ITEM 1. BUSINESS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of a21, Inc. We may, from time to time, make written or oral statements that are "forward-looking," including statements contained in this Annual Report on Form 10-K, the documents incorporated herein by reference, and other filings with the Securities and Exchange Commission. These statements are based on management's current expectations, assumptions and projections about a21, Inc. and its industry and are made on the basis of management's views as of the time the statements are made. All statements, analyses and other information contained in this report relative to trends in sales, gross margin, anticipated expense levels and liquidity and capital resources, as well as other statements including, but not limited to, words such as "anticipate," "believe," "plan," "estimate," "expect," "seek," "intend" and other similar expressions, constitute forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict and that could cause our actual results to differ materially from our past performance and our current expectations, assumptions and projections. Differences may result from actions taken by the Company as well as from risks and uncertainties beyond the Company's control. Potential risks and uncertainties include, among others, those set forth herein under "Factors that may Affect the Business," as well as in Part II, Item 7, "Management's Discussion and Analysis or Plan of Operations." Except as required by law, the Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future developments or otherwise. Readers should carefully review the factors set forth in other reports or documents that the Company files from time to time with the Securities and Exchange Commission.
In this Annual Report on Form 10-K, "a21," "the Company," "we," "us," and "our" refer to a21, Inc. and its consolidated subsidiaries, unless the context otherwise dictates. The consolidated financial statements included herein include ArtSelect, Inc. from its respective acquisition date during 2006.
GENERAL DEVELOPMENT AND NARRATIVE DESCRIPTION OF THE BUSINESS
OVERVIEW
a21, Inc. was incorporated in the State of Texas in October 1998, under the name Saratoga Holdings I, Inc. In February 2004, we acquired SuperStock, Inc. (“SuperStock”). In October 2005, our UK subsidiary SuperStock Ltd. acquired Ingram Publishing Limited (“Ingram”) and in May 2006, we acquired ArtSelect, Inc. (“ArtSelect”). On July 31, 2006, we changed our state of incorporation from Texas to Delaware.
Through SuperStock, we aggregate visual content from photographers, photography agencies, archives, libraries and private collections and license the visual content to our customers. Our customer base consists of four major groups: creative (advertising and design agencies), editorial (publishing and media entities), corporate (in-house communications departments and outside corporate communications firms) and consumers (the general public). Our products are sold directly and through a global network of distributors. We provide subscription, CD-ROM and individual royalty free images as well as vector graphics and fonts, vehicle online templates, and print price guides for the worldwide graphics design, printing, sign making, advertising and publishing communities.
ArtSelect supplies home and office framed and unframed wall décor to retailers, catalogers, membership organizations and consumers through both online and traditional retail and wholesale distribution channels.
Page
BACKGROUND
OPERATIONS AND TECHNOLOGY
Through SuperStock and its subsidiary Ingram, we aggregate visual content from photographers, photography agencies, archives, libraries and private collections, and make such visual content available to creative professionals at advertising and design agencies, publishing and media entities, in-house communication departments and outside corporate communications firms, small and home office businesses, and the general public.
SuperStock’s Images are not typically sold but their reproduction and usage rights are licensed. Such licenses fall generally into two types - rights-managed and royalty-free. A rights-managed license is a limited license whereby the usage (i.e., a magazine advertisement or a billboard), term (either for one-time use or for a specified time) and venue (i.e., within the U.S. or Europe or globally) are fully defined. A royalty-free license is an unlimited license, whereby the image can be reused indefinitely for an unlimited time, as long as the license is not re-sold or transferred. Certain image rights are licensed on a subscription basis typically ranging from one-month to twelve-month terms.
The Internet and digital imaging technology allows an image that has been digitized to be seen worldwide and be reproduced and distributed indefinitely, at little or no additional cost. This has created significant opportunities for us to streamline our operations and to realize the benefits of economies of scale. On our website, images can be found, licenses transacted and product delivered via downloads.
Acquisition and distribution of SuperStock’s products is primarily performed digitally. Independent photographers and/or vendors deliver images to use either in digital form or on film, which we then digitize using our in-house scanning facilities. The image files are uploaded onto our online storage facility and are assigned various file names and information. Finally, they are assigned various metadata such as keywords and subject codes, enabling the search engine to find and display the images to our customers.
ArtSelect supplies home and office framed and unframed wall décor to retailers, catalogers, membership organizations and consumers through both online and traditional retail and wholesale distribution channels.
Through ArtSelect’s Private Label Site (PLS) program, ArtSelect creates for its customer-partners branded sub-domains on ArtSelect’s global website. ArtSelect assigns an ArtSelect URL specific to the customer-partner’s branded site. The customer-partner provides ArtSelect with its identifying graphic and ArtSelect prominently displays it on web pages throughout the customer-partner’s branded site. The customer-partner’s identifying graphic also serves as the link to the partner’s website. Limited customization of the customer-partner’s sub-domain is possible upon request.
ArtSelect’s drop-ship wholesale customer-partners offer specific ArtSelect wall décor stock-keeping units, or SKUs, on their websites. Drop-ship wholesale is not linked to a privately labeled sub-domain on the ArtSelect website. The customer-partner is responsible for all promotions, web development, transaction processing, and customer interactions.
Our operating subsidiaries each have a centralized and integrated technology platform as the foundation for website and back-office systems. These platforms enable our customers to search, select, license, transact payments and download our imagery. It also provides for centralized sales order, customer database, finance and accounting management systems. These systems cover many operational activities, from customer interaction and transaction processing, order fulfillment and invoicing, to photographer and vendor royalty reports and payments. Our technology platforms are primarily owned and operated by our operating subsidiaries.
Page
We upgrade our systems as the need and opportunity arises. We are dedicated to regularly upgrading our hardware and search engine to increase its speed and accuracy. We also routinely obtain additional online storage as our library of images continues to grow. Similarly, we continue to build new search and communication tools on our websites in order to improve its functionality and user-friendliness. We use a combination of software developed in house and third party service providers to support our operations.
PRODUCTS
SuperStock’s images are available for delivery to our customers through online downloads or on CD-ROM and may be viewed on our website. Certain of those images may also be viewed on our distributors’ websites. Customers typically search for images by using the search engine on our website. Given any number of input parameters, which include keywords, subject matter, product type and image number, the search engine returns the appropriate images for the customer to peruse and select. The search can then be refined or repeated with modified input parameters. An image search is usually an iterative process. Upon request and for no additional cost to the client, we make available the search capability of our in-house research team. SuperStock’s collection of contemporary photography forms the largest part of our library. It is a comprehensive offering of current and cutting-edge imagery in a wide variety of subjects, such as people and lifestyles, world travel and places, nature and wildlife, business and industry, sports and concepts. The bulk of SuperStock’s vintage collection consists of the Devaney Collection, which is comprised of commercial and advertising photography from the 1940’s through the 1960’s. SuperStock’s broad offering of fine art imagery ranges from prehistoric cave paintings to modern and contemporary pieces from living artists, many artistic movements throughout history, religious and cultural works, and photographs of antiques and artifacts.
ArtSelect sells custom framed art print reproductions on-line through its own website and through privately labeled sub-domains of its website. ArtSelect’s innovative, see it as you design it, “virtual frame-shop” functionality instantly shows shoppers how their finished framed art print would look under each of the selected pairings. Through ArtSelect’s private labeled sub-domains, catalogers and retailers offer their customers ArtSelect’s range of choice in wall décor in their own names, with no perception by their customers that they were not being served by the cataloger or retailer.
For SuperStock, pricing for each customer group varies depending upon product type, with rights-managed images generally selling at a higher price point than royalty-free images. Pricing of rights-managed licenses is determined by a number of factors. These factors are selected by our customers to suit their specific needs. Pricing for images procured through a rights-managed license currently range from approximately $300 for a quarter page editorial inside a magazine to over $10,000 for use in a major print advertising campaign. Pricing for images procured through a royalty-free license currently range from approximately $80 for a low-resolution image to approximately $450 for a high resolution, full-page image. Rights-managed image sales generally require more of the time of our support staff than royalty-free image sales, because of the time and effort required to negotiate and monitor the rights-managed licenses and because rights-managed licensors are often a higher level, more sophisticated customer. SuperStock’s subscription pricing model offers access to certain images for fees ranging from $150 to $600 depending on the term of the license.
