . . . . . . . . . . . . . . . 502 3,900 Depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 282 Non-cash compensation expense (benefit) related to stock options. . . . . . . . . . . 1,200 (1,087) (Gain) loss on disposition of property and equipment. . . . . . . . . . . . . . . . . 51 30 Equity in net losses of investee companies. . . . . . . . . . . . . . . . . . . . . . - 394 Loss on disposition of equity investments, net. . . . . . . . . . . . . . . . . . . . 701 17,445 Gain on disposition of other short-term investments . . . . . . . . . . . . . . . . . (6) (2) Changes in operating assets and liabilities (net of effect of acquisitions and discontinued operations): Decrease in accounts receivable, net. . . . . . . . . . . . . . . . . . . . . . . . 1,189 1,235 (Increase) decrease in other current assets . . . . . . . . . . . . . . . . . . . . 837 (640) Decrease in other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 43 Decrease in accounts payable and accrued expenses . . . . . . . . . . . . . . . . . (1,587) (9,234) ------------- ------------- Net cash used in operating activities of continuing operations. . . . . . . . . . . . . . (2,476) (10,405) Net cash used in operating activities of discontinued operations. . . . . . . . . . . . . (3,838) (67,536) ------------- ------------- Net cash used in operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . (6,314) (77,941) ------------- ------------- Cash flows from investing activities: Proceeds from maturities and sales of short-term investments, net . . . . . . . . . . . 19,595 51,648 Proceeds from sale of property and equipment. . . . . . . . . . . . . . . . . . . . . . 7 5 Payments for purchase of equity investments . . . . . . . . . . . . . . . . . . . . . . - (766) Payment for purchase of property and equipment. . . . . . . . . . . . . . . . . . . . . - (675) ------------- ------------- Net cash provided by investing activities of continuing operations. . . . . . . . . . . . 19,602 50,212 Net cash provided by (used in) investing activities of discontinued operations. . . . . . (2) 9,419 ------------- ------------- Net cash provided by investing activities . . . . . . . . . . . . . . . . . . . . . . . . 19,600 59,631 ------------- ------------- Cash flows from financing activities: Proceeds from purchase by employee stock purchase plan. . . . . . . . . . . . . . . . . - 77 Payment for purchase of treasury stock. . . . . . . . . . . . . . . . . . . . . . . . . - (6,858) Payment of long-term debt and liability related to anniversary issuance of common stock to former Intelligent Communications, Inc. stockholders. . . . . . . . . . . . . . . . - (2,490) Principal payments of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . - (660) ------------- ------------- Net cash used in financing activities of continuing operations. . . . . . . . . . . . . . - (9,931) Net cash used in financing activities of discontinued operations. . . . . . . . . . . . . (60) (4,467) ------------- ------------- Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . (60) (14,398) Foreign exchange effect on cash and cash equivalents. . . . . . . . . . . . . . . . . . . - (24) ------------- ------------- Net increase (decrease) in cash and cash equivalents. . . . . . . . . . . . . . . . . . . 13,226 (32,732) Cash and cash equivalents, beginning of period. . . . . . . . . . . . . . . . . . . . . . 14,960 44,731 ------------- ------------- Cash and cash equivalents, end of period. . . . . . . . . . . . . . . . . . . . . . . . . $ 28,186 $ 11,999 ============= ============= The accompanying notes are an integral part of these condensed consolidated financial statements.
-4- SOFTNET SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The financial information included herein is unaudited, however, such information reflects all adjustments (consisting solely of normal recurring adjustments, except as otherwise noted) which are, in the opinion of management, necessary for a fair presentation of the condensed consolidated balance sheet as of June 30, 2002, and condensed consolidated statements of operations and cash flows for the interim periods ended June 30, 2002 and 2001. SoftNet Systems, Inc.'s annual report on Form 10-K for the fiscal year ended September 30, 2001, as amended and filed with the Securities and Exchange Commission, should be read in conjunction with the accompanying condensed consolidated financial statements. The condensed consolidated balance sheet as of September 30, 2001 was derived from SoftNet Systems, Inc. and subsidiaries (the "Company") audited consolidated financial statements. The results of operations for the three months and nine months ended June 30, 2002 are based in part on estimates that may be subject to year-end adjustments and are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet as of September 30, 2001, the condensed consolidated statements of operations for the three months and nine months ended June 30, 2001, and the condensed consolidated statements of cash flows for the nine months ended June 30, 2001, have been reclassified for the effects of the discontinued operations of Intelligent Communications, Inc. Additionally, certain reclassifications have been made to prior period financial statements in order to conform to the current period presentation. 2. DISCONTINUED OPERATIONS Discontinued Operations of Intelligent Communications, Inc. ("Intellicom") On March 29, 2002, the Company and its wholly-owned subsidiary, Intellicom, entered into an agreement to sell its operating business and certain assets to Loral Cyberstar, Inc. Following the sale of its operating business and certain assets to Loral Cyberstar, Inc., the Company's Board of Directors unanimously agreed to cease the operations of Intellicom on April 3, 2002. Subsequently on April 22, 2002, Intellicom entered into an agreement to sell certain assets to Native Intellicom, Inc., a wholly-owned subsidiary of the Pinoleville Band of Pomo Indians, for cash, subject to the termination of Intellicom's lease for its facility in Livermore, California. The operating results of Intellicom have been segregated from continuing operations and are reported as a loss from discontinued operations on the condensed consolidated statements of operations. Although it is difficult to predict the final results, the loss on disposition from discontinued operations includes management's estimates of costs to wind down the business, costs to settle its outstanding liabilities, and the proceeds from the sale of assets. The actual results could differ materially from these estimates. The Company recorded an estimated loss on disposition of Intellicom of $3,120,000 for the nine months ended June 30, 2002. The Company initially recognized an estimated loss on disposal provision of Intellicom of $3,300,000 for the three months ended March 31, 2002, and subsequently reduced it by $180,000 for the three months ended June, 30, 2002. The assets and liabilities of such operations are reflected in net liabilities associated with discontinued operations of the accompanying condensed consolidated balance sheets as of June 30, 2002, and September 30, 2001. Operating results of Intellicom are as follows (in thousands):
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30, --------------------------- -------------------------- 2002 2001 2002 2001 ------------ ------------- ------------ ------------ Revenues . . . . . . . . . $ - $ 811 $ 1,463 $ 3,211 ============ ============= ============ ============ Loss before income taxes . $ - $ (3,913) $ (1,829) $ (26,625) Provision for income taxes - - - - ------------ ------------- ------------ ------------ Net loss . . . . . . . . . $ - $ (3,913) $ (1,829) $ (26,625) ============ ============= ============ ============
-5- Net assets (liabilities) associated with discontinued operations of Intellicom at June 30, 2002, and September 30, 2001, are as follows (in thousands):
JUNE 30, SEPTEMBER 30, 2002 2001 --------------- -------------- Current assets: Accounts receivable, net. . . . . . . . . . . . . . $ 53 $ 91 Inventory, net. . . . . . . . . . . . . . . . . . . - 537 Other current assets. . . . . . . . . . . . . . . . 2 66 --------------- -------------- Total current assets. . . . . . . . . . . . . . . . . 55 694 Property, plant and equipment, net. . . . . . . . . . - 1,644 Restricted cash . . . . . . . . . . . . . . . . . . . - 639 Accounts receivable, non current portion. . . . . . . 12 - Other assets. . . . . . . . . . . . . . . . . . . . . 39 49 --------------- -------------- Total assets. . . . . . . . . . . . . . . . . . . . . $ 106 $ 3,026 =============== ============== Current liabilities: Accounts payable. . . . . . . . . . . . . . . . . . $ 25 $ 423 Estimated closure costs . . . . . . . . . . . . . . 1,223 - Restructuring accrual . . . . . . . . . . . . . . . 4 512 Other accrued expenses. . . . . . . . . . . . . . . 22 689 --------------- -------------- Total liabilities . . . . . . . . . . . . . . . . . . $ 1,274 $ 1,624 =============== ============== Net assets (liabilities) associated with discontinued operations. . . . . . . . . . . . . . . . . . . . . $ (1,168) $ 1,402 =============== ==============
