U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2001
---------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-27649
-------
UPGRADE INTERNATIONAL CORPORATION
(Exact name of small business issuer as specified in its charter)
Washington 58-2441311
------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1411 FOURTH AVENUE - SUITE 629 SEATTLE, WASHINGTON 98101
(Address of principal executive offices)
(206) 903-3116
(Issuer's telephone number, including area code)
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 Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
YES x NO
--- ---
State the number of shares outstanding of each of the issuer's classes of common
equity as of the latest practicable date: As of July 31, 2001, 24,024,615 shares
of common stock, $.0001 par value were outstanding.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
1
INDEX
PART I - Financial Information Page
Item 1. Financial Statements
-------- ---------------------
Consolidated balance sheets at September 30, 2000 (audited) and
June 30, 2001 (unaudited)
Consolidated statements of operations for the nine months and three
months ended June 30, 2001 and 2000 and cumulative since inception
(February 5, 1997) through June 30, 2001 (unaudited)
Consolidated statement of cash flows for the nine months ended June
30, 2001 and 2000 and cumulative since inception (February 5, 1997)
through June 30, 2001 (unaudited)
Notes to the Financial Statements (unaudited)
Item 2. Management's Discussion and Analysis or Plan of Operation
-------- ---------------------------------------------------------
PART II - Other Information
Item 1. Legal Proceedings
-------- -------------------
Item 2. Changes In Securities and Use of Proceeds
-------- -----------------------------------------------
Item 5. Other Information
-------- ------------------
Item 6. Exhibits and Reports on Form 8 - K
-------- -----------------------------------------
Signatures
2
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, June 30,
2000 2001
--------------- -------------
CURRENT ASSETS (unaudited)
Cash and cash equivalents $ 398,989 $ 107,919
Restricted deposit 805,687 300,000
Subscription receivable 32,725 -
Due from related party - 130,000
Equipment held for resale - 3,054,125
Prepaid expenses, deposits and other 121,491 358,245
--------------- -------------
Total current assets 1,358,892 3,950,289
PROPERTY AND EQUIPMENT - AT COST,
less accumulated depreciation and amortization 1,791,257 2,093,076
EQUIPMENT UNDER CONSTRUCTION 3,301,625 -
ADVANCES TO THE PATHWAYS GROUP, INC 1,900,825 -
less allowance for uncollectible advances of $0. and
$3,399,780, respectively
ADVANCES TO ROCKSTER, INC. - 950,000
OTHER ASSETS
Intangible and deferred assets, net of accumulated amortization 370,206 622,606
Deposits & notes 328,051 332,845
--------------- -------------
Total assets $ 9,050,856 $ 7,948,816
=============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,993,796 $ 4,496,134
Accrued liabilities 733,241 2,151,140
Bridge loans 799,177 434,259
Notes payable - 431,453
Equipment purchase contract payable 2,307,025 1,850,000
Royalty fee payable to Card Tech, Inc., net 487,500 975,000
Payable to related parties 175,240 1,170,560
--------------- -------------
Total current liabilities 6,495,979 11,508,546
NOTES PAYABLE, net of unamortized discount - 890,322
CONVERTIBLE DEBENTURES, net of unamortized discount 809,043 1,662,973
MINORITY INTEREST - -
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock - $.001 par value, 50,000,000 shares authorized 20,341 23,725
Stock subscriptions 323,640 711,012
Additional paid in capital 36,925,837 50,829,216
Receivable from stockholders of subsidiary (266,621) (266,621)
Accumulated development stage deficit (35,257,363) (57,410,357)
--------------- -------------
1,745,834 (6,113,025)
--------------- -------------
Total liabilities and stockholders' equity (deficit) $ 9,050,856 $ 7,948,816
=============== =============
The accompanying notes are an integral part of these statements.