For ArtSelect, pricing for each customer group varies depending upon the framed art product type including print, size, and materials. Framed art pieces sold by ArtSelect have an average price of approximately $160 per unit.
Page
CUSTOMERS
SuperStock serves a variety of customers in four major categories: creative (advertising and design agencies), editorial (publishing and media entities), corporate (in-house communications departments and outside corporate communications firms) and retail (the general public). These customer categories are not mutually exclusive. Due to the large number of our customers and their dispersion across many geographic areas, we are not dependent on a single customer or a few customers, the loss of which would have a material adverse effect on us. SuperStock supplies its creative customers with imagery that typically conveys a commercial or advertising message. SuperStock also supplies a variety of imagery for use in the publication of textbooks, magazines, newspapers and web portals where there is a need to illustrate the stories and editorials with imagery. Additionally, SuperStock supplies a variety of imagery for use in business and corporate communications, which may be included in brochures, annual reports, newsletters, websites, and multi-media presentations.
ArtSelect serves a variety of customer-partners who range from major market to mid-market e-tailers. These customer-partners value ArtSelect’s one-stop bundling of technology interface and framed art fulfillment. ArtSelect’s customer-partners are reasonably dispersed, but the loss of a large customer-partner could significantly reduce our revenues.
MARKETING
The SuperStock brand is a fundamental draw and market-positioning device. On occasion, we have been able to co-brand certain image-content products, services and marketing activities with those of certain vendors, especially vendors who have well established brand identities. On occasion, we have used the names of individual photographers, especially those with unique bodies of work or those who are well renowned, in our marketing activities. SuperStock reaches our customers and prospective customers through a variety of marketing activities, which include print advertising, direct mail, web mail and telemarketing. These activities are designed to create and reinforce brand awareness, drive traffic to our website, and advertise our latest products and services. We seek to build and reinforce our brand and promote our latest products and services through ongoing print advertising campaigns in a number of trade publications targeted to reach our professional customers. Direct mail forms are an integral part of SuperStock’s marketing efforts. Our direct mail campaigns consist of postcards, brochures and print catalogs and are designed to depict the most current styles and trends, incorporate our newest photography and appeal to the tastes and expectations of our customers.
ArtSelect typically deploys a targeted partner-customer approach intended to establish key relationships with the appropriate decision makers of its broad e-tailer market. This approach also includes valuable participation at the appropriate related trade industry events.
Our operating companies regularly send e-mails to current and prospective users and partners that contain invitations to visit various pages or features on our websites. Our ongoing effort to update our customer list is also an opportunity to build and reinforce the personal contacts that are critical in servicing our customer’s needs.
Page
SALES AND DISTRIBUTION
SuperStock’s licensing revenue is generated from its direct sales operations in certain markets including North America the UK, and also through revenue sharing arrangements with our distributors in global markets. ArtSelect sells custom framed art print reproductions on-line through its own website and through privately labeled sub-domains of its website. Through ArtSelect’s private labeled sub-domains, catalogers and retailers offer their customers ArtSelect’s range of choice in wall décor in their own names, with no perception by their customers that they are not being served by the cataloger or retailer itself.
SuperStock and ArtSelect’s sales and service staff consists of Account Executives, a Customer Service Group, a Research Team, and a Technical Support Group. Account Executives are assigned key accounts, typically high volume and regular customers, and are responsible for managing and building these relationships. Account Executives are also given the opportunity to prospect for new accounts. The Customer Service Group handles new customers and other inbound inquires. After we assess specific criteria, such as the frequency of its purchases, volume and types of purchases, a customer is typically assigned to an Account Executive for further development. The Research Team provides sales support to the Account Executives and Customer Service Group by completing online searches and image selections based on criteria provided by the client. We also employ a Technical Support Group that provides expertise in web, online and digital imagery applications and assists our customers in using our products.
SuperStock’s imagery is licensed to customers worldwide through its international distribution network. The use of our brand name, licensing rights to the imagery, access to various tools on our website and the provision of digital files are granted under license and revenue sharing arrangements. The appointment of local distributors in various global markets allows us to realize revenue opportunities without building operational infrastructure in different languages, cultures, legal systems and currencies.
INTELLECTUAL PROPERTY
Other than a portion of our library that is fully owned by SuperStock, the copyright to the images that we sell belongs to the independent photographer or company that grants us their licensing and distribution rights. We recognize copyright protection as an invaluable asset and have implemented an outreach process to alert us to unauthorized use of our images. When discovered, the user is notified of the copyright laws and requested to comply by remitting payment. If this action does not result in copyright enforcement, legal action may be pursued.
COMPETITION
The market for visual content is highly competitive, and we expect such competition to continue in the future. We have observed that the main competitive factors include quality of images, branding, reputation, service, breadth and depth of content, content provider associations, customer associations, technology, pricing, and sales and marketing. In addition, accessibility and timeliness of service are important competitive factors.
SuperStock’s current competitors include other general visual content providers such as Getty Images, Corbis, Jupitermedia, Masterfile, Punchstock, Index Stock and dozens of smaller stock photography agencies and image content aggregators throughout the world. Many of our competitors are larger than us and have substantially greater financial, technical, and marketing resources than we do.
The market for selling custom framed art print reproductions online is also highly competitive, and we expect such competition to continue in the future. We believe that the main competitive factors include quality of art content, ease of use and functionality of e-commerce offerings, breadth and depth of art content, customer-partner associations, technology, pricing, and sales and marketing. ArtSelect’s current competitors include other providers of online framed art such as Art.com.
Page
EMPLOYEES
As of December 31, 2007, we had a total of approximately 150 employees, with the majority as full-time employees. We believe our relationship with our employees is good. We have not experienced any labor stoppages. None of our employees is covered by collective bargaining agreements, although UK based employees are subject to statutory requirements as governed by UK law.
FINANCIAL INFORMATION ABOUT SEGMENTS AND GEOGRAPHIC AREAS
We operate by Corporate, SuperStock, and ArtSelect segments. Our revenue is generated through a diverse customer base, and there is no reliance on a single customer or small group of customers; no customer represented 10% or more of our total revenue in the periods presented in this Annual Report on Form 10-K. The geographic information required herein is contained in Notes to our Consolidated Financial Statements and is incorporated by reference herein.
ITEM 1A.
ITEM 1A. RISK FACTORS
As a smaller reporting company, we are not required to include this information in our annual report on Form 10-K.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
As a smaller reporting company, we are not required to include this information in our annual report on Form 10-K.
ITEM 2.
ITEM 2. PROPERTIES
In April 2004, SuperStock contracted with an institutional buyer to sell the approximately 73,000 square foot building in Jacksonville, Florida in which our headquarters is located. This transaction closed in June 2004 and SuperStock received $7.5 million and a closing credit for SuperStock’s benefit of $180,000. SuperStock also entered into a long term lease of the premises with the buyer. With the proceeds of the sale, we repaid the then outstanding mortgage of approximately $4.0 million, repaid an approximately $1.6 million note issued by us in connection with the acquisition of SuperStock, and used the balance as working capital for operations and acquisitions. In September 2004, SuperStock entered into a sublease agreement with Vurv (formerly Recruitmax Software, Inc.) under which SuperStock subleased to Vurv approximately 25,000 square feet with subsequent increases to bring the total to approximately 40,000 square feet of the premises. The remaining sub-lease payments to SuperStock will range from $56,000 to $62,000 per month. The sublease terminates on October 31, 2010, subject to Vurv’s renewal option.
SuperStock operates a small leased office in London to support our combined UK SuperStock Ltd. sales and product operations.
ArtSelect operates two locations in Fairfield, Iowa; a small leased office to support ArtSelect operations, and also an extended 24,000 square foot mixed use space for its framing operation, for which it pays approximately $10,900 per month through December 2009.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various claims and lawsuits in the ordinary course of business. Management believes that there are no such matters outstanding that would have a material adverse effect on the Company's results of operations and financial position.
Page
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 1, 2007, a proxy notification was sent to shareholders giving notice to the Annual Meeting of the Shareholders to be held on November 13, 2008 at the offices of the Company. The meeting was called for the primary purpose of electing a board of directors to serve until the next Annual Meeting or until their successors are elected and shall qualify. Upon that date, shareholders representing a quorum of our outstanding shares of common stock elected John Z. Ferguson, Laura B. Sachar, and John O. Hallberg as directors.