In an effort to bring Intellicom to profitability, the Company initiated an overall cost cutting program and organizational restructuring during May 2001. As a result of the organizational restructuring, the Company established a $1,290,000 restructuring reserve, which consisted of severance costs for affected employees and shut down costs for certain offices, and is reflected in net liabilities associated with discontinued operations of the condensed consolidated balance sheet as of June 30, 2002, and September 30, 2001. Through June 30, 2002, $1,286,000 of severance payments, and write offs of leasehold improvements and office furniture related to the various offices have been applied to this reserve. The remaining $4,000 will be utilized for severance of an identified former employee. Discontinued Operations of Aerzone Corporation ("Aerzone") On December 19, 2000, the Company decided to discontinue the Aerzone business in light of significant long-term capital needs and the difficulty of securing the necessary financing because of the current state of the financial markets. The loss from disposition of discontinued operations includes management's estimates of the remaining costs to wind down the business and costs to settle its outstanding liabilities. As of June 30, 2002, Aerzone had substantially wound down its activities. For the three and nine months ended June 30, 2002, the Company increased the estimated loss on disposition of Aerzone by $250,000, as a result of a superior court decision related to a breach of contract. The assets and liabilities of such operations are reflected in net liabilities associated with discontinued operations of the accompanying condensed consolidated balance sheets as of June 30, 2002, and September 30, 2001. -6- Net liabilities associated with discontinued operations of Aerzone as of June 30, 2002, and September 30, 2001, are as follows (in thousands):
JUNE 30, SEPTEMBER 30, 2002 2001 -------------- -------------- Current assets: Other current assets. . . . . . . . . . . . . . . . . $ - $ 22 -------------- -------------- Total current assets. . . . . . . . . . . . . . . . . . - 22 Other assets. . . . . . . . . . . . . . . . . . . . . . 5 2 -------------- -------------- Total assets. . . . . . . . . . . . . . . . . . . . . . $ 5 $ 24 ============== ============== Current liabilities: Estimated closure costs . . . . . . . . . . . . . . . $ 1,556 $ 2,039 Accrued expenses. . . . . . . . . . . . . . . . . . . 53 54 Laptop Lane Limited acquisition reserve . . . . . . . 27 27 -------------- -------------- Total liabilities . . . . . . . . . . . . . . . . . . . $ 1,636 $ 2,120 ============== ============== Net liabilities associated with discontinued operations $ 1,631 $ 2,096 ============== ==============
Discontinued Operations of ISP Channel, Inc. ("ISP Channel") On December 7, 2000, the Company's Board of Directors approved a plan to discontinue providing cable-based Internet services through its ISP Channel subsidiary by December 31, 2000, because of (1) consolidation in the cable television industry made it difficult for ISP Channel to achieve the economies of scale necessary to provide such services profitably, and (2) the Company was no longer able to bear the costs of maintaining the ISP Channel. The loss from discontinued operations includes management's estimates of the remaining costs to wind down the business, costs to settle its outstanding liabilities, and the proceeds from the sale of assets. As of June 30, 2002, ISP Channel had substantially wound down its activities. For the nine months ended June 30, 2002, the Company reduced the estimated loss on disposition reserve of ISP Channel by $900,000, primarily as a result of the Company experiencing better than previously estimated contract settlements. The assets and liabilities of such operations are reflected in net liabilities associated with discontinued operations of the accompanying condensed consolidated balance sheets as of June 30, 2002, and September 30, 2001. Net liabilities associated with discontinued operations of ISP Channel as of June 30, 2002, and September 30, 2001, are as follows (in thousands):
JUNE 30, SEPTEMBER 30, 2002 2001 -------------- -------------- Current assets: Short-term investments, available-for-sale. . . . . . $ - $ 20 Other current assets. . . . . . . . . . . . . . . . . 1 2 -------------- -------------- Total assets. . . . . . . . . . . . . . . . . . . . . . $ 1 $ 22 ============== ============== Current liabilities: Accrued expenses. . . . . . . . . . . . . . . . . . . $ 314 $ 422 Estimated closure costs . . . . . . . . . . . . . . . 144 1,663 -------------- -------------- Total liabilities . . . . . . . . . . . . . . . . . . . $ 458 $ 2,085 ============== ============== Net liabilities associated with discontinued operations $ 457 $ 2,063 ============== ==============
Discontinued Operations of Micrographic Technology Corporation ("MTC") As a result of a preliminary arbitration decision related to a dispute with Applications Informatiques Multimedia and a dispute related to the sale of MTC to Global Information Distribution GmbH ("GID"), the Company recorded a $590,000 estimated loss on disposition reserve of MTC for the nine months ended June 30, 2002. MTC was previously owned by the Company, and was sold to GID on September 30, 1999. The estimated loss on disposition reserve of MTC is reflected in net liabilities associated with discontinued operations of the condensed consolidated balance sheet as of June 30, 2002, and the corresponding charge is reflected in loss on disposition of discontinued -7- operations of the condensed consolidated statement of operations for the nine months ended June 30, 2002. Net liabilities associated with discontinued operations of MTC as of June 30, 2002, and September 30, 2001, are as follows (in thousands):
JUNE 30, SEPTEMBER 30, 2002 2001 -------------- -------------- Current liabilities: Estimated closure costs. . . . . . . . . . $ 442 $ - -------------- -------------- Net liabilities associated with discontinued operations . . . . . . . . . . . . . . . . $ 442 $ - ============== ==============
3. RESTRUCTURING CHARGE On December 28, 2000, the Company's Board of Directors approved a plan to reduce its corporate headquarters staff in conjunction with discontinuing the Aerzone and ISP Channel businesses. As a result of this plan, the Company established a $3,900,000 restructuring reserve, which consisted primarily of severance costs for affected employees. Subsequently, for the nine months ended June 30, 2002, the Company increased the restructuring reserve by $502,000 for additional estimated lease termination costs associated with Company headquarters. The restructuring reserve is reflected in restructuring accrual on the condensed consolidated balance sheet as of June 30, 2002, and September 30, 2001. Through June 30, 2002, $2,953,000 of severance payments have been applied to this reserve. The remaining $1,449,000 will be utilized primarily for lease termination costs associated with Company headquarters. 4. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS, AVAILABLE-FOR-SALE Cash equivalents consist of securities with maturities of three months or less from date of purchase. Short-term investments, available-for-sale are carried at fair value based on quoted market prices. Net unrealized holding losses amounted to $22,000, which is based on market value as of June 30, 2002, and is reflected in accumulated other comprehensive loss on the condensed consolidated balance sheet as of June 30, 2002. Short-term investments, available-for-sale as of June 30, 2002, consist of $41,100,000 of debt securities that mature between one to five years, and $17,000 of common stock. Cash, cash equivalents and short-term investments, available-for-sale consist of the following as of June 30, 2002 (in thousands):
UNREALIZED UNREALIZED COST GAIN LOSS MARKET ----------- ----------- ------------ ----------- Cash and cash equivalents: Cash. . . . . . . . . . . . . . . . . . . $ 2,867 $ - $ - $ 2,867 Money market funds. . . . . . . . . . . . 25,319 - - 25,319 ----------- ----------- ------------ ----------- $ 28,186 $ - $ - $ 28,186 =========== =========== ============ =========== Short-term investments, available-for-sale: Market auction securities . . . . . . . . $ 41,100 $ - $ - $ 41,100 Common stock. . . . . . . . . . . . . . . 39 - (22) 17 ----------- ----------- ------------ ----------- $ 41,139 $ - $ (22) $ 41,117 =========== =========== ============ ===========