3
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Cumulative
Nine months Three months results of
ended June 30, ended June 30, operations since
------------------------- ----------------------- inception
2000 2001 2000 2001 (February 5, 1997)
------------ ----------- ----------- ---------- -------------------
Costs and expenses
Research and development $ 2,523,486 $ 5,030,133 $ 654,359 $1,490,718 $ 13,180,805
Purchased in-process research and development 425,800 - - - 5,971,603
Sales and marketing 1,115,910 1,276,559 187,375 140,908 4,891,522
General and administrative 8,666,055 8,519,784 4,276,125 1,430,092 19,667,791
------------ ----------- ----------- ---------- -------------------
12,731,251 14,826,476 5,117,859 3,061,718 43,711,721
Other expenses (income)
Equity in losses of UltraCard - - - - 1,264,316
Interest expense 588,858 3,733,448 68,214 2,706,606 4,697,442
Provision for uncollectible advances - 3,399,780 3,339,780 3,399,780
Other, net 209,299 193,290 295,790 106,504 435,438
------------ ----------- ----------- ---------- -------------------
798,157 7,326,518 364,004 6,212,890 9,796,976
Minority interest in losses of subsidiaries (1,758,371) - (71,038) - (2,115,135)
------------ ----------- ----------- ---------- -------------------
NET LOSS $11,771,037 $22,152,994 $5,410,825 $9,274,608 $ 51,393,562
============ =========== =========== ========== ===================
LOSS PER COMMON
SHARE-BASIC AND DILUTED $ 0.64 $ 1.01 $ 0.28 $ 0.39 $ 4.12
============ =========== =========== ========== ===================
The accompanying notes are an integral part of these statements.
4
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended June 30, 2001 (unaudited)
Receivable
from Accumulated
Voting common stock Common stock subscribed Additional Stockholders Development
------------------- ------------------------- paid-in of stage
Shares Amount Shares Amount Capital subsidiary deficit Total
---------- ------- ----------- ------------ ------------ ------------ ------------- -------------
Balances at
October 1, 2000 20,340,610 $20,341 102,609 $ 323,640 $36,925,837 $ (266,621) $(35,257,363) $ 1,745,834
Issuance of shares in
October 2000
subscribed to shares
in May 2000 102,609 102 (102,609) (323,640) 323,538 - - -
Issuance of common
shares at $10.50 per
share in October 2000,
net of costs 142,860 143 - - 1,349,857 - - 1,350,000
Shares subscribed to
at $6.00 per share in
October 2000, net
of costs - - 258,333 1,070,000 (100,000) - - 970,000
Allocation of debenture
proceeds to
common stock 167,768 168 444,435 444,603
Allocation of
debenture proceeds
to common
stock warrants - - - - 829,551 - - 829,551
Allocation of debenture
proceeds to
beneficial
conversion feature - - - - 1,051,096 - - 1,051,096
Allocation of
promissory note
proceeds to
common stock 40,000 40 - - 136,167 - - 136,207
Common stock
subscribed to at $4.00
per share in
December 2000 - - 125,000 500,000 - - - 500,000
Common shares
subscribed at $2.00
per share in
December 2000, net
of issuance costs - - 389,129 778,257 (102,208) - - 676,049
Common shares
subscribed in
December 2000
at $0.25 through
the exercise of
stock warrants - - 20,000 5,000 - - - 5,000
5
"Continued"
Issuance of common
shares at $2.02 per
share pursuant to
conversion of
debentuer 107,981 108 218,014 - - 218,122
Issuance of common
shares pursuant to
warrant exercise
at $0.25 per share 200,000 50,000 - - 50,000
Shares subscribed to
at $2.50 per share
in January 2001,
net of costs - - 200,000 500,000 (50,000) - - 450,000
Modification of
warrants - - - - 2,414,000 - - 2,414,000
Issuance of common
shares at $1.43
per share pursuant
to conversion
of debentures 307,509 307 - - 438,049 - - 438,356
Shares subscribed to
at $2.50 per share
in February 2001
net of costs 80,000 200,000 (20,000) 180,000
Common shares
subscribed at $3.75
per share as
additional
consideration
on debt - - 16,267 61,001 - - 61,001
Common shares
subscribed at $3.31
as additional
consideration on debt 18,429 61,001 - - 61,001
Common stock issued
in March 2001 for
shares previously
subscribed 253,334 254 (253,334) (925,000) 924,746 - - -
Warrants issued with a
strike price of $6.00
per share as
additional
compensation
on debt - - 7,708 - - 7,708
Warrants issued with
a Strike price of $3.75
per share as
additional
compensation
on debt - - 14,659 - - 14,659
Warrants issued with
a Strike price of $3.31
per share as
additional
compensation
on debt - - - 12,715 - - 12,715
Issuance of common
shares at $2.00 per
share net of
financing costs 828,496 1,656,992 (5,000) - - 1,651,952
Placement fees accrued
on prior financings (831,133) (831,133)
Allocation of debenture
Proceeds to beneficial
Conversion feature - - - - 790,369 - - 790,369
Adjustment to
remeasurement of
attorney stock
options
(510,315) (510,315)
The accompanying notes are an integral part of this statement.