Page
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION
Since September 2003, our common stock has traded on the OTC Bulletin Board under the symbol “ATWO”.
The following table sets forth for the quarterly periods indicated the high and low bid prices of our common stock as reported on the OTC Bulletin Board. The bid prices reflect inter-dealer prices, without retail mark-up, markdown or commission and may not represent actual transactions.
HOLDERS
There were approximately 2,000 holders of record of our common stock on December 31, 2007.
DIVIDENDS
We have not paid or declared any dividends on our common stock since our inception. Our Board of Directors does not expect to declare cash dividends on our common stock in the near future. We anticipate that we will retain our future earnings to finance the continuing development of our business.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
Page
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
As a smaller reporting company, we are not required to include this information in our annual report on Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following should be read in conjunction with our Consolidated Financial Statements and the notes thereto included in "Item 8. Financial Statements."
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. (“GAAP”) requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Following are accounting policies that we believe are most important to the portrayal of our financial condition and results of operations and that require our most difficult judgments as a result of the need to make estimates and assumptions about the effects of matters that are inherently uncertain.
Goodwill
Goodwill is the excess of the purchase price and related costs over the fair value of net assets acquired in business combinations. Goodwill is tested for impairment annually effective October 1. When assessing impairment, we apply the implied fair value based on a market capitalization value model. As circumstances change, it is possible that future goodwill impairment tests could result in a loss on impairment of assets, which would be included in the determination of income from operations. At October 1, 2007, the implied fair value of our goodwill significantly exceeded its carrying value, therefore goodwill was not impaired.
Estimated Useful Lives of Certain Long-Lived Assets
The estimated useful lives of our most significant property and equipment and identifiable intangible assets are discussed in the footnotes to our consolidated financial statements. Should we determine at some point in the future that the useful lives of these assets are shorter than estimated; it is possible that we would be required to accelerate the amortization, or write off an impaired portion, of these assets.
Page
PHOTO COLLECTION AND PHOTOGRAPHER CONTRACTS
The estimated useful lives of our photo collection and photographer contracts are determined based on the estimated number of years over which they generate the majority of their revenue. Periodically, we perform analyses of the photo collection and photographer contracts. With respect to periodic analysis, historical revenue may not be indicative of future revenue, and therefore, these estimated useful lives are inherently uncertain.
IDENTIFIABLE INTANGIBLE ASSETS
Identifiable intangible assets are assets that do not have physical representation, but that arise from contractual or other legal rights or are capable of being separated or divided from us and sold, transferred, licensed, rented, or exchanged. Identifiable intangible assets are generally valued based on discounted future cash flows that we estimate will be generated by the assets and are amortized on a straight-line basis over their estimated useful lives. Identifiable intangible assets are reviewed for impairment and the appropriateness of these assets’ estimated useful lives are reviewed whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. Impairment exists when the carrying value of the asset is not recoverable and exceeds its fair value.
The net book value of our identifiable intangible assets at December 31, 2007, consisted substantially of customer relationships, license agreements, software, and non-compete covenants. We evaluate the remaining useful lives of our identifiable intangible assets each reporting period to determine whether events and circumstances warrant revisions to the remaining periods of amortization. No revisions were determined to be necessary during the periods presented.
The estimated useful lives of identifiable intangible assets are generally based on contractual or other legal terms, our plans for use of the assets and the cost and difficulty of renewing the lives of the assets. The useful lives of these assets may change or terminate prior to their contractual lives due to changes in operating plans, brand strategy, acquisition or disposition of businesses and legal action, among other circumstances.
Page
RESULTS OF OPERATIONS 2007 COMPARED TO 2006
LICENSING REVENUES. Licensing revenues were $11.9 million for 2007, compared to $12.0 million for 2006.
PRODUCT REVENUES. Product revenues were $11.4 million for 2007, compared to $7.7 million for 2006. The increase was attributable to the inclusion of the full year period for ArtSelect during 2007 compared to 2006 due to our acquisition of ArtSelect which occurred on May 15, 2006. On an organic basis, product revenues were nominally lower.
COST OF LICENSING REVENUE. Cost of licensing revenue was $3.8 million for 2007 and 2006. As a percentage of licensing revenues, cost of licensing sales was 32% for 2007and 2006, respectively. Cost of licensing sales as a percentage of licensing revenues may vary in any period depending on SuperStock’s relative mix of stock photography distributed that is either licensed from third parties or owned by us.
COST OF PRODUCT REVENUE. Cost of product revenue was $5.7 million for 2007, compared to $3.6 million for 2006. Nearly all of the increase was attributable to the effect of ArtSelect for the full year compared to the prior year due to our acquisition which occurred on May 15, 2006. As a percentage of product revenues, cost of product sales was 50% and 47% for 2007 and 2006, respectively. The increase in the cost of product sales percentage reflects the weighted impact of certain higher cost for ArtSelect’s raw materials including prints, mats, frames, molding, and packaging material as well as shipping and handling costs. In addition, ArtSelect incurred higher transition production costs due to integration of previously out-sourced framing operations.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses were $13.9 million for 2007, compared to $15.0 million for 2006. The decrease in SG&A expenses was primarily attributable to an increase of $1.8 million for the full year for ArtSelect, offset by a reduction of $2.9 million in organic reductions for SuperStock and a21, including reductions primarily in personnel costs, including share-based compensation, and professional fees.
RESTRUCTURE COSTS. Restructure costs were $426,000 for 2007, and were primarily attributable to severance expense resulting from staff reductions of a net total of 18 positions at both ArtSelect and SuperStock.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization was $2.5 million for 2007, compared to $3.0 million for 2006. The decrease was primarily attributable to lower amortization resulting from an impairment charge recorded during the three months ended December 31, 2006, against the intangible assets related to the SuperStock Limited subsidiary, offset by incremental depreciation and amortization expense resulting from the acquisition of ArtSelect.
INTANGIBLE ASSET IMPAIRMENT. During our annual impairment assessment for 2006, we evaluated and tested the carrying value of the Ingram intangible assets with definite lives. As a result of that testing, we have concluded that impairment existed and recorded an impairment charge totaling $1.7 million consisting of $1.3 million and $360,000 for the Ingram license agreements and Ingram non-compete agreements, respectively, for 2006.
INTEREST EXPENSE. Interest expense was $1.8 million for 2007, compared to $1.7 million for 2006 reflecting the relative outstanding debt during 2007 and 2006.
Page
OTHER INCOME, NET. Other income, net was $211,000 for 2007, compared to other income, net of $265,000 for 2006. The other income, net of $211,000 for 2007 was primarily comprised of interest income of $139,000 and cumulative translation adjustment of $71,000 during 2007.
NET LOSS ATTRIBUTED TO COMMON STOCKHOLDERS. Net loss attributed to common stockholders improved to $4.7 million or $0.05 per share, for 2007, compared to net loss of $9.6 million, or $0.12 per share, for 2006. There were approximately 8.2 million more weighted average shares outstanding during 2007 as compared to 2006.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2007, we had $2.1 million of cash and cash equivalents and working capital of $1.5 million, compared to $5.5 million in cash and cash equivalents and working capital of $4.3 million at December 31, 2006. The decrease in cash is primarily due cash used in operations and IT-related investments made during 2007.
Net cash used in operating activities for 2007 was $1.8 million, compared to net cash used in operating activities of $2.8 million for 2006. The net cash used in operating activities during 2007, was lower primarily due to the net loss of $4.7 million adjusted by $2.5 million for depreciation and amortization and $554,000 for non-cash share-based compensation. The net cash used in operating activities during 2006 was primarily due to the net loss of $9.1 million, reduced by $3.0 million for depreciation and amortization, $1.7 million for impairment of intangible assets, $1.1 million for stock based compensation, and an increase in accounts payable and accrued expenses of $1.1 million, and offset by an increase in prepaid expenses and other current assets of $272,000 and an increase in accounts receivable of $449,000. The increase in accounts payable and accrued expenses was largely due to an increase in trade payables and increased accruals for audit fees, legal fees, compensation, and services. Accounts receivable increased largely due to higher SuperStock and ArtSelect trade receivables.