5. EQUITY INVESTMENTS The Company recognized a loss of $230,000 related to the 1,000,000 SkyNet Global Limited common stock shares and $471,000 related to the 400,000 SkyNet Global Limited preference stock shares for the nine months ended June 30, 2002. The loss is reflected in loss on disposition of equity investments in the accompanying condensed consolidated statements of operations for the nine months ended June 30, 2002. 6. COMMITMENTS AND CONTINGENCIES Legal Proceedings On September 26, 2001, Lucent Technologies Inc. ("Lucent") brought an action in San Francisco Superior Court against the Company, alleging that the Company breached a contract by failing to purchase Lucent's shares in -8- Freewire Networks, Inc. ("Freewire") and claiming damages of approximately $3.5 million, which may increase over time. On December 31, 2001, the San Francisco Superior Court issued an order to deny Lucent's application for writ of attachment, finding that Lucent had not shown a substantial probability that it will prevail on its claim. The Company continues to believe that Lucent's claims are without merit and will contest these claims vigorously. On November 9, 2001, Nokia, Inc. ("Nokia") commenced an action in San Francisco Superior Court against the Company and Aerzone, alleging breach of contract arising out of the Aerzone's proposed operations in certain airports. Nokia seeks approximately $2.1 million in damages. The Company believes that Nokia's claims are without merit and intends to contest these claims vigorously. Additionally, the Company deposited security collateral of $1,053,000 as required by the performance bond indemnity agreement with the surety company. In the event that the Company prevails, any balance on the collateral will be returned by the surety company to the Company. The security collateral is reflected in other assets of the accompanying condensed consolidated balance sheets as of June 30, 2002, and September 30, 2001. On October 30, 2001, GID commenced a demand for arbitration against the Company, alleging breach of contract and warranties relating to the sale of MTC to GID on September 30, 1999. GID claims approximately $2.1 million in damages. The Company believes GID's claims are without merit and intends to contest these claims vigorously. The Company is also involved in other legal proceedings and claims, which arise in the ordinary course of its discontinued businesses. The Company believes the results of the above noted legal proceedings, other pending legal proceedings and claims are not expected to have a material adverse effect on its results of operations, financial condition or cash flows. 7. COMPREHENSIVE LOSS The components of comprehensive loss for the three months and nine months ended June 30, 2002 and 2001, are as follows (in thousands):
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30, --------------------------- -------------------------- 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Net loss . . . . . . . . . . . . . . $ (1,393) $ (12,781) $ (10,782) $ (54,898) Unrealized gain (loss) on securities (16) 3,589 442 272 Foreign currency translation adjustments. . . . . . . . . . . . - (15) 16 (25) ------------ ------------ ------------ ------------ Comprehensive loss . . . . . . . . . $ (1,409) $ (9,207) $ (10,324) $ (54,651) ============ ============ ============ ============
8. SUPPLEMENTAL CASH FLOW INFORMATION The supplemental cash flow information for the nine months ended June 30, 2002 and 2001, is as follows (in thousands):
NINE MONTHS ENDED JUNE 30, -------------------------- 2002 2001 ---------- ---------- Cash paid: Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 72 $ 355 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - Non-cash investing and financing activities: Common stock issued for- Acquisition of Laptop Lane Limited . . . . . . . . . . . . . . . . . . . . - 332 Payment of promissory note and related interest, and business acquisition Liability to former Intelligent Communications, Inc. stockholders. . . . - 199 Payment of affiliate contract termination fees with Mediacom LLC . . . . . - 1,500 Decrease in additional-paid-in capital associated with termination of common stock options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (65) (25,644) Unrealized gain on short-term investments. . . . . . . . . . . . . . . . . . 442 272
-9- 9. SEGMENT INFORMATION As a result of the April 3, 2002, unanimous consent by the Company's Board of Directors to cease the operations of Intellicom, the Company discontinued its last business segment. Accordingly, no segment information is disclosed in the accompanying notes to these condensed consolidated financial statements. 10. SUBSEQUENT EVENTS On July 29, 2002, the Company entered into an agreement to acquire First Security Holdings Corporation ("FSHC") from Independence Holding Company ("IHC") for $31.9 million in cash. FSHC and its wholly-owned subsidiaries are engaged in the insurance and reinsurance business. Upon closing of the transaction, the Company will become an insurance holding company, the employment of all of the Company's current employees will terminate, and substantially all of the Company's operations will be directed by IHC management and employees pursuant to a services agreement between the Company and IHC. Consummation of this acquisition is subject to satisfaction of certain conditions, including approval by insurance regulators and the Company's stockholders. The Company anticipates the completion of the transaction by December 31, 2002. In a separate transaction, IHC acquired Pacific Century Cyberworks Limited's ("PCCW") entire interest in the Company consisting of 5,000,000 common stock shares at $3.00 per share for a total value of $15,000,000. As a result of this transaction, Pacific Century Cyberworks Limited appointees Linus W.L. Cheung and Jeffrey A. Bowden have resigned from the Company's Board of Directors, and Edward Netter, Chairman of IHC, and Roy Thung, Chief Executive Officer of IHC, have been appointed to the Company's Board of Directors. Additionally, upon closing of the transaction, IHC has agreed to make a cash tender offer at $3.00 per share for at least 3,000,000 outstanding common stock shares of the Company, subject to certain limitations. Separately, the Company's Board of Directors also approved a shareholder rights plan (the "Plan"). Pursuant to the Plan's approval, the Company's Board of Directors declared a dividend distribution of one Preferred Share Purchase Right (the "Rights") on each outstanding common stock share. The dividend distribution of the Rights will be payable to common stock stockholders of record on August 14, 2002. The Rights distribution is not taxable to stockholders. Subject to limited exceptions, the Rights will be exercisable if a person or group acquires or announces a tender offer for 4.99% or more of the Company's common stock. Under certain circumstances, each Right will entitle shareholders to buy one one-hundredth of a share of newly created Series A Junior Participating Preferred Stock of the Company at an exercise price of $3.00. The Company's Board of Directors will be entitled to redeem the Rights at $0.01 per Right at any time before a person has acquired 4.99% or more of the outstanding common stock. The Rights designed to inhibit some acquisitions of the Company's common stock shares that could result in the imposition of limitations on the use of its Federal net operating loss carryforwards and certain income tax credits. The Rights are also intended to enable all stockholders to realize the long-term value of their investment in the Company. The Rights are not being distributed in response to any specific effort to acquire control of the Company. The Rights are designed to help protect the tax benefits associated with the Company's net operating loss carryforwards. If a person becomes an Acquiring Person, each Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the Company's common shares having a market value at that time of twice the Right's exercise price. The Rights held by the Acquiring Person will become void and will not be exercisable to purchase shares at the bargain purchase price. If Company is acquired in a merger or other business combination transaction which has not been approved by the Company's Board of Directors, each Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the acquiring company's common shares having a market value at that time of twice the Right's exercise price. The Plan will expire on the close of business on the earliest date that (a) a vote of Company's stockholders does not approve an amendment or an amendment and restatement of the Company's Certificate of Incorporation proposed by the Company's Board of Directors providing for limitations on the acquisition of the Company's common stock in excess of certain percentage amounts, (b) such restated Certificate of Incorporation is filed with the Secretary of State of the State of Delaware or (c) the Company's stock purchase agreement with SSH Corp. and IHC is terminated, subject to the Company's right to extend such date and the Company's earlier redemption or exchange of such rights or termination of the Plan. -10- On May 17, 2002, the Company received a NASDAQ Staff Determination Letter stating that the Company's common stock is no longer eligible for continued listing on the NASDAQ National Market, as a result of the Company ceasing the operations of its last business segment, Intellicom, and that the Company therefore does not meet the requirements for continued listing set forth in Marketplace Rules 4300 and 4330. Subsequently, the Company requested and was granted an oral hearing before a NASDAQ Listing Qualifications Panel to appeal the NASDAQ Staff Determination Letter, which stayed the delisting of the Company's common stock pending the outcome of the hearing. On July 12, 2002, the Company appeared before the NASDAQ Listing Qualifications Panel to present the Company's plan to acquire FSHC, which would allow the Company to comply with the Marketplace Rules 4300 and 4330. The Company is awaiting a decision from the NASDAQ Listing Qualifications Panel. -11- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Form 10-Q contains forward-looking statements