6
"Continued"
Issuance of common
Stock in April for
shares previously
subscribed 1,606,721 1,607 (1,606,721) (3,703,442) 3,701,835 - - -
Common stock
subscribed at $2.00 per
share in April - - 15,000 30,000 - - - 30,000
Common stock
subscribed at $1.74 per
share pursuant to
conversion of
debentures
in June 2001 - 12,784 22,203 - - - 22,203
Common stock
subscribed at $2.70
per share in
connection
with debt in
June 2001 - 50,000 135,000 - - - 135,000
Common stock
subscribed at $2.32
to $2.83 per share
from April through
June 2001 as
additional
financing fees - 47,490 125,000 - - - 125,000
Shares issued pursuant
to conversion of
debentures
at $1.25 per share 82,000 82 - - 102,418 - - 102,500
Shares issued pursuant
to conversion of
debentures
at $1.74 115,606 116 - - 200,692 - - 200,808
Shares issued pursuant
to conversion of
debentures at $1.00 29,433 29 - - 29,404 - - 29,433
Shares subscribed in
April, 2001 for $2.00
per share pursuant to
private placement net
of stock issue costs 375,000 375 - - 649,625 - - 650,000
Issuance of warrants
issued at $2.03 to $3.75
as additional
financing fees - - - - 1,383,353 - - 1,383,353
Allocation of debenture
proceeds to beneficial
conversion feature - - - - 281,843 - - 281,843
Allocation of debenture
proceeds to cashless
exercise warrants - - - - 48,487 - - 48,487
Common stock
subscribed in lieu of
loan origination fees - - 50,000 145,000 - - - 145,000
Common stock issued
at $3.19 per share from
April through June 2001
as additional
financing fees 53,185 53 - - 169,474 - - 169,527
Net consolidated loss
for the nine months
ended June 30, 2001 - - - - - - (22,152,994) (22,152,994)
---------- ------- ----------- ------------ ------------ ------------ ------------- -------------
Balances
June 30, 2001 23,724,616 $23,725 450,873 $ 711,012 50,829,216 $ (266,621) $(57,410,357) $ 6,113,025
========== ======= =========== ============ ============ ============ ============= =============
The accompanying notes are an integral part of this statement.
7
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine months ended
June 30, Cumulative
---------------------------- since inception
2000 2001 (February 5, 1997)
------------- ------------- -------------------
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities
Net loss $(11,771,037) $(22,152,994) $ (51,393,562)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 159,888 531,544 833,396
Amortization of beneficial conversion feature
and debenture discount 522,208 1,884,151 2,693,194
Allowance for potentially uncollectible advances - 3,399,780 3,399,780
Loss on sale of property and equipment - 29,904 29,904
Adjustment to receivables from subsidiary shareholders - - 133,379
Write off of option costs - - 76,250
Equity in loss of UltraCard - - 1,264,316
Common stock subscribed for financing fees - 416,529 416,529
Purchased in-process research and
development 425,800 - 5,971,603
Warrants and options issued for services 1,387,170 1,903,685 5,134,175
Warrants issued for interest on notes payable - -
Warrants issued for financing fees - 1,418,433 1,418,433
Shares issued for services 242,900 - 298,650
Expenses incurred through loan assumption - - 470,005
Stock of subsidiary issued in exchange for
contribution of intellectual property charged to expense - - 125,000
Minority interest (1,758,371) - (2,115,135)
Changes in assets and liabilities: - -
Prepaid expenses, deposits and other (201,264) (274,976) 583,734
Accounts payable and accrued liabilities 315,435 4,400,180 6,197,804
------------- ------------- -------------------
Net cash used in operating activities (10,677,271) (8,443,764) (24,462,545)
Cash flows from investing activities
Advances to The Pathways Group, Inc. - (1,498,955) (3,383,955)
Advances to Rockster, Inc. - (950,000) (950,000)
Payments on equipment under construction - - (1,200,000)
Acquisition of property and equipment, net (687,348) (587,063) (1,707,947)
Acquisition of Centurion Technologies, Inc.,
net of cash acquired - - (1,000,000)
Acquisition of UltraCard, Inc., net of cash acquired (260,300) - (5,571,105)
Acquisition of additional equity interest in eForNet
from a minority shareholder (200,000) - (200,000)
Note due from related party - (130,000) (130,000)
Proceeds from sale of property and equipment - - 52,593
Acquisition deposit (1,225,000) (15,000) (15,000)
Additions to intangible assets (71,927) (66,470) (183,648)
------------- ------------- -------------------
Net cash used in investing activities (2,444,575) (3,247,488) (14,289,062)
Cash flows from financing activities
Proceeds from sale of common stock and stock subscriptions 7,731,798 6,255,614 32,779,064
Borrowings, net of loan costs and repayments 832,681 5,945,251 9,616,789
Principal payments on borrowings - (1,361,370) (4,004,113)
Release of restricted cash - 505,687 505,687
Purchase of collateral on subsidary's letter of credit - - (805,687)
Proceeds from exercise of stock options and warrants - 55,000 767,786
------------- ------------- -------------------
Net cash provided by
financing activities 8,564,479 11,400,182 38,859,526
------------- ------------- -------------------
Net increase (decrease) in cash and cash equivalents (4,557,367) (291,070) 107,919
Cash and cash equivalents at the beginning of the period 4,781,330 398,989 -
------------- ------------- -------------------
Cash and cash equivalents at the end of the period $ 223,963 $ 107,919 $ 107,919
============= ============= ===================
The accompanying notes are an integral part of these statements.