Net cash used in investing activities for 2007, was $1.6 million, compared to net cash used in investing activities for 2006 of $6.4 million. Net cash used in investing activities for 2007, was primarily due to an $765,000 investment in software development, a $349,000 investment in SuperStock’s photo collection, and a $285,000 payment relating to the SuperStock acquisition earn-out payment. Net cash used in investing activities for 2006 was primarily due to $4.5 million used as partial consideration for the ArtSelect acquisition, $750,000 used to secure a letter of credit issued in satisfaction of a lease security deposit, additions to property, plant and equipment of $248,000, investment in technology of $281,000 and investment in the photo collections of $333,000.
Net cash provided by financing activities for 2007, was $26,000, compared to net cash provided by financing activities of $13.4 million for 2006. Net cash provided by financing activities for 2006 resulted substantially from the $15.3 million April 2006 senior convertible debt financing described below, offset by repayments of $3.3 million of outstanding debt. In addition, we realized proceeds of $1.2 million during 2006 upon the exercise of stock warrants.
During April 2006, we entered into a securities purchase agreement with certain purchasers and Queequeg Partners, L.P., as agent, whereby we issued $15.5 million of 5% Senior Secured Convertible Notes (“Senior Convertible Notes”). The Senior Convertible Notes are secured by substantially all of our assets and are convertible into 23,846,149 of a21’s common stock at a minimum conversion price of $0.65 per share, subject to adjustment as provided in the Senior Convertible Notes. The interest on the Senior Convertible Notes is payable quarterly in arrears, and the principal will be due and payable on March 31, 2011. If the 45-day volume weighted average price of a21’s common stock equals or exceeds $1 per share, the Senior Convertible Notes will automatically be converted into a21’s common stock under certain conditions. The Senior Convertible Notes include customary events of default, such as the failure to pay any principal or interest when due, the breach of any covenant or term or condition of the Senior Convertible Notes, the breach of any representation or warranty in the Purchase Agreement, Senior Convertible Notes or other documents executed in connection with the transactions contemplated thereby.
Page
On January 31, 2008, we entered into a waiver agreement with the holders of a majority of the outstanding principal amount of the Secured Convertible Notes, to waive cash quarterly interest payments until March 31, 2008. Instead of paying in cash, the agreement provides that we will settle quarterly interest payments due in January and April 2008 with new notes in the aggregate principal amount equal to the interest due, having substantially the same terms as the original notes. We will resume paying quarterly interest in cash beginning with the quarterly interest due in July 2008.
Our future plans include further developing our distribution channels for SuperStock while improving the leveraging of SuperStock’s owned and licensed image content, introducing new products and customer channels in the stock photography space, gaining new key customer relationships for ArtSelect while introducing new products and customer channels, and seeking integration cost reduction opportunities where feasible across the Company. In addition, we continue to review potential acquisition targets that, if successful, could result in an enhanced market position and incremental cash flow from operations. However, there can be no assurance that these efforts will be successful. We may have to seek additional funding sooner than expected. There can be no assurance that sufficient additional capital needed to sustain operations will be obtained by us, if needed, or that our operations will become profitable.
We have sustained significant recurring losses and an accumulated deficit of $28.0 million at December 31, 2007, that raise substantial doubt about our ability to continue as a going concern, and may need to raise cash from equity and debt financings to fund our operations. If we are unable to secure the required funding, we may not be able to implement our business plan and may not be able to conduct business as a going concern.
OFF BALANCE SHEET ARRANGEMENTS
We do not currently have any off balance sheet arrangements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, we are not required to include this information in our annual report on Form 10-K
.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
See the consolidated financial statements beginning on page 21.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of December 31, 2007. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2007, these disclosure controls and procedures were effective.
Management’s Annual Report on Internal Control Over Financial Reporting. See Management’s Report on Internal Control Over Financial Reporting on page 22 of this Annual Report on Form 10-K. This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Controls. No change in our internal controls over financial reporting occurred during the fourth quarter of our fiscal year ended December 31, 2007, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
Page
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to this Item is incorporated herein by reference to the Company’s Proxy Statement for its Annual Meeting of Stockholders to be held in 2008. We have adopted a Code of Business Conduct and Ethics (the “Code”) that applies to our directors, officers and employees, including our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial and accounting officer, respectively). The Code is incorporated by reference as Exhibit 14 to this Form 10-K. A written copy of the Code will be provided upon request at no charge by writing to our Chief Financial Officer, 7660 Centurion Parkway, Jacksonville, Florida 32256.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this Item is incorporated herein by reference to the Company’s Proxy Statement for its Annual Meeting of Stockholders to be held in 2008.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information with respect to this Item is incorporated herein by reference to the Company’s Proxy Statement for its Annual Meeting of Stockholders to be held in 2008.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this Item is incorporated herein by reference to the Company’s Proxy Statement for its Annual Meeting of Stockholders to be held in 2008.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information with respect to this Item is incorporated herein by reference to the Company’s Proxy Statement for its Annual Meeting of Stockholders to be held in 2008.
Page
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
EXHIBITS
Page
* Management contract or compensatory plan or arrangement.
(1)
Incorporated herein by reference to Appendix D of the Registrant’s Definitive Information Statement on Schedule 14C, filed on July 11, 2006.
(2)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on August 4, 2006.
(3)
Incorporated herein by reference to the Registrant’s Registration Statement on Form S-8, filed on April 25, 2002.
(4)
Incorporated herein by reference to the Registrant’s Registration Statement on Form S-8, filed on July 18, 2002.
(5)
Incorporated herein by reference to the Registrant’s Annual Report on Form 10-KSB, filed on April 14, 2004.
(6)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on July 14, 2004.
(7)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on October 25, 2005.
(8)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on November 23, 2005.
(9)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K/A, filed on December 27, 2005
(10)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on January 9, 2006.
Page
(11)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on June 30, 2005.
(12)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on May 3, 2006.
(13)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on May 19, 2006.
(14)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on October 10, 2006.
(15)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K, filed on January 11, 2007.
(16)
Incorporated herein by reference to Exhibit A of the Registrant’s Definitive Information Statement on Schedule 14C, filed on February 16, 2006.
(17)
Incorporated herein by reference to the Registrant’s Registration Statement on Form S-8, filed on February 14, 2007.
(18)
Incorporated herein by reference to the Registrant’s Current Report on Form 8-K dated February 6, 2008.
Page
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.
March 28,
a21, Inc.
By: /s/ John Z. Ferguson
John Z. Ferguson
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Thomas Costanza
Thomas Costanza
(Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE
TITLE (CAPACITY)
Date
/s/John Z. Ferguson
Chief Executive Officer
March 28, 2008
John Z. Ferguson
(Principal Executive Officer), and Director
/s/ Thomas Costanza
Vice President, Chief Financial Officer
March 28, 2008
Thomas Costanza
(Principal Financial Officer)
/s/ John O. Hallberg
Director
March 28, 2008
John O. Hallberg
/s/Laura B. Sachar
Director
March 28, 2008
Laura B. Sachar
Page
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
a21, Inc. and Subsidiaries
Jacksonville, Florida
We have audited the accompanying consolidated balance sheets of a21, Inc. and Subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, changes in stockholders’ equity (capital deficit), and cash flows for each of the two years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of a21, Inc. and Subsidiaries at December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note B[1] to the consolidated financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note B[1]. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
West Palm Beach, Florida
/s/ BDO Seidman, LLP
March 28, 2008
Certified Public Accountants
Page
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of a21 Inc. and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Internal control over financial reporting, no matter how well designed, has inherent limitations. Therefore, internal controls over financial reporting determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, it used the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management’s assessment included an evaluation of the design of the Company’s internal controls over financial reporting and testing of the operational effectiveness of its internal controls over financial reporting.
Based on our assessment, management has determined that, as of December 31, 2007, the Company maintained effective internal control over financial reporting.