that involve risks and uncertainties. The actual consolidated results of SoftNet Systems, Inc. and Subsidiaries (the "Company") could differ significantly from those set forth herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Factors Affecting the Company's Operating Results" as set forth in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2001, as filed with the Securities and Exchange Commission, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as those discussed elsewhere in this quarterly report. Statements contained herein that are not historical facts are forward-looking statements that are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. Words such as "believes", "anticipates", "expects", "intends", "estimates", "likelihood", "unlikelihood", "assessment", and "foreseeable" and other similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. A number of important factors could cause the Company's actual results for the year ending September 30, 2002, and beyond to differ materially from past results and those expressed or implied in any forward-looking statements made by the Company, or on its behalf. The Company undertakes no obligation to release publicly the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. The following discussion of the financial condition and results of operations of the Company should be read in conjunction with, and is qualified in its entirety by reference to, the Consolidated Financial Statements of the Company and the related Notes thereto appearing in our annual report on Form 10-K for the fiscal year ended September 30, 2001, as filed with the Securities and Exchange Commission and our Condensed Consolidated Financial Statements and related Notes thereto appearing elsewhere in this quarterly report. OVERVIEW On July 29, 2002, the Company entered into an agreement to acquire First Security Holdings Corporation ("FSHC") from Independence Holding Company ("IHC") for $31.9 million in cash. FSHC and its wholly-owned subsidiaries are engaged in the insurance and reinsurance business. Upon closing of the transaction, the Company will become an insurance holding company, the employment of all of the Company's current employees will terminate, and substantially all of the Company's operations will be directed by IHC management and employees pursuant to a services agreement between the Company and IHC. Consummation of this acquisition is subject to satisfaction of certain conditions, including approval by insurance regulators and the Company's stockholders. The Company anticipates the completion of the transaction by December 31, 2002. In a separate transaction, IHC acquired Pacific Century Cyberworks Limited's ("PCCW") entire interest in the Company consisting of 5,000,000 common stock shares at $3.00 per share for a total value of $15,000,000. As a result of this transaction, Pacific Century Cyberworks Limited appointees Linus W.L. Cheung and Jeffrey A. Bowden have resigned from the Company's Board of Directors, and Edward Netter, Chairman of IHC, and Roy Thung, Chief Executive Officer of IHC, have been appointed to the Company's Board of Directors. Additionally, upon closing of the transaction, IHC has agreed to make a cash tender offer at $3.00 per share for at least 3,000,000 outstanding common stock shares of the Company, subject to certain limitations. Separately, the Company's Board of Directors also approved a shareholder rights plan (the "Plan"). Pursuant to the Plan's approval, the Company's Board of Directors declared a dividend distribution of one Preferred Share Purchase Right (the "Rights") on each outstanding common stock share. The dividend distribution of the Rights will be payable to common stock stockholders of record on August 14, 2002. The Rights distribution is not taxable to stockholders. Subject to limited exceptions, the Rights will be exercisable if a person or group acquires or announces a tender offer for 4.99% or more of the Company's common stock. Under certain circumstances, each Right will entitle shareholders to buy one one-hundredth of a share of newly created Series A Junior Participating Preferred Stock of the Company at an exercise price of $3.00. The Company's Board of Directors will be entitled to redeem the Rights at $0.01 per Right at any time before a person has acquired 4.99% or more of the outstanding common stock. The Rights designed to inhibit some acquisitions of the Company's common stock shares that could result in the imposition of limitations on the use of its Federal net operating loss carryforwards and certain income tax credits. The Rights are also intended to enable all stockholders to realize the long-term value of their investment in the Company. The Rights are not being distributed in response to any specific effort to acquire control of the Company. -12- The Rights are designed to help protect the tax benefits associated with the Company's net operating loss carryforwards. If a person becomes an Acquiring Person, each Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the Company's common shares having a market value at that time of twice the Right's exercise price. The Rights held by the Acquiring Person will become void and will not be exercisable to purchase shares at the bargain purchase price. If Company is acquired in a merger or other business combination transaction which has not been approved by the Company's Board of Directors, each Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the acquiring company's common shares having a market value at that time of twice the Right's exercise price. The Plan will expire on the close of business on the earliest date that (a) a vote of Company's stockholders does not approve an amendment or an amendment and restatement of the Company's Certificate of Incorporation proposed by the Company's Board of Directors providing for limitations on the acquisition of the Company's common stock in excess of certain percentage amounts, (b) such restated Certificate of Incorporation is filed with the Secretary of State of the State of Delaware or (c) the Company's stock purchase agreement with SSH Corp. and IHC is terminated, subject to the Company's right to extend such date and the Company's earlier redemption or exchange of such rights or termination of the Plan. On May 17, 2002, the Company received a NASDAQ Staff Determination Letter stating that the Company's common stock is no longer eligible for continued listing on the NASDAQ National Market as a result of the Company ceasing the operations of its last business segment, Intellicom, and that the Company therefore does not meet the requirements for continued listing set forth in Marketplace Rules 4300 and 4330. Subsequently, the Company requested and was granted an oral hearing before a NASDAQ Listing Qualifications Panel to appeal the NASDAQ Staff Determination Letter, which stayed the delisting of the Company's common stock pending the outcome of the hearing. On July 12, 2002, the Company appeared before the NASDAQ Listing Qualifications Panel to present the Company's plan to acquire FSHC, which would allow the Company to comply with the Marketplace Rules 4300 and 4330. The Company is awaiting a decision from the NASDAQ Listing Qualifications Panel. On December 7, 2000, the Company's Board of Directors approved a plan to discontinue its ISP Channel, Inc. ("ISP Channel") operations because of (1) the consolidation in the cable industry made it difficult for ISP Channel to achieve the economies of scale necessary to provide such services profitably, and (2) the Company was no longer able to bear the costs of maintaining the ISP Channel. Subsequently on December 19, 2000, the Company's Board of Directors approved a plan to discontinue its Aerzone Corporation ("Aerzone") business in light of, among other things, significant long-term capital needs and the difficulty of securing the necessary financing because of the financial markets. In conjunction with discontinuing the ISP Channel and Aerzone businesses, the Company's Board of Directors on December 28, 2000, approved a plan to reduce its corporate headquarters staff. As a result of the Company's Board of Directors decisions, the Company wound down the ISP Channel and Aerzone businesses, and reduced its corporate headquarters staff. As of June 30, 2002, the ISP Channel and Aerzone businesses, including Laptop Lane Limited, were substantially wound down. On March 29, 2002, the Company and its wholly-owned subsidiary, Intelligent Communications, Inc. ("Intellicom"), entered into an agreement to sell its operating business and certain assets to Loral Cyberstar, Inc. Following the sale of its operating business and certain assets to Loral Cyberstar, Inc., the Company's Board of Directors unanimously agreed to cease the operations of Intellicom on April 3, 2002. Subsequently on April 22, 2002, Intellicom entered into an agreement to sell certain assets to Native Intellicom, Inc., a wholly-owned subsidiary of the Pinoleville Band of Pomo Indians, for cash, subject to the termination of Intellicom's lease for its facility in Livermore, California. The Company reports operating expenses in several categories: (i) selling and marketing; (ii) engineering; and (iii) general and administrative costs. Also included in operating expenses are depreciation and non-cash compensation