8
UPGRADE INTERNATIONAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001 AND 2000
(UNAUDITED)
NOTE A - FINANCIAL STATEMENTS
The unaudited consolidated financial statements of the Company and its
subsidiaries have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles (GAAP) have been
condensed or omitted pursuant to such rules and regulations. The results of
operations for interim periods are not necessarily indicative of the results to
be expected for the entire fiscal year ending September 30, 2001. This form
10-QSB should be read in conjunction with the form 10-KSB that includes audited
consolidated financial statements for the year ended September 30, 2000 and 1999
and the related consolidated statements of operations, stockholders' equity and
cash flows for the years then ended and since inception (February 5, 1997) filed
on January 16, 2001 and the form 10-QSB that included consolidated financial
results for the six months ended March 31, 2001 and 2000, filed on May 21, 2001.
NOTE B - BASIS OF PRESENTATION
The Company consolidates all companies in which it has a controlling financial
interest. This generally occurs when the Company owns more than 50% of the
outstanding voting shares of the company. The Company also consolidates
50%-owned companies in which it has voting control through agreements with other
shareholders. Investments in Companies where the Company has significant
influence through ownership of 20% to 50% of the investors voting shares or
contractual arrangements are accounted for by the equity method.
The balance sheet as of June 30, 2001 and September 30, 2000, reflects the
consolidated financial position of the Company and its subsidiaries
(Subsidiaries) as follows: UltraCard, Inc. (UltraCard); cQue Corporation
(formerly Centurion Technologies, Inc.); CTI Acquisition Corporation (CTI);
Global CyberSystems, Inc. (Global); EforNet Corporation (EforNet); Global
Cybersystems SA. (GCSA) and Global Cybersystems PLC (GCPLC). The statements of
operations and cash flows for the nine months ended June 30, 2001 and 2000
include the consolidated results of the Company and its Subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. Minority interest represents the minority stockholders'
proportionate share in the equity of the Company's consolidated Subsidiaries.
The losses incurred by a subsidiary are allocated on a proportionate basis to
minority interest until the carrying amount of minority interest is eliminated.
Further losses are then included in the net loss of the Company.
9
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001 and 2000
NOTE C - LOSS PER COMMON SHARE
Basic loss per share is computed by dividing the net loss by the weighted
average number of common shares outstanding during the period. The weighted
average number of shares outstanding was 21,829,283 and 18,323,267 for the nine
months ended June 30, 2001 and 2000, respectively, 23,610,401 and 19,324,375
for the three months ended June 30, 2001 and 2000, respectively and 12,481,773
since inception (February 5, 1997) through June 30, 2001. Diluted loss per
share for all periods presented equaled basic loss per share due to antidilutive
effect of the potentially issueable common stock equivalents. As of June 30,
2001, total warrants and options of 6,115,959 were not included in loss per
share computations due to the antidilutive effect.
NOTE D - MANAGEMENT PLANS
The Company is a development stage enterprise as defined under Statement of
Financial Accounting Standards No. 7. The Company is devoting its present
efforts into establishing a new business in the information technology industry
and, is currently in the process of identifying markets and establishing
applications for its technologies. The process of commercialization of the
Company's core technology is focused upon the development of that core
technology, the UltraCard and read/write device. In addition, the Company is in
the process of acquiring strategically aligned businesses to facilitate certain
applications of the Company's core technology. To date, no operating revenues
have been generated. The Company's operations to date have consumed substantial
and increasing amounts of cash. The Company's negative cash flow from
operations is expected to continue and to accelerate in the foreseeable future.
The development of the Company's technology and potential products will continue
to require a commitment of substantial funds. The Company expects that its
existing and expected financings will be adequate to satisfy the requirements of
its current and planned operations until the end of fiscal year 2001.