By: /s/ JOHN Z. FERGUSON
----------------------------------
John Z. Ferguson
Chief Executive Officer
(Principal Executive Officer)
By: /s/ THOMAS COSTANZA
----------------------------------
Thomas Costanza
Chief Financial Officer
(Principal Financial Officer)
Dated: March 28, 2008
Page
Page
Page
Page
Page
Page
Page
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - FINANCIAL STATEMENT PRESENTATION AND THE DESCRIPTION OF BUSINESS
a21, Inc. (the “Company”) was incorporated in the State of Texas in October 1998, under the name Saratoga Holdings I, Inc. In April 2002, we changed our name from Saratoga Holdings I, Inc. to a21, Inc. In February 2004, we completed the acquisition of all of the voting common stock, representing 83% of the outstanding equity, of SuperStock, Inc. In October 2005, our UK subsidiary SuperStock Ltd. completed the acquisition of all of the outstanding stock of Ingram Publishing Limited, and in May 2006, we completed the acquisition of ArtSelect, Inc. through the merger of a wholly owned subsidiary into ArtSelect. On July 31, 2006, we changed our state of incorporation from Texas to Delaware.
Through SuperStock, we aggregate visual content from photographers, photography agencies, archives, libraries and private collections and license the visual content to our customer base consisting of four major groups: creative (advertising and design agencies), editorial (publishing and media entities), corporate (in-house communications departments and outside corporate communications firms) and consumers (the general public). SuperStock products are sold directly and through a global network of distributors.
ArtSelect supplies home and office framed and unframed wall décor to retailers, catalogers, membership organizations and consumers through both online and traditional retail and wholesale distribution channels in the United States.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
[1] Basis of presentation/Going concern:
The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. We have sustained significant recurring losses and an accumulated deficit of $28.0 million that raise substantial doubt about our ability to continue as a going concern, and may need to raise cash from equity or debt financings to fund our operations. However, there can be no assurance that sufficient additional capital needed to sustain operations will be obtained by us, if needed. If we are unable to secure the required funding, we may not be able to implement our business plan and may not be able to conduct business as a going concern. In an effort to improve our operational efficiency, on September 12, 2007, we consolidated the support positions at ArtSelect from Fairfield, Iowa, into the Company’s Jacksonville, Florida headquarters. In addition, SuperStock, Inc. was reorganized to support the Company’s growth initiatives. The restructure resulted in a net reduction of 18 positions (see Note N[4]). Finally, on January 31, 2008, we entered into a waiver agreement with the holders of a majority of the outstanding principal amount of the Secured Convertible Notes, to waive quarterly cash interest payments until March 31, 2008 (see Note O). No assurances can be given that these changes will result in the expected improvements. At December 31, 2007, we have cash of $2.1 million and working capital of $1.5 million.
Our future plans include further developing our distribution channels for SuperStock while improving the leveraging of SuperStock’s owned and licensed image content, introducing new products and customer channels in the stock photography space, gaining new key customer relationships for ArtSelect while introducing new products and customer channels, and seeking integration cost reduction opportunities where feasible across the Company. In addition, we continue to review potential acquisition targets that, if successful, could result in an enhanced market position and incremental cash flow from operations. However, there can be no assurance that these efforts will be successful or that our operations will become profitable.
Page
[2] Principles of consolidation:
The consolidated financial statements include all of our accounts including our primary operating subsidiaries, SuperStock and ArtSelect (acquired May 2006). The minority interest in the consolidated balance sheets at December 31, 2007 and 2006, represents the interest of the holders of preferred shares of SuperStock (“SuperStock Seller Preferred”), which are exchangeable into a21 common shares. All significant inter-company balances and transactions have been eliminated.
[3] Revenue recognition:
Revenue is recognized when the following criteria are met: evidence of an arrangement exists, the price is fixed or determinable, collectibility is reasonably assured and delivery has occurred or services have been rendered.
Licensing fee revenue is recorded at invoiced amounts except in the case of licensing rights through distributors, where revenue is recorded at our share of invoiced amounts. Distributors typically earn and retain a percentage of the license fee according to their contract, and we record the remaining license fee as revenue. Persuasive evidence of an arrangement exists and the price is fixed or determinable at the time the customer agrees to the terms and conditions of the license agreement. We maintain a credit department and credit policies that set credit limits and ascertain customer credit worthiness, thus reducing our risk of credit loss. Based on our policies and procedures, as well as our historical experience, we are able to determine that the likelihood of collection is reasonably assured prior to recognizing revenue. These first three general revenue recognition criteria have been met at or prior to the time of delivery of the imagery, regardless of the format or delivery medium. Delivery occurs upon making digital images available for download by the customer, or upon shipment of CD, analog film and transparencies. We also sell subscriptions of certain images for terms ranging from one to twelve months. Subscription revenue is recognized over the respective term of the subscription agreement and, accordingly, $389,000 and $242,000 is recorded as deferred revenue as of December 31, 2007 and 2006.
Revenue from product sales is recognized when the product is shipped and title is transferred to the customer. Revenue from sales via ArtSelect’s website and/or related sub-domains is recognized on a gross basis. Revenue from sales through customers’ distribution channels is recognized net of related costs. We base our estimates for sales returns on historical experience.
[4] Cost of revenue:
Cost of licensing fee revenue reflects royalties on revenue generated from images licensed under contracts with photographers. Royalties are expensed in the period that they are incurred. Cost of revenue excludes amortization of revenue generating assets. Cost of product sales reflects payments made to suppliers of art content, framing materials, and shipment and handling costs.
[5] Use of estimates:
The preparation of financial statements in conformity with accounting principles generally accepted 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 revenue and expenses during the reporting period. Actual results could differ significantly from those estimates. The recoverability of the carrying values of goodwill and long-lived assets, including goodwill and identifiable intangible assets represent sensitive estimates subject to change.
Page
[6] Fair value of financial instruments:
Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, and short-term debt, which approximate fair value because of their short maturities. The carrying amount of long-term debt approximates fair value due to the market rate of interest incurred by us. The fair value of our notes payable to stockholders and an affiliated company are not reasonably determinable based on the related party nature of the transactions.
[7] Cash, cash equivalents and restricted cash:
We consider all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 2007 and 2006, we had no investments with maturities greater than three months. We are required to maintain a security deposit in accordance with our lease agreement for the SuperStock facility. This consists of restricted cash funded by us to secure a letter of credit in the amount of $750,000 at December 31, 2007 and 2006.
[8] Accounts Receivable and Allowance for Doubtful Accounts:
Accounts receivable are trade receivables, net of allowances for doubtful accounts. We estimate our allowance for doubtful accounts based on historical loss ratios, existing economic conditions, and specific account analysis of high-risk accounts. Concentration of credit risk is limited due to the dispersion of customers. No single customer represents more than 10% of the total accounts receivable.
[9] Inventory:
Inventory is valued at the lower of cost or market and is determined on the first-in, first-out (FIFO) basis. Inventories include raw materials and finished goods. Raw materials include prints, mats, frames, molding, and packaging material. Finished goods consist of pre-framed art and compact disk products produced for resale. The requirements for any provisions of estimated losses for obsolete, excess, or slow-moving inventories are reviewed periodically.
[10] Deferred Rent Receivable
During 2004, we entered into an agreement to sublease a significant portion of our headquarters and SuperStock facility for a term of six years with an option to renew for an additional two-year term. Statement of Financial Accounting Standards (“SFAS”) No. 13, “Accounting for Leases”, requires rental income from an operating lease be recognized on a straight-line basis over the non-cancelable lease term. Accordingly, we recognize total contractual minimum lease payments, including scheduled rent increases, as rental income evenly over the lease term. Accrued revenues from contractually scheduled rent increases in excess of amounts currently due are reported as a long-term receivable. We monitor this asset for collection risk and will establish reserves for any amounts deemed not collectible. However, amounts collected in future periods may vary from our expectations.
[11] Defined Contribution Employee Benefit Plan
We maintain defined contribution retirement plans pursuant to Section 401(k) of the Internal Revenue Code (the Plan), in which U.S. employees at least 21 years of age may participate after completing six months of service. Eligible employees may contribute up to a certain percentage of their annual compensation to the Plan, subject to the annual IRS limitations. The Company may match employee contributions on a discretionary basis. No company match was made during 2007 or 2006.
Page
[12] Foreign Currency:
We translate assets and liabilities of foreign subsidiaries, whose functional currency is the local currency, at exchange rates in effect as of the balance sheet date. We translate revenue and expenses at the monthly average rates of exchange prevailing during the year. We include the adjustment resulting from translating the financial statements of such foreign subsidiaries in accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity. Gains and losses, which are denominated in currency other than a subsidiary’s local currency and re-measured in the subsidiary’s local currency, are recognized in the consolidated statements of operations.