expense related to stock options. Non-cash compensation expense related to stock options relates primarily to the amortization of deferred stock compensation resulting from below market value stock options granted between October 1998 and March 1999. The results of operations for the three months and nine months ended June 30, 2001, have been reclassified for the effects of discontinued operations of Intellicom. -13- CRITICAL ACCOUNTING POLICIES The preparation of consolidated financial statements and related disclosures in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of the revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company believes the following critical accounting policies are significantly affected by judgments, assumptions and estimates used in preparation of its condensed consolidated financial statements. For a detailed discussion on the application of these and other accounting policies, see Note 2 to the consolidated financial statements in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2001. Discontinued Operations The Company accounts for discontinued operations in accordance to Accounting Principles Board Opinion No. 30 ("APB 30"), Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Under APB 30, the Company accrued estimates of expected liabilities related to discontinued operations through its eventual discharge. The estimated remaining liabilities related to discontinued operations include contract terminations, litigation and loss from operations subsequent to June 30, 2002. The Company reviews the estimated closure costs liability on a quarterly basis to determine changes in the costs of the discontinued operations activities. Restructuring Expense The Company recorded restructuring expenses related to an approved plan to reduce corporate headquarters staff and to relocate its corporate offices in conjunction with discontinuing the Aerzone, ISP Channel and Intellicom businesses. These restructuring expenses are based on estimates of the expected costs associated with employee severance, lease terminations, and facility relocation. The Company reviews the estimated restructuring costs accrual on a quarterly basis to determine changes in the costs of the restructuring activities. Impairment of Long-lived Assets The Company evaluates long-lived assets for impairment whenever current events or changes in circumstances, as defined in Statement of Financial Accounting Standards No. 121 ("SFAS 121"), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Short-term Investments The Company accounts for its short-term investments in debt and equity securities under Statement of Financial Accounting Standards No. 115 ("SFAS 115"), Accounting for Certain Investments in Debt and Equity Securities. Short-term investments generally consist of highly liquid securities with original maturities in excess of three months. The Company has classified its short-term investments as available-for-sale securities. These short-term investments are carried at fair value based on quoted market prices with unrealized gains and losses reported in accumulated other comprehensive loss in the accompanying condensed consolidated balance sheets. Realized gains and losses on short-term investments are computed using the specific identification method and are reported in miscellaneous income (expense), net in the accompanying condensed consolidated statements of operations. Declines in value judged to be other-than-temporary is determined based on the specific identification method and are reported in loss in disposition of equity investments in the accompanying condensed consolidated statements of operations. -14- RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2002, COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2001 Selling and Marketing. The Company incurred no selling and marketing expenses ----------------------- for the three months ended June 30, 2002, compared to $9,000 for the three months ended June 30, 2001, as a result of eliminating the public relations department associated with the December 28, 2000, corporate restructuring plan. Engineering. The Company incurred no engineering expenses for the three months ----------- ended June 30, 2002, compared to $71,000 for the three months ended June 30, 2001, as a result of eliminating the corporate technology department associated with the December 28, 2000, corporate restructuring plan. General and Administrative. Consolidated general and administrative expenses ---------------------------- decreased $347,000, or 22%, to $1,265,000 for the three months ended June 30, 2002, compared to $1,612,000 for the three months ended June 30, 2001, primarily due to reduced expenses resulting from staff reductions associated with the December 28, 2000, corporate restructuring plan. Depreciation. Consolidated depreciation expense decreased $44,000, or 56%, to ------------ $34,000 for the three months ended June 30, 2002, compared to $78,000 for the three months ended June 30, 2001, primarily due to reduced depreciation expense resulting from sales and disposal of property. Non-Cash Compensation Expense Related to Stock Options. The Company recognized ------------------------------------------------------- a non-cash compensation expense related to stock options of $400,000 for the three months ended June 30, 2002, compared to non-cash compensation expense related to stock options of $483,000 for the three months ended June 30, 2001. For the three months ended June 30, 2002 and 2001, non-cash compensation expense related to stock options issued to employees relates primarily to the amortization of deferred stock compensation resulting from below market value stock options granted between October 1998 and March 1999. Non-cash compensation expense related to stock options should continue to decrease as the Company continues to reduce its staff due to its discontinued operations and corporate restructuring. Interest Income. Consolidated interest income decreased $832,000, or 68%, to ---------------- $391,000 for the three months ended June 30, 2002, compared to $1,223,000 for the three months ended June 30, 2001, as a result of lower interest rates, and decrease in cash, cash equivalents, and short-term investments, available-for-sale. Interest Expense. Consolidated interest expense increased $14,000 to $18,000 ----------------- for the three months ended June 30, 2002, compared to $4,000 for the three months ended June 30, 2001. Loss on Disposition of Equity Investments. For the three months ended June 30, ------------------------------------------- 2001, the Company recognized a charge of $3,684,000 related to its China Broadband Corporation investment in anticipation of the Company's July 13, 2001, agreement to sell its interest in China Broadband Corporation to Canaccord International Limited. Miscellaneous Income/Expense, Net. Consolidated miscellaneous income increased ---------------------------------- $53,000 to $3,000 for the three months ended June 30, 2002, compared to consolidated miscellaneous expense of $50,000 for the three months ended June 30, 2001. This increase is primarily due to losses incurred from the disposal of property for the three months ended June 30, 2001. Income Taxes. The Company made no provision for income taxes for the three ------------- months ended June 30, 2002 and 2001, as a result of the Company's continuing losses. Loss Attributed to Discontinued Operations. The Company recognized a $70,000 ---------------------------------------------- loss attributed to discontinued operations for the three months ended June 30, 2002, compared to a loss of $8,013,000 for the three months ended June 30, 2001. For the three months ended June 30, 2002, the loss attributed to discontinued operations consisted of a $180,000 gain on disposition of Intellicom, resulting from a lower than anticipated costs of closing Intellicom, and a $250,000 loss on disposition of Aerzone, resulting from a superior court decision related to a breach of contract. For the three months ended June 30, 2001, the loss attributed to discontinued operations consisted of a $3,913,000 loss from operations of Intellicom, a $3,000,000 gain on the disposition of ISP Channel, resulting from lower than anticipated costs of closing ISP Channel, and a $7,100,000 loss on the disposition of Aerzone, resulting primarily from the reduction of the anticipated sales price of Laptop Lane Limited. Net Loss. The Company had a net loss of $1,393,000, or a net loss per share of --------- $0.05, for the three months ended June 30, 2002, compared to a net loss of $12,781,000, or a net loss per share of $0.51, for the three months ended June 30, 2001. -15- RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED JUNE 30, 2002, COMPARED TO THE NINE MONTHS ENDED JUNE 30, 2001 Selling and Marketing. The Company incurred no selling and marketing expenses ----------------------- for the nine months ended June 30, 2002, compared to $196,000 for the nine months ended June 30, 2001, as a result of eliminating the public relations department associated with the December 28, 2000, corporate restructuring plan. Engineering. The Company incurred no engineering expenses for the nine months ----------- ended June 30, 2002, compared to $529,000 for the nine months ended June 30, 2001, as