However, the rate at which the Company expends its resources is variable, may be
accelerated, and will depend on many factors. The Company will need to raise
substantial additional capital to fund its operations and may seek such
additional funding through public or private equity or debt financing. There can
be no assurance that such additional funding will be available on acceptable
terms, if at all. The Company's continued existence as a going concern is
ultimately dependent upon its ability to secure additional funding for
completing and marketing its technology and the success of its future
operations.
During the three months ended June 30, 2001, the Company completed the
following debt and equity transactions:
During March and April 2001, the Company completed the issuance of convertible
debentures aggregating $825,500, bearing interest at a rate of 8% per annum and
convertible into the common stock of the Company at a conversion ratio of $1.25
per share. The convertible debentures are due October 15, 2001. During the
period debentures aggregating $102,500 had been converted into common stock.
10
During April 2001, the Company completed a private placement of common stock
aggregating $780,000 at a price of $2.00 per share. In addition UltraCard Inc.
received proceeds pursuant to a subscription agreement aggregating $175,000 for
the sale of common stock at a price of $7.00 per share.
During the month of June 2001, the Company borrowed a further $450,000 from
existing shareholders pursuant to certain 30 day note agreements. Interest and
penalties are required under the terms of the notes payable every 30 days
comprised of 10% interest, 10% payable in share capital and warrants equal to
32.5% of the loan value at a current market strike price. In addition, as a cost
of the financing, the Company granted a $50,000 note payable, 50,000 shares, and
warrants entitling the holder to purchase 162,500 shares of common stock at
$2.00 per share. The warrants are exercisable immediately and expire five years
from the date of grant.
During June 2001, the Company completed a further issuance of convertible
debentures aggregating $239,685, bearing interest at a rate of 8% per annum and
convertible into the common stock of the Company at a conversion ratio of $1.50
per share. The convertible debentures are due October 15, 2001.
During the quarter ended June 30, 2001, additional bridge loans aggregating
$354,675 were provided to the Company by shareholders, resulting in aggregate
bridge loans of $436,859. These bridge loans are to be settled through the
issuance of common stock, on terms to be determined.
In May and June 2001, the Company issued 29,433 and 115,606 shares of its common
stock at $1.00 and $1.73 per share upon conversion of debentures.
Subsequent to the period end the Company borrowed a further $1.1 million from a
related party. The loan is subject to 10% interest along with convertibility
provisions to common stock of the Company on terms to be determined.
The Company is actively pursuing new investment into the Company. This
financing may take the form of equity, convertible debentures and other types of
debt.
NOTE E - ACQUISITIONS
On September 8, 2000 the Company signed an Agreement and Plan of Reorganization
("Agreement") to acquire 100% of The Pathways Group, Inc. The Company loaned
operating capital to Pathways during the course of the acquisition transaction.
On February 15, 2001 the Company delivered notice to The Pathways Group, Inc.
terminating the merger agreement between the two companies. The balance of funds
loaned to Pathways by the Company in the amount of approximately $3.4 million is
collateralized by a blanket assignment over the Pathways assets. The Company is
in the process of filing a claim for the recovery of the amounts loaned to
Pathways. However, as of June 30,2001, the Company set up an allowance to offset
advances due from Pathways due to the potential that the funds advanced may not
be recoverable.
On December 11, 2000 the Company entered into a letter of intent for the
acquisition of a majority position in entertainment distribution technology
developer Rockster, Inc. Under the terms of the agreement, Upgrade will acquire
an ownership interest of 57 percent of Rockster from the Company. The Companies
are working towards the development of a definitive agreement. To date the
Company has non-secured advances aggregating $950,000 to Rockster. The Company
believes the advances will be recovered through the acquisition.
11
NOTE F - COMMITMENTS
In the prior fiscal year, a subsidiary of the Company entered into an agreement
with SciVac, Inc. to build a sputtering machine as a part of its research and
development activities for an amount of $3,000,000. As of June 30, 2001, the
subsidiary had paid $1,200,000 and recorded a liability for the amounts billed
but unpaid as of June 30, 2001 equaling $1,800,000. The sputtering machine is
expected to be sold within the next fiscal year to a contract manufacturer to
facilitate the production of shims used in the UltraCard. The sputtering machine
is reflected as a current asset on the balance sheet of the Company.
In the prior period the Company reported the lease of a new facility in Los
Angeles. The Company has expended $125,000 during the recent quarter ended June
30, 2001, on leasehold improvements towards the completion of the facility.
Currently Rockster Inc. is occupying the premises.