[13] Land and building and property and equipment and depreciation:
The land and building in Jacksonville, Florida with our SuperStock and corporate offices were sold and leased back in a SuperStock transaction accounted for as a financing transaction. The building is being depreciated over the twenty-year term of the related lease. Property and equipment consisting of furniture, fixtures and equipment, photography and computer equipment are recorded at cost. Depreciation of property and equipment is computed by the straight-line method over the assets' estimated lives. The estimated applicable life for furniture, fixtures, and equipment is 7 years; the applicable, estimated life of photography and computer equipment is 5 to 7 years.
Expenditures for major additions and improvements are capitalized. Maintenance and repairs are charged to operations as incurred. Upon sale or retirement of property and equipment, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in operations.
[14] Photo collection and contracts with photographers:
Expenditures for additions and improvements to the photo collection are capitalized. The photo collection is categorized by type of imagery (fine art, vintage and contemporary). Depreciation of the photo collection is computed by the straight-line method over the assets’ estimated lives of forty years for fine art and vintage images and four years for contemporary images. Upon sale or retirement of any portion of the collection, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in operations.
Contracts with photographers have an average life of ten years including those that are automatically renewable. Amortization of the photographer’s contracts is based on projected revenues expected to be generated over the estimated average ten-year life of the underlying images covered by the respective contracts.
[15] Goodwill and intangible assets:
We test goodwill for impairment at least annually, or more often if deemed necessary based on certain circumstances. Our goodwill impairment test is a two-step process: Step 1 - test for potential impairment by comparing the fair value of each reporting unit with its carrying amount; if the fair value of the reporting unit is greater than its carrying amount (including recorded goodwill), then no impairment exists and Step 2 is not performed; Step 2 - if the carrying amount of the reporting unit (including recorded goodwill) is greater than its fair value, then the amount of the impairment, if any, is measured and recorded as needed. The Company’s impairment test performed on October 1, 2007, concluded that no impairment of goodwill exists. As circumstances change, it is reasonably possible that future goodwill impairment tests could results in a loss from impairment to goodwill, which would be included in the determination of net income or loss.
Intangible assets with definite lives are amortized over their estimated useful life and reviewed for impairment in accordance with SFAS 144 (as defined below). Intangible assets with definite lives are amortized using either the straight-line method or based on expected usage of the asset, depending on the nature of the asset over their expected useful life.
Page
The Company capitalizes software development costs for modifications to various web site components and management information systems that result in additional functionality in accordance with AICPA Statement of Position (SOP), 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Software development costs are amortized on a straight-line basis over four years.
[16] Long-lived assets:
We evaluate our long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), pursuant to which an impairment loss is recognized if the carrying amount of a long-lived asset is not recoverable and exceeds its undiscounted cash flows. A long-lived asset is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Our consideration of SFAS 144 involves significant assumptions and estimates based on management’s best judgments of current and future circumstances, including currently enacted tax laws and our future financial performance. No impairment charges have been recognized during 2007.
[17] Other assets, net:
[18] Income taxes:
We recognize deferred tax assets and liabilities for both the expected impact of differences between the financial statements and tax bases of assets and liabilities, and for the expected future tax benefit to be derived from offsetting the net operating loss and tax credit carry-forwards against taxable income, if any. We established a valuation allowance to reflect the likelihood of realization of deferred tax assets. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The difference in basis of the investment in foreign subsidiary relates to goodwill which is a temporary difference. The Company recognizes accrued interest and penalties associated with uncertain tax positions as part of income tax expense, if applicable.
[19] Net loss attributed to common stockholders per share:
We calculate net loss attributed to common stockholders per share in accordance with the provisions of SFAS No. 128, "Earnings per Share”. SFAS No. 128 requires a dual presentation of "basic" and "diluted" income (loss) per share on the face of the consolidated statements of operations. Basic income (loss) per share is computed by dividing the net loss attributed to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted loss per share includes the effect, if any, from the potential exercise or conversion of securities, such as stock options, warrants or unvested shares of restricted stock, which would result in the issuance of incremental shares of common stock.
For 2007 and 2006, the basic and diluted net loss attributed to common stockholders per share is the same since the effect from the potential exercise of 12,618,813 and 16,231,955 outstanding stock options and warrants as of December 31, 2007 and 2006, respectively, or the vesting of 929,513 and 1,594,658 shares of restricted stock as of December 31, 2007 and 2006, respectively, would have been anti-dilutive.
Page
For 2007 and 2006, 1,913,253 and 4,025,139 shares of common stock issuable upon the conversion of the SuperStock Seller Preferred, respectively, have also been excluded from the weighted average shares outstanding due to their anti-dilutive effect.
[20] Reclassifications:
Certain reclassifications have been made to the prior period financial statements to conform to the respective current year presentation.
[21] Comprehensive Loss and Accumulated Other Comprehensive Income:
Accumulated other comprehensive income consists of net unrealized foreign currency translation adjustments and is presented in the consolidated balance sheets as a component of stockholders’ equity.
[22] Share based payments:
We have a 2005 Stock Option Plan and a 2002 Stock Option Plan, which are described in Note M below. We apply the fair value recognition provisions of SFAS 123(R) whereby compensation cost for all share-based payments are based on the grant date estimated fair value.
The fair value of each option is measured at the grant date using a Black-Scholes option-pricing model, which requires the use of a number of assumptions including volatility, risk-free interest rate, expected life and expected dividends. SFAS 123(R) requires the cash flows resulting from the tax benefits that are derived from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. For awards with graded vesting, we recognize share-based compensation cost using the straight-line method over the requisite service period for each tranche of shares granted. During the years ended December 31, 2007 and 2006, there were 230,000 and 6,658,060 options to purchase the Company’s common stock granted. The weighted average grant date fair value of these option grants was $0.05 per share and $0.28 per share for 2007 and 2006, respectively. The following assumptions were used to compute the fair value of stock options granted during 2007 and 2006, respectively: no annual dividends, expected volatility of 130% and 117%, risk-free interest rates of 2.94% and 4.00%, and expected lives ranging from 1 to 4 years.
Expected volatility is based primarily on historical volatility. Historical volatility was computed using daily pricing observations for the most recent three years. We believe this method produces an estimate that is representative of our expectations of the future volatility over the expected term of these options. We currently have no reason to believe future volatility over the expected life of these options is likely to differ materially from historical volatility. The weighted-average expected life is based on share option exercises, pre and post-vesting terminations and share option term expiration. The risk-free interest rate is based on the U.S. Treasury security rate estimated for the expected life of the options at the date of grant.
During May and June 2006, we modified and accelerated the vesting for 200,000 options held by certain former executives as part of their separation agreements with the Company. The fair value of the modifications of $68,000 was recognized as incremental compensation expense during 2006.
SFAS 123(R) requires the estimation of forfeitures when recognizing compensation expense and that this estimate of forfeitures be adjusted over the requisite service period should actual forfeitures differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative adjustment, which is recognized in the period of change and which impacts the amount of unamortized compensation expense to be recognized in future periods. We have estimated our forfeitures to be 5% based primarily on our historical forfeiture rate.
Page
The following summarizes our stock option activity for the year ended December 31, 2007:
The 130,000 options exercised during the year ended December 31, 2007, included certain shares exercised on a cashless basis, resulting in the issuance of 96,838 common shares. The aggregate intrinsic value for options exercised during 2007 was approximately $8,000.
The following table summarizes information about stock options outstanding at December 31, 2007:
The aggregate intrinsic value of options outstanding and exercisable as of December 31, 2007, was $0. This amount represents the total pre-tax intrinsic value (the difference between our closing stock price on the last trading day of the fourth quarter of 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2007.
Page
The following is a summary of the status of and changes to the Company’s non-vested restricted shares as of and for the twelve months ended December 31, 2007:
Share-based compensation expense of $554,000 and $1,302,000 was recognized for 2007 and 2006, respectively, for the fair value of restricted shares and options that vested during the year. Share-based compensation expense for 2007 and 2006 included grants of fully vested shares of common stock to non-employees of $36,000 and $0, respectively. As of December 31, 2007, there was $374,000 of total unrecognized compensation cost related to non-vested share based compensation arrangements, including options and restricted stock grants. That cost is expected to be recognized over a weighted average period of about two years.