a result of eliminating the corporate technology department associated with the December 28, 2000, corporate restructuring plan. General and Administrative. Consolidated general and administrative expenses ---------------------------- decreased $2,056,000, or 32%, to $4,347,000 for the nine months ended June 30, 2002, compared to $6,403,000 for the nine months ended June 30, 2001, primarily due to reduced expenses resulting from staff reductions associated with the December 28, 2000, corporate restructuring plan. Depreciation. Consolidated depreciation expense decreased $122,000, or 43%, to ------------ $160,000 for the nine months ended June 30, 2002, compared to $282,000 for the nine months ended June 30, 2001, primarily due to reduced depreciation expense resulting from sales and dispoal of property. Non-Cash Compensation Expense/Benefit Related to Stock Options. The Company ------------------------------------------------------------------ recognized a non-cash compensation expense related to stock options of $1,200,000 for the nine months ended June 30, 2002, compared to non-cash compensation benefit related to stock options of $1,087,000 for the nine months ended June 30, 2001. For the nine months ended June 30, 2002 and 2001, non-cash compensation expense/benefit related to stock options issued to employees relates primarily to the amortization of deferred stock compensation resulting from below market value stock options granted between October 1998 and March 1999. Non-cash compensation benefits are recognized following the reversal of previously recognized expenses related to terminated unvested stock options with a cliff vesting feature. Non-cash compensation expense related to stock options should continue to decrease as the Company continues to reduce its staff due to its discontinued operations and corporate restructuring. Provision for Impaired Assets. The Company recognized a charge of $352,000 for ------------------------------- the nine months ended June 30, 2002, as a result of writing off its accounting software. The Company migrated to an off-the-shelf accounting software. Restructuring Expense. The Company recognized a restructuring charge for the ----------------------- nine months ended June 30, 2001, related to a plan to downsize its corporate headquarters staff. The charge in the amount of $3,900,000 was recognized as restructuring expense and consisted primarily of termination payments for affected employees. The Company increased the restructuring reserve by $502,000 for the nine months ended June 30, 2002, as a result of additional estimated lease termination costs associated with Company headquarters. At June 30, 2002, a restructuring accrual of $1,449,000 remained outstanding. Interest Income. Consolidated interest income decreased $4,110,000, or 74%, to ---------------- $1,423,000 for the nine months ended June 30, 2002, compared to $5,533,000 for the nine months ended June 30, 2001, as a result of lower interest rates, and decrease in cash, cash equivalents, and short-term investments, available-for-sale. Interest Expense. Consolidated interest expense decreased $35,000, or 39%, to ----------------- $54,000 for the nine months ended June 30, 2002, compared to $89,000 for the nine months ended June 30, 2001. This decrease is primarily due to the reduction of interest expense resulting from the payment of the 8.5% promissory note to the former Intellicom stockholders. Loss on Disposition of Equity Investments. The Company recognized a loss on ---------------------------------------------- disposition of equity investments of $701,000 for the nine months ended June 30, 2002, consisting of $230,000 related to the 1,000,000 SkyNet Global Limited common stock shares and $471,000 related to the 400,000 SkyNet Global Limited preference stock shares. For the nine months ended June 30, 2001, the Company recognized a charge of $17,445,000, consisting of a $768,000 write down of a note receivable and related interest, and $16,677,000 of write-downs and realized losses related to various short-term and long-term equity investments. Equity in Net Losses of Investee Companies. The Company recognized equity in ---------------------------------------------- net losses of investee companies of $394,000 for the nine months ended June 30, 2001. The Company did not incur any equity in net losses of investee companies -16- for the nine months ended June 30, 2002, as a result of the sale and write offs of investee companies accounted for under the equity method for the year ended September 30, 2001. Miscellaneous Expense, Net. The Company incurred no consolidated miscellaneous --------------------------- expense for the nine months ended June 30, 2002, compared to consolidated miscellaneous expense of $153,000 for the nine months ended June 30, 2001, primarily resulting from the write off of costs associated with a failed business acquisition. Income Taxes. The Company made no provision for income taxes for the nine ------------- months ended June 30, 2002 and 2001, as a result of the Company's continuing losses. Loss Attributed to Discontinued Operations. The Company recognized a $4,889,000 ------------------------------------------- loss attributed to discontinued operations for the nine months ended June 30, 2002, compared to a loss of $33,453,000 for the nine months ended June 30, 2001. For the nine months ended June 30, 2002, the loss attributed to discontinued operations consisted of a $3,120,000 loss on disposition of Intellicom, a $1,829,000 loss from operations of Intellicom, a $590,000 loss on disposition of Micrographic Technology Corporation ("MTC"), as a result of a preliminary arbitration decision related to a dispute with Applications Informatiques Multimedia and a dispute related to the sale of MTC to Global Information Distribution GmbH ("GID"), a $900,000 gain on disposition of ISP Channel, resulting from the lower than anticipated costs of closing ISP Channel, and a $250,000 loss on disposition of Aerzone, resulting from a superior court decision related to a breach of contract. For the nine months ended June 30, 2001, the loss attributed to discontinued operations consisted of a $26,625,000 loss from operations of Intellicom, a $9,008,000 gain on the disposition of ISP Channel, resulting from lower than anticipated costs of closing ISP Channel, and a $15,836,000 loss on the disposition of Aerzone, resulting primarily from the reduction of the anticipated sales price of Laptop Lane Limited. Extraordinary Item-Gain on Settlement of Obligation. The Company recognized a ------------------------------------------------------ gain of $1,326,000 for the nine months ended June 30, 2001, resulting from the cash payment made in lieu of the Company's obligation to pay off the 8.5% promissory note and interest, and to settle business acquisition liability to former Intellicom stockholders with common stock. Net Loss. The Company had a net loss of $10,782,000, or a net loss per share of -------- $0.42, for the nine months ended June 30, 2002, compared to a net loss of $54,898,000, or a net loss per share of $2.20, for the nine months ended June 30, 2001. -17- LIQUIDITY AND CAPITAL RESOURCES Since September 1998, the Company has funded the significant negative cash flows from its subsidiary operating activities and the associated capital expenditures through a combination of public and private equity sales, convertible debt issues and equipment leases. As of June 30, 2002, the Company had $69,303,000 in cash, cash equivalents, and short-term investments compared with $75,454,000 as of September 30, 2001. Net cash used in operating activities of continuing operations for the nine months ended June 30, 2002, was $2,476,000. This results from a net loss of $5,893,000 from continuing operations and a net decrease in operating liabilities of $1,587,000, offset by several non-cash items including loss on write down of impaired assets of $352,000, loss on disposition of equity investments of $701,000, provision for restructuring costs of $502,000, amortization of deferred stock compensation expense of $1,200,000, depreciation expense of $160,000, and a net decrease in operating assets of $2,044,000. Net cash used in operating activities of discontinued operations was $3,838,000. Net cash provided by investing activities of continuing operations for the nine months ended June 30, 2002, was $19,602,000, and was provided by proceeds from maturities and sales of short-term investments, net of purchases. Net cash used in investing activities of discontinued operations was $2,000. No cash was provided by or used in financing activities for the nine months ended June 30, 2002. Net cash used in financing activities of discontinued operations was $60,000. The Company believes it has sufficient cash to meet its presently anticipated business requirements over the next twelve months including the funding of operating losses, discontinued operations, working capital requirements, and capital investments. The Company expects continued reductions in cash usages from its discontinued operating activities for the year ending September 30, 2002. -18- FACTORS AFFECTING THE COMPANY'S OPERATING RESULTS The risks and uncertainties described below are not the only ones that the Company faces. Additional risks and uncertainties