On October 10, 1997, Ultracard licensed the rights to two technology patents
from Cardtech, Inc. (Cardtech). Ultracard's president is also the controlling
stockholder of Cardtech. Ultracard is required to pay Cardtech a minimum royalty
fee of $650,000. Royalty fees are due on January 1 of each calender year. As of
March 31, 2001, $1,300,000 for both the calendar year 2000 and 2001 royalty fees
remained unpaid, causing Ultracard to be past due on the agreement. Cardtech has
deferred the required 2000 and 2001 payments to September 30, 2001. In
consideration for the deferral, Ultracard has granted a patent mortgage to
Cardtech on all its intellectual properties.
12
ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-QSB, including,
without limitation, statements containing the words "believes, " anticipates,"
"estimates," "expects," and words of similar import, constitute "forward looking
statements." You should not place undue reliance on these forward- looking
statements. Our actual results could differ materially from those anticipated
in these forward- looking statements for many reasons, including the risks faced
by us described in this Quarterly Report and in other documents we file with the
Securities and Exchange Commission.
Net losses aggregated $22.2 million in the first nine months of the current
fiscal year ending June 30, 2001 compared with an $11.8 million net loss for the
corresponding period of the prior fiscal year. This increase in net loss
reflects a continued and growing level of investment into the Companies
technology, production processes and the development of commercialization of the
Companies core technology. Research and development expenditures more than
doubled in the current fiscal year compared to the prior year, comprising a
large part of the increased expenditures as the Company nears the completion of
a production ready product.
In the preceding quarter the Company announced that it had terminated the merger
agreement with Pathways. Advances of $3.4 million dollars have been made to
Pathways by the Company as of June 30, 2001. The Company has collateralized the
amounts due from Pathways by way of a general security over the Pathways assets.
The collectability of the amounts due from Pathways are potentially
unrecoverable and accordingly the Company has provided an allowance for
collection of the amount due in the quarter ended June 30, 2001. The Company
plans to actively pursue collections.
The Company has been able to reduce its general and administrative costs by
$2.85 million compared to the corresponding 3-month period in the prior fiscal
year. This reduction is comprised of lower legal costs, and reduced
compensation components related to key employee warrant issuances. The Company
has experienced significantly higher interest expense as a result of debt
financing entered into during the current and past quarter. UltraCard Inc. has
again increased its research and development expenditures by $0.8 million over
the corresponding prior period in a concentrated effort to complete a
commercialized version of its high memory capacity UltraCard and read write
device. These increasing expenditures reflect the Company's focused efforts
upon completing its research and development initiatives, while at the same
time, establishing production processes and specifications to facilitate the
Company to engage others to produce the UltraCard and its read write device.
The other significant operating subsidiary cQue (formerly Centurion) contributed
only 6% of the total loss reflecting the focus of the consolidated groups
efforts to complete the UltraCard technology. For the near future research and
development expenditures are expected to increase to meet the Company's numerous
potential market opportunities. All of the Company's research and development
costs have been expensed as incurred.
In an effort to accelerate the Company's market penetration with the UltraCard
and related products, and in order to augment internally developed research and
development initiatives, the Company will license technology from other
businesses, engage others to develop components and/or acquire other businesses
as an alternative to internal research and development and marketing efforts.
The marketplace is beginning to recognize the UltraCard as a leader and superior
product in the smart card industry and management are focused upon accelerating
the Companies access to this multi-billion dollar marketplace.
Sales and marketing expenditures have increased by approximately $161,000 as
compared to the nine month period ended June 30, 2000, as the Company nears
completion of UltraCard's products. Sales and marketing expenditures are
13
associated with the Company's attendance at trade shows and industry awareness
programs as the Company builds market awareness to establish and develop new
markets and prepare for effective product launches for products which are
nearing the first phase of completion.
LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents were approximately $108,000 at June 30, 2001. The Company
is managing tight cash flows in providing funding for an aggressive research and
development program at UltraCard while developing acquisitions in the software
development area of business. Cash flows from financing activities of $ 11.4
million in the current period represents a 34 % increase in the capital raised
in the corresponding period of the preceding year. In light of the more
restrictive financial conditions at the current time this fact speaks well for
the Companies ability to manage and continue to grow through economic downturns.
The proceeds were used as to operations $8.4 million, with the balance of $ 3.2
million allocated to investing activities for acquisitions in process of
Rockster Inc. and the development of the UltraCard, Upgrade and Rockster
facilities.
The Company has experienced a significant increase in its current liabilities,
increasing from $6.5 million in September 2000 to $11.5 million as at June 30,
2001. The Company has relied upon trade creditors to extend payment terms, while
it aggressively pursues equity and debt capital from sources internationally. At
the date of this report, negotiations for the sale of additional debt and equity
securities in amounts in excess of $50 Million dollars are underway.