[23] Advertising
Advertising expenses of $647,000 and $573,000 were incurred for 2007 and 2006, respectively. Advertising costs are expensed as incurred.
[24] Recently Issued Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No.109” (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 effective January 1, 2007, had no impact on our consolidated financial statements (see Note K).
In September 2006, the FASB issued SFAS 157, "Fair Value Measurements." SFAS 157 simplifies and codifies guidance on fair value measurements under generally accepted accounting principles. This standard defines fair value, establishes a framework for measuring fair value and prescribes expanded disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the effect, if any, the adoption of SFAS 157 will have on our financial condition, results of operations and cash flows.
In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. This Statement is expected to expand the use of fair value measurement. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the effect, if any, the adoption of SFAS 159 will have on our financial condition, results of operations and cash flows.
Page
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) establishes the principles and requirements for how an acquirer; (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (iii) the nature and financial effects of the business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008, with early adoption prohibited. We are currently evaluating the impact SFAS 141(R) will have upon adoption on our accounting for acquisitions. Previously any changes in valuation allowances, as a result of income from acquisitions, for certain deferred tax assets would serve to reduce goodwill, whereas, under the new standard, any changes in the valuation allowance related to income from acquisitions currently or in prior periods will serve to reduce income taxes in the period in which the reserve is reversed. Additionally, under SFAS 141(R), transaction-related expenses, which were previously capitalized as “transaction costs,” will be expensed as incurred. Capitalized transaction costs were approximately $221,000 for the 2006 acquisition of ArtSelect.
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements - an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards that require (i) non-controlling interests to be reported as a component of equity, (ii) changes in a parent’s ownership interest while the parent retains its controlling interest to be accounted for as equity transactions, and (iii) any retained non-controlling equity investment upon the de-consolidation of a subsidiary to be initially measured at fair value. SFAS 160 is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008, with early adoption prohibited. We are currently evaluating the effect, if any, which the adoption of SFAS 160 may have on our financial position or results of operations and cash flows.
NOTE C - ACQUISITION
On May 16, 2006, we acquired ArtSelect, Inc. ArtSelect supplies home and office framed and unframed wall décor to retailers, catalogers, membership organizations, and consumers through both online and traditional retail and wholesale distribution channels. The primary reason for the acquisition of ArtSelect was that it provided us with technology, business partners, and infrastructure to sell framed imagery.
In consideration, the stockholders of ArtSelect received $4.5 million of cash, $2.4 million in secured notes, and 10,000 shares of a21 convertible preferred stock valued at $3.15 million. The selling stockholders of ArtSelect also received warrants to purchase 750,000 shares of a21’s common stock at $1.00 per share valued at $0.50 per share or $375,000. We have also incurred approximately $221,000 in related transaction costs, which have been recorded as part of the purchase price.
The seller notes bear interest at 6% per year and mature on the earlier to occur of a change of control or May 15, 2009. The first year of interest on the notes will be accrued and added to the principal of the notes. After the first year, interest will be payable quarterly, in arrears. The notes are secured by substantially all the assets of ArtSelect (provided that, with respect to up to $3.0 million of the assets of ArtSelect, the notes are junior to the previously issued $15.5 million Senior Secured Notes described in Note J).
Page
The value of the convertible preferred stock was determined using the as-if converted value of $3.15 million. On May 16, 2006, the holders of convertible preferred stock elected to exchange all of the convertible preferred stock for an aggregate of 4,200,000 shares of a21’s common stock at the minimum conversion price of $0.75 per share. Pursuant to the terms of the exchange agreement with such holders, the exchange stock was issued by a21 in August 2006 after we reincorporated in Delaware, pursuant to which a21 increased the number of authorized shares of its common stock in part to accommodate such exchange.
The Warrants expire four years from the closing date of the acquisition. The fair value of the warrants has been determined using a Black-Scholes model by applying the following assumptions: risk-free interest rate, 4.9%; volatility, 129%; underlying stock price, $0.64; exercise price, $1.00; term, 4 years.
The aggregate purchase price was approximately $10.6 million. The following summarizes the fair values assigned to the assets acquired and liabilities assumed at the date of acquisition.
PROFORMA EFFECT OF ACQUISITION
The results of operations of ArtSelect have been included in the consolidated financial statements of the Company since May 16, 2006. The proforma information below presents the results of operations for 2006, as if the acquisition of ArtSelect had occurred on January 1, 2006, the first day of the period presented. The proforma information is presented for informational purposes only, has not been audited by our external auditors, and is not intended to represent or be indicative of the results of operations of the combined companies had these events occurred at the beginning of 2006, nor is it indicative of future results:
Page
NOTE D - INVENTORY
The major components of inventory are summarized as follows:
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant, and equipment are summarized as follows:
During 2004, land and building were sold and leased back in a transaction accounted for as a financing transaction. The building is being depreciated over the twenty-year term of the related lease (see Note K).
Depreciation expense was $611,000 and $630,000 for the year ended December 31, 2007 and 2006, respectively.
NOTE F - GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the years ended December 31, 2007 and 2006, were as follows:
Page
Identifiable intangible assets, net of accumulated amortization and impairment charges at December 31, 2006 are as follows:
Identifiable intangible assets, net of amortization at December 31, 2007, are as follows:
Amortization expense during the years ended December 31, 2007 and 2006 was $1.1 million and $1.5 million, respectively. Approximate remaining annual amortization expense is as follows for each of the following years: 2008: $880,000, 2009: $636,000, 2010: $427,000, 2011: $203,000 and 2012: $198,000.
Page
Changes in intangible assets during the years ended December 31, 2007 and 2006, were as follows:
During our 2006 annual impairment assessment, we evaluated and tested the carrying value of certain identifiable intangible assets with definite lives that resulted from our acquisition of Ingram. Utilizing a cash flow methodology, the results of that testing led to the conclusion that certain of these assets were impaired due to decreased actual and forecasted revenues for the Ingram component of our SuperStock Limited subsidiary, and reported an impairment charge of $1.7 million for 2006, consisting of $1.3 million and $360,000 for the Ingram license agreements and Ingram non-compete agreements, respectively.
NOTE G - PHOTO COLLECTION AND CONTRACTS WITH PHOTOGRAPHERS
The gross book value of our photo collection as of December 31, 2007 and 2006, was $3.3 million and $2.9 million, respectively. The book value of the photo collection, net of accumulated amortization was $1.2 million and $1.5 million at December 31, 2007 and 2006, respectively. Amortization expense was $635,000 and $528,000 for 2007 and 2006, respectively. Approximate remaining annual amortization expense is as follows for each of the following years: 2008: $269,000, 2009: $189,000, 2010: $153,000, 2011: $49,000, and 2012: 18,000.
The gross book value of contracts with photographers as of December 31, 2007 and 2006, was $1.3 million, respectively. The book value of contracts with photographers, net of accumulated amortization was $511,000 and $718,000 as of December 31, 2007 and 2006, respectively. Amortization expense was $207,000 and $210,000 for 2007 and 2006, respectively. Approximate remaining annual amortization expense is as follows for each of the following years: 2008: $169,000, 2009: $124,000, 2010: $61,000, 2011: $50,000, and 2012: $50,000.
NOTE H - MINORITY INTEREST
Minority interest represents 637,751 shares of SuperStock Seller Preferred held by the former owners of SuperStock at December 31, 2007, which is exchangeable for 1,913,253 shares of a21’s common stock. The SuperStock Seller Preferred has no voting rights, pays no dividend, and, except for exchange rights into common stock, it has no other special rights except a liquidation preference. In liquidation, it is senior to the common stock of SuperStock and has distribution rights to the greater of $1.6 million or 7% of the total liquidation distributions after creditors. The minority interest is valued as if it had been exchanged into a21’s common stock at the closing price on the day of the acquisition.
Page
During 2007 and 2006, respectively, we issued 2,111,886 and 975,012 shares of a21 common stock upon the conversion of 703,962 and 325,004 shares of SuperStock Seller Preferred with adjustments to equity of $1,182,000 and $547,000, respectively, representing the allocable, original fair value of the SuperStock Seller Preferred as if it had been exchanged into a21’s common stock at the closing price on the day of the acquisition.
NOTE I - OPERATING SEGMENTS
Effective with the ArtSelect acquisition during May 2006, we operate in the following segments: Corporate, SuperStock, and ArtSelect. No customer represented 10% or more of our total revenue in the periods presented.
93% and 91% of our total revenues for all segments were based domestically in the U.S. for the years ended December 31, 2007 and 2006, respectively. 90% and 89% of our long-lived assets were based domestically in the U.S. as of December 31, 2007 and 2006, respectively.
The following table presents information about our segment activity as of December 31, 2007 and 2006, and for the years then ended:
The SuperStock segment information reflects the operation of foreign subsidiaries.
Page
NOTE J - DEBT FINANCINGS
The following table summarizes the future maturities of long-term debt obligations at December 31, 2007 (in thousands):
$15.5 Million Senior Secured Convertible Notes
During April 2006, we entered into a securities purchase agreement (“Purchase Agreement”) with certain purchasers and Queequeg Partners, LP, as agent (“Agent”), whereby we issued $15.5 million of 5% Senior Secured Convertible Notes (“Senior Convertible Notes”) in consideration for which we received net proceeds of $11.7 million in cash after the repayment of certain outstanding debt of $3.3 million, the exchange of Notes totaling $215,000 to retire warrants to purchase 637,500 shares of a21’s common stock, the repayment of total interest due of $216,000, and the payment of a finder’s fee of $100,000. Queequeg Partners L.P. and Queequeg, Ltd. (each of which are affiliated with Ahab Capital Management, Inc., which was a 10% beneficial owner of a21’s common stock prior to April 27, 2006) (collectively “Ahab”), and StarVest Partners, LP (“StarVest”), which was a 10% beneficial owner of a21’s common stock prior to April 27, 2006, purchased a portion of the Notes sold in this transaction. As part of this transaction, we released $690,000 of certificate of deposits (“CDs”), which had been pledged by Ahab to secure the letter of credit issued by SuperStock in connection with its capital lease for our facility in Jacksonville, Florida, and replaced the deposit with new CDs from the net proceeds of the financing.
See Note O - Subsequent Events.
The Senior Convertible Notes are secured by substantially all of our assets and are convertible into 23,846,149 of a21’s common stock at a minimum conversion price of $0.65 per share, subject to adjustment as provided in the Senior Convertible Notes. In addition, the conversion price of the Senior Convertible Notes may be adjusted based on a weighted average anti-dilution formula in the event of issuances of a21’s common stock at a price per share below $0.65. The minimum conversion price is set at $0.50 per share on a diluted basis. The interest on the Senior Convertible Notes is payable quarterly in arrears, and the principal will be due and payable on March 31, 2011. If the 45-day volume weighted average price of a21’s common stock equals or exceeds $1 per share, the Senior Convertible Notes will automatically be converted into a21’s common stock under certain conditions.
The Senior Convertible Notes include customary events of default, including the failure to pay any principal or interest when due, the breach of any covenant or term or condition of the Senior Convertible Notes, the breach of any representation or warranty in the Purchase Agreement, Senior Convertible Notes or other documents executed in connection with the transactions contemplated thereby, defaults in the performance of any other indebtedness of greater than $500,000, the insolvency or bankruptcy of the company, and the SEC issuing a stop trade order or suspension of trading relating to a21’s common stock. Upon the occurrence of an event of default, each Note will become due and payable, either upon notice from the agent for the holders of Senior Convertible Notes at the direction of the holders of a majority of the outstanding principal amount of the Senior Convertible Notes or automatically, depending on the particular event of default.
Pursuant to the terms of the Purchase Agreement, for so long as StarVest beneficially owns at least 8,000,000 shares of a21’s common stock, StarVest has the right to name a designee to our Board of Directors. In addition, for so long as at least 40% of the aggregate principal amount of the Senior Convertible Notes is outstanding, we may not, without the prior written consent of the Agent, engage in certain activities or transactions, including, but not limited to, declaring dividends, liquidating, dissolving,
Page
effecting a reorganization or change of control, or incurring certain indebtedness. The Purchase Agreement also provides that the purchasers have a pro-rata “first right of refusal” to provide up to 25% of the amount of any additional financing the amount of which will be in excess of $2.0 million.
Secured Notes - Related Party (ArtSelect Sellers)
In partial consideration for the sale of ArtSelect to a21, the stockholders of ArtSelect received $2.4 million in secured notes. The seller notes bear interest at 6% per year and mature on the earlier to occur of a change of control or May 15, 2009. The first year of interest on the notes was accrued and added to the principal of the notes. Since the first year, interest has been payable quarterly, in arrears. The notes are secured by substantially all the assets of ArtSelect (provided that, with respect to up to $3.0 million of the assets of ArtSelect, the notes are junior to the previously issued $15.5 million Senior Convertible Notes described above). The notes, including accrued interest, are recorded in our consolidated balance sheets at $2.6 million and $2.5 million at December 31, 2007 and 2006, respectively, and are included in the caption “Secured notes payable, net- related party (ArtSelect Sellers)”.
NOTE K - LOAN PAYABLE ON BUILDING
During June 2004, we completed the sale and leaseback of the land and an approximately 73,000 square foot building in which our headquarters is located in Jacksonville, Florida. The facility was sold for $7.7 million and resulted in net proceeds of $7.5 million, of which $4.0 million was used to repay a bank note that was secured by a first mortgage on the facility and $1.6 million was used to repay other indebtedness to the selling stockholders of SuperStock. The building was leased back for a term of twenty years. The lease provides us with two five-year renewal options at specified payments.
Based on the terms of the leasing arrangement, the transaction does not qualify for sale recognition and has been accounted for as a financing transaction pursuant to SFAS No. 98, "Accounting for Leases". Accordingly, the accompanying financial statements reflect the net proceeds from the sale of the land and building as a loan payable with an effective interest rate of 10.1%. The building is included in property and equipment and is being depreciated on a straight-line basis over the twenty-year term of the lease.
The following table summarizes our annual maturities under the loan payable on the building at December 31, 2007:
The current portion of the loan payable is included in other current liabilities.
Page
The following table summarizes our related annual lease payments on building:
NOTE L - INCOME TAXES
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
The Company adopted the provisions of FIN 48 effective January 1, 2007. The Company recognizes accrued interest and penalties associated with uncertain tax positions as part of income tax expense, if applicable. As of the date of adoption and through December 31, 2007, the Company did not have any unrecognized tax benefits recorded as a provision for the uncertainty of certain tax positions. As such, no estimated interest and penalties on the provision for the uncertainty of certain tax positions is included in the consolidated financial statements.
The Company, or one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. Without exception, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2001. Income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states. The Company currently does not have any income tax returns under review.
The components of income tax expense were as follows:
Page
A reconciliation between the provision for income taxes and the expected tax benefit using the federal statutory rate of 34% for 2007 and 2006 is as follows:
The Company’s deferred tax assets and liabilities relate to the following temporary differences between financial accounting and tax bases at December 31, 2007 and 2006:
The Company has recorded a valuation allowance to state its deferred tax assets at estimated net realizable value due to the uncertainty related to realization of these assets through future taxable income. The increase in the valuation allowance was $1.8 million and $4.1 million for 2007 and 2006, respectively.
At December 31, 2007, the Company had U.S. net operating loss and foreign tax credit carry-forwards for income tax purposes of $21.8 million, and $579,000, respectively. The net operating loss and foreign tax credit carry-forwards expire in varying amounts through 2025. The Company’s ability to benefit from these carry-forwards is limited under certain provisions of the Internal Revenue Code. At December 31,
Page
2007, the Company had foreign net operating loss carry-forwards for income tax purposes of $1.2 million that have no expiration date.
NOTE M -STOCKHOLDERS’ EQUITY
[1] Common and Preferred stock:
We are authorized to issue 200,000,000 shares of a21 common stock.
We are authorized to issue 100,000 shares of $.001 par value preferred stock having rights, preferences, and privileges which may be determined by our Board of Directors.
During May 2007, we issued 100,000 shares of fully vested common stock, valued at $30,000, to a non-employee consultant as partial payment for services provided to the Company.
During April 2007, we issued 66,666 shares of our restricted common stock, valued at $20,000, as partial compensation to a new Board Director for his service on the Board of Directors, which