not presently known to the Company or that the Company currently deems immaterial may also impair the Company's business operations. If any of the following risks actually occur, the Company's business, financial condition or results of operations could be materially adversely affected. In such case, the trading price of the Company's common stock could decline, and you may lose all or part of your investment. COMPANY RISKS THE COMPANY'S ACQUISITION OF FSHC SUBJECTS THE COMPANY TO RISKS IN A NEW MARKET On July 29, 2002, the Company entered into an agreement to acquire First Security Holdings Corporation ("FSHC") from Independence Holding Company ("IHC") for $31.9 million in cash. FSHC and its wholly-owned subsidiaries are engaged in the insurance and reinsurance business. Upon closing of the transaction, the Company will become an insurance holding company, the employment of all of the Company's current employees will terminate, and substantially all of the Company's operations will be directed by IHC management and employees pursuant to a services agreement between the Company and IHC. Consummation of this acquisition is subject to satisfaction of certain conditions, including approval by insurance regulators and the Company's stockholders. The Company anticipates the completion of the transaction by December 31, 2002, although the Company cannot assure that it will complete the transaction on schedule, if at all. The Company will rely on new management to operate the business. As such, the Company is faced with risks that are new to the Company and which may adversely affect the Company's business, financial condition, and prospects. THE COMPANY'S ACQUISITION OF FSHC MAY ADVERSELY AFFECT THE COMPANY'S FINANCIAL CONDITION The acquisition of FSHC involve other risks including potential negative effects on the Company's reported results of operations from acquisition-related charges and amortization of other intangible assets. As a result of the FSHC acquisition, the Company may record additional intangible assets. Such recording of intangible assets may adversely affect the Company's earnings and profitability for the foreseeable future. If the amount of such recorded intangible assets is increased or if the Company has future losses and is unable to demonstrate the Company's ability to recover the amount of intangible assets recorded during such time periods, the intangible asset can be written down or the period of amortization could be shortened, which may further increase annual amortization charges. In such event, the Company's business and financial condition could be materially and adversely affected. In addition, the acquisition of all of the outstanding stock of FSHC was structured as a purchase by the Company. As a result, the Company could be adversely affected by direct and contingent liabilities of FSHC. It is possible that the Company is not aware of all of the liabilities of FSHC and that FSHC has greater liabilities than the Company expected. THE COMPANY HAS A HISTORY OF LOSSES AND EXPECTS TO INCUR LOSSES IN THE FUTURE The Company has sustained substantial losses over the last five fiscal years and expects to continue to report net losses for the foreseeable future. For the nine months ended June 30, 2002, the Company had a net loss of $10,782,000. As of June 30, 2002, the Company had an accumulated deficit of $401,029,000. The Company expects to incur additional losses and experience negative cash flows related to process of winding down the Intellicom, ISP Channel and Aerzone businesses. These efforts may be more expensive than the Company currently anticipates. THE COMPANY MAY NOT GENERATE SUFFICIENT CASH FLOWS TO SUPPORT ITS EXPENSES The Company's current expense levels are based on the resources necessary to complete the process of winding down the Intellicom, ISP Channel and Aerzone Businesses. Depending upon the costs to complete the process of winding down Intellicom, ISP Channel and Aerzone, the Company is unlikely to be able to generate sufficient interest income to cover expenses. -19- IF THE COMPANY IS UNABLE TO SUCCESSFULLY INTEGRATE FUTURE ACQUISITIONS INTO THE COMPANY'S OPERATIONS, THEN THE COMPANY'S RESULTS AND FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED The Company may acquire other businesses. The Company cannot predict if or when any prospective acquisitions will occur or the likelihood that they will be completed on favorable terms. Acquiring a business involves many risks, including: - Diversion of resources and management time; - Dilution to existing stockholders if the Company uses equity securities to finance acquisitions; - Incurrence of unforeseen obligations or liabilities; - Inability of management to maintain uniform standards, controls, procedures and policies; - Difficulty assimilating the acquired operations and personnel; - Risks of entering markets in which the Company has little or no direct prior experience; and - Impairment of relationships with employees as a result of changes in management. The Company cannot assure that it will make any acquisitions or that it will be able to obtain additional financing for such acquisitions, if necessary. If any acquisitions are made, the Company cannot assure that it will be able to successfully integrate the acquired business into its operations or that the acquired business will perform as expected. THE COMPANY'S EQUITY INVESTMENTS IN OTHER COMPANIES MAY NOT YIELD ANY RETURNS The Company has made equity investments in Internet-related companies. In most instances, these investments are in the form of unregistered securities of private companies. These companies typically are in an early stage of development and may be expected to incur substantial losses. The Company's investments in these companies may not yield any return. Furthermore, if these companies are not successful, the Company could incur and have incurred charges related to the write-down or write-off of these investments. For example, the Company wrote down equity investments by $701,000 for the nine months ended June 30, 2002. The Company also records and continues to record a share of the net losses in these companies, up to the Company's cost basis. The Company may make additional investments in the future. Losses or charges resulting from these investments could harm the Company's operating results. THE COMPANY'S STOCK PRICE IS VOLATILE The volatility of the Company's stock price may make it difficult for holders of the common stock to transfer their shares at the prices they want. The market price for the Company's common stock has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future. These factors include: - Announcements of developments related to the Company's business; - Fluctuations in the Company's results of operations; - Sales of substantial amounts of the Company's securities in the marketplace; - General conditions in the Company's industries or the worldwide economy; - An outbreak of war or hostilities; - A shortfall in earnings compared to securities analysts' expectations; - Changes in analysts' recommendations or projections; and - Changes in the Company's relationships with the Company's suppliers. The market price of the Company's common stock may fluctuate significantly in the future, and these fluctuations may be unrelated to the Company's performance. General market price declines or market volatility in the future could adversely affect the price of the Company's common stock, and thus, the current market price may not be indicative of future market prices. On May 17, 2002, the Company received a NASDAQ Staff Determination Letter stating that the Company's common stock is no longer eligible for continued listing on the NASDAQ National Market as a result of the Company ceasing the operations of its last business segment, Intellicom, and that the Company therefore does not meet the requirements for continued listing set forth in Marketplace Rules 4300 and 4330. Subsequently, the Company requested and was granted an oral hearing before a NASDAQ Listing Qualifications Panel to appeal the NASDAQ Staff Determination Letter, which stayed the delisting of the Company's common stock pending the outcome of the hearing. On July 12, 2002, the Company appeared before the NASDAQ Listing Qualifications Panel to present the Company's plan to acquire FSHC, which would allow the Company to comply with the Marketplace -20- Rules 4300 and 4330. The Company is awaiting a decision from the NASDAQ Listing Qualifications Panel. There can be no assurance that the NASDAQ Listing Qualifications Panel will grant the Company's request for continued listing. Delisting from the NASDAQ National Market could result in a lower average trading volume of the Company's common stock, which in turn could lead to an increase in stock price volatility. PROSPECTIVE ANTI-TAKEOVER PROVISIONS COULD NEGATIVELY IMPACT THE COMPANY'S STOCKHOLDERS The Company is a Delaware corporation. Delaware General Corporation Law contains certain provisions that may discourage, delay or make a change in control of the Company more difficult or prevent the removal of incumbent directors. In addition, the Company's certificate of incorporation and bylaws contain certain provisions that have the same effect. These provisions may have a negative impact on the price of the