In order for the Company to meet the funding requirements from its investee
Companies and to meet ongoing operating requirements, it will have to raise
additional financing. The Company expects that its existing and planned capital
resources will be adequate to satisfy the requirements of the current and
planned operations until the end of the current fiscal year. However the rate at
which the Company expends its resources is variable, may be accelerated, and
will depend on many factors. The Company will need to raise substantial
additional capital to fund its operations and may seek such additional funding
through public or private equity or debt financing, or through the licensing of
its technology. There can be no assurance that such additional funding will be
available on acceptable terms, if at all. The Company's continued existence as
a going concern is ultimately dependent upon its ability to secure additional
funding for completing and marketing its technology and the success of its
future operations.
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PART II Other Information
Item 1. Legal Proceedings
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Upgrade, its president, Daniel S. Bland, and Chief Operating & Financial
Officer, Howard Jaffe, are defendants in The Pathways Group, Inc. v. Upgrade
-----------------------------------
International Corporation et al., Superior Court of the State of California in
----------------------------------
for the County of Sonoma. The complaint, filed August 3, 2001, alleges breach of
merger and collateral agreements between Upgrade and plaintiff, breach of oral
argument, fraud, and negligent material misrepresentation, and seeks specific
performance of the agreements, an injunction against exercising provisions
pursuant to the merger agreement whereby Upgrade could obtain control of
Pathways. Specifically, the complaint alleges that Upgrade failed to provide
interim financing to Pathways pending consummation of the proposed merger
transaction, and prevented Pathways from obtaining alternate sources of
financing. Upgrade believes that the plaintiff's allegations are without legal
or factual basis and intends to vigorously defend the lawsuit. Upgrade also
intends to file a counterclaim against Pathways, its Board of Directors and all
Executive Officers, for moneys due and owing from funds advanced, fraud in the
inducement as well as other misrepresentations made by Pathways to Upgrade. As a
result, upgrade recorded a provision for the advances made to Pathways in the
event those amounts prove to be uncollectible.
Item 2. Changes in Securities and Use of Proceeds
--------
During the three months ended June 30, 2001, the Company sold unregistered
securities as follows:
In April, 2001, Upgrade completed a private placement offering of 175,000
shares of its common stock at a price of $4.00 per share for total proceeds of
$700,000. The offer and sale of securities was made pursuant to an exemption
from registration under Regulation S of the Securities Act of 1933 (the "Act"),
due to the foreign nationality of the investor.
In April, 2001, Upgrade completed a private placement offering of 390,000
shares of its common stock at a price of $2.00 per share for total proceeds of
$780,000. The offer and sale of securities was made pursuant to an exemption
from registration under Regulation S of the Securities Act of 1933 (the "Act"),
due to the foreign nationality of the investors.
In April, 2001, Upgrade completed a private placement offering of 25,000
shares of its common stock at a price of $6.00 per share for total proceeds of
$150,000. The offer and sale of securities was made pursuant to an exemption
from registration under Regulation S of the Act, due to the foreign nationality
of the investor.
In April, 2001, Upgrade completed a private placement offering of 183,334
shares of its common stock at a price of $2.00 per share for total proceeds of
$366,668. The offer and sale of securities was made pursuant to an exemption
from registration under Regulation S of the Act, due to the foreign nationality
of the investor.
In April, 2001, Upgrade completed a private placement offering of 41,666
shares of its common stock at a price of $2.00 per share for total proceeds of
$83,332. The offer and sale of securities was made pursuant to an exemption from
registration under Regulation S of the Act, due to the foreign nationality of
the investor.
In April, 2001, Upgrade completed a private placement offering of 80,000
shares of its common stock at a price of $2.00 per share for total proceeds of
$160,000. The offer and sale of securities was made pursuant to an exemption
from registration under Regulation S of the Act, due to the foreign nationality
of the investor.
15
In April, 2001, Upgrade completed a private placement offering of 200,000
shares of its common stock at a price of $2.50 per share for total proceeds of
$500,000. The offer and sale of securities was made pursuant to an exemption
from registration under Regulation S of the Act, due to the foreign nationality
of the investor.
In April, 2001, Upgrade completed a private placement offering of 616,721
shares of its common stock at a price of $2.00 per share for total proceeds of
$1,233,442. The offer and sale of securities was made pursuant to an exemption
from registration under Regulation S of the Act, due to the foreign nationality
of the investor.
In April 2001, Upgrade issued a $825,500 convertible debenture that bears
8% simple interest and is due October 15, 2001. The debenture is convertible
into shares of Upgrade's common stock at $1.25. The issuance was exempt under
Rule 506 under and Section 4(2) of the Act.
In April, 2001, Upgrade completed a private placement offering of 80,000
shares of its common stock at a price of $2.50 per share for total proceeds of
$200,000. The offer and sale was exempt under Rule 506 under and Section 4(2) of
the Act.
In April, 2001, Upgrade completed a private placement offering of 205,000
shares of its common stock at a price of $2.00 per share for total proceeds of
$410,000. The offer and sale was exempt under Rule 506 under and Section 4(2) of
the Act.
In April, 2001, Upgrade completed a private placement offering of 375,000
shares of its common stock at a price of $2.00 per share for total proceeds of
$750,000. The offer and sale was exempt under Rule 506 under and Section 4(2) of
the Act.
In April, 2001, Upgrade issued 53,185 shares of its common stock for
services performed. The issuance was exempt under Rule 506 under and Section
4(2) of the Act and Regulation S of the Act due to the foreign nationality of
the investor.
In May, 2001, Upgrade issued 32,000 shares of its common stock at a price
of $1.25 per share pursuant to the conversion of debentures. The issuance was
exempt under Rule 506 under and Section 4(2) of the Act.
In May, 2001, Upgrade issued 40,000 shares of its common stock at a price
of $1.25 per share pursuant to the conversion of debentures. The issuance was
exempt under Rule 506 under and Section 4(2) of the Act.
In May, 2001, Upgrade issued 10,000 shares of its common stock at a price
of $1.25 per share pursuant to the conversion of debentures. The issuance was
exempt under Rule 506 under and Section 4(2) of the Act.
In May, 2001, Upgrade issued 29,433 shares of its common stock at a price
of $1.00 per share pursuant to the conversion of debentures. As reported in the
Company's Form 10-QSB for the period ended December 31, 2000, the issuance was
exempt under Rule 506 under and Section 4(2) of the Act.
In June, 2001, Upgrade issued 115,606 shares of its common stock at a price
of $1.74 per share pursuant to the conversion of debentures. As reported in the
Company's Form 10-QSB for the period ended December 31, 2000, the issuance was
exempt under Rule 506 under and Section 4(2) of the Act.
16
In June 2001, Upgrade issued a $239,685 convertible debenture that bears 8%
simple interest and is due October 15, 2001. The debenture is convertible into
shares of Upgrade's common stock at $1.50. The issuance was exempt under Rule
506 under and Section 4(2) of the Act.
In June, 2001, Upgrade issued 50,000 shares of its common stock for loan
fees. The issuance was exempt under Rule 506 under and Section 4(2) of the Act
and Regulation S of the Act due to the foreign nationality of the investor.
In June, 2001, Upgrade completed a private placement offering of 15,000
shares of its common stock at a price of $2.00 per share for total proceeds of
$30,000. The offer and sale of securities was made pursuant to an exemption from
registration under Regulation S of the Act, due to the foreign nationality of
the investor.
In June, 2001, Upgrade issued warrants to purchase 162,500 shares of its
common stock at $2.00 per share. The warrants are exercisable immediately and
expire five years from date of grant. The issuance was exempt under Regulation S
of the Act due to the foreign nationality of the investor.
In June, 2001, Upgrade issued 50,000 shares of its common stock for at
$2.70 a share for total proceeds of $135,000, in connection with the issuance of
a debenture. The issuance was exempt under Rule 506 under and Section 4(2) of
the Act and Regulation S of the Act due to the foreign nationality of the
investor.
In June, 2001, Upgrade issued 47,490 shares of its common stock for total
proceeds of $125,000 as part of a loan penalty fee. The issuance was exempt
under Rule 506 under and Section 4(2) of the Act and Regulation S of the Act due
to the foreign nationality of the investor.
In June, 2001, Upgrade issued 12,784 shares of its common stock at a price
of $1.74 per share pursuant to the conversion of debentures, for total proceeds
of $22,206. The issuance was exempt under Rule 506 under and Section 4(2) of the
Act and Regulation S of the Act due to the foreign nationality of the investor.
Item 6. Exhibits
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Exhibit No. Description
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Upgrade International Corporation
Date: August 19, 2001 /s/ Daniel Bland
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Daniel Bland, President and Chief
Executive Officer, and Secretary
Date: August 19, 2001 /s/ Howard A. Jaffe
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Howard A. Jaffe, Chief Operating and
Financial Officer
17