Company's common stock and may discourage third-party bidders from making a bid for the Company or may reduce any premiums paid to stockholders for their common stock. The Company's Board of Directors also approved a shareholder rights plan (the "Plan"). Pursuant to the Plan's approval, the Company's Board of Directors declared a dividend distribution of one Preferred Share Purchase Right (the "Rights") on each outstanding common stock share. The dividend distribution of the Rights will be payable to common stock stockholders of record on August 14, 2002. The Rights distribution is not taxable to stockholders. Subject to limited exceptions, the Rights will be exercisable if a person or group acquires or announces a tender offer for 4.99% or more of the Company's common stock. Under certain circumstances, each Right will entitle shareholders to buy one one-hundredth of a share of newly created Series A Junior Participating Preferred Stock of the Company at an exercise price of $3.00. The Rights are designed to inhibit some acquisitions of the Company's common stock shares that could result in the imposition of limitations on the use of its Federal net operating loss carryforwards and certain income tax credits. The Rights are also intended to enable all stockholders to realize the long-term value of their investment in the Company. The Rights are not being distributed in response to any specific effort to acquire control of the Company. The Rights are designed to help protect the tax benefits associated with the Company's net operating loss carryforwards. If a person becomes an Acquiring Person, each Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the Company's common shares having a market value at that time of twice the Right's exercise price. The Rights held by the Acquiring Person will become void and will not be exercisable to purchase shares at the bargain purchase price. If Company is acquired in a merger or other business combination transaction which has not been approved by the Company's Board of Directors, each Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the acquiring company's common shares having a market value at that time of twice the Right's exercise price. The Company's Board of Directors will be entitled to redeem the Rights at $0.01 per Right at any time before a person has acquired 4.99% or more of the outstanding common stock. The issuance of rights could have the effect of delaying or preventing a change in control of the Company. INTELLICOM RISKS THE COMPANY MAY FACE UNEXPECTED LIABILITIES IN WINDING DOWN THE BUSINESS OF INTELLICOM The Company has determined that it is in the best interests of the Company and its shareholders to wind down the business of Intellicom. While the Company expects the process of winding down Intellicom to be substantially complete by September 30, 2002, there can be no assurances that it will be able to do so. The Company expects to incur significant costs related to terminating contracts, reducing the workforce and recovering and disposing of deployed assets. In addition, the Company may face litigation with respect to the wind down of its activities. ISP CHANNEL RISKS THE COMPANY MAY FACE UNEXPECTED LIABILITIES IN WINDING DOWN THE BUSINESS OF ISP CHANNEL While the business of ISP Channel has been substantially wound down, there can be no assurance that all claims and issues have been resolved. In addition, the Company may face litigation with respect to the wind down of its activities. -21- AERZONE RISKS THE COMPANY MAY FACE UNEXPECTED LIABILITIES IN WINDING DOWN THE BUSINESS OF AERZONE While the business of Aerzone has been substantially wound down, there can be no assurance that all claims and issues have been resolved. In addition, the Company may face litigation with respect to the wind down of its activities. -22- ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE RISK The Company's exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income the Company can earn on its investment portfolio, and on the increase or decrease in the amount of interest expense the Company must pay with respect to its various outstanding debt instruments. The risk associated with fluctuating interest expense is limited, however, to the exposure related to those debt instruments and credit facilities, which are tied to market rates. The Company does not use derivative financial instruments or engage in hedging activities in its investment portfolio. The Company ensures the safety and preservation of its invested principal funds by limiting default risks, market risk and reinvestment risk. The Company mitigates default risk by investing in safe and high-credit quality securities. The Company had short-term investments of $41,117,000 at June 30, 2002. Except for investments in common and preferred stock, these short-term investments consist of highly liquid investments with original maturities at the date of purchase of between thirteen and twenty-five months. These investments are subject to interest rate risk and will fall in value if market interest rates increase. The Company believes a hypothetical increase in market interest rates by 10% from levels at June 30, 2002, would cause the fair value of these short-term investments to fall by an immaterial amount. Since the Company is not required to sell these investments before maturity, it has the ability to avoid realizing losses on these investments due to a sudden change in market interest rates. On the other hand, declines in the interest rates over time will reduce its interest income. The Company had outstanding convertible debt of approximately $1,444,000 at June 30, 2002. This instrument has a fixed interest rate of 5.0%. Because the interest rate of this instrument is fixed, a hypothetical 10% increase in interest rates will not have a material effect on the Company. Interest rate increases, however, will increase interest expense associated with future borrowings by the Company, if any. The Company does not hedge against interest rate fluctuations. CURRENCY EXCHANGE RISK The Company has historically had very low exposure to changes in foreign currency exchange rates, and as such, has not used derivative financial instruments to manage foreign currency fluctuation risk. -23- PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On September 26, 2001, Lucent Technologies Inc. ("Lucent") brought an action in San Francisco Superior Court against SoftNet Systems, Inc. and subsidiaries (the "Company"), alleging that the Company breached a contract by failing to purchase Lucent's shares in Freewire Networks, Inc. ("Freewire") and claiming damages of approximately $3.5 million, which may increase over time. On December 31, 2001, the San Francisco Superior Court issued an order to deny Lucent's application for writ of attachment, finding that Lucent had not shown a substantial probability that it will prevail on its claim. The Company continues to believe that Lucent's claims are without merit and will contest these claims vigorously. On November 9, 2001, Nokia Inc. ("Nokia") commenced an action in San Francisco Superior Court against the Company and Aerzone Corporation ("Aerzone"), alleging breach of contract arising out of the Aerzone's proposed operations in certain airports. Nokia seeks approximately $2.1 million in damages. The Company believes that Nokia's claims are without merit and intends to contest these claims vigorously. Additionally, the Company deposited security collateral of $1,053,000 as required by the performance bond indemnity agreement with the surety company. In the event that the Company prevails, any balance on the collateral will be returned by the surety company to the Company. On October 30, 2001, Global Information Distribution GmbH ("GID") commenced a demand for arbitration against the Company, alleging breach of contract and warranties relating to the sale of Micrographic Technology Corporation ("MTC") to GID on September 30, 1999. GID claims approximately $2.1 million in damages. The Company believes GID's claims are without merit and intends to contest these claims vigorously. The Company is also involved in other legal proceedings and claims, which arise in the ordinary course of its discontinued businesses. The Company believes the results of the above noted legal proceedings, other pending legal proceedings and claims are not expected to have a material adverse effect on its results of operations, financial condition or cash flows. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not Applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable ITEM 5. OTHER INFORMATION Not Applicable -24- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS Not Applicable (b) REPORTS ON FORM 8-K: Current Report on Form 8-K filed with the Commission on April 11, 2002 Current Report on Form 8-K filed with the Commission on May 30, 2002 -25- 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. SOFTNET SYSTEMS, INC. /s/ Edward A. Bennett Date: August 14, 2002 ------------------------------------- ------------------- Edward A. Bennett Acting Chairman of the Board of Directors /s/ George L. Hernandez Date: August 14, 2002 ------------------------------------- ------------------- George L. Hernandez Acting Chief Operating Officer; Vice President, Finance and Administration; and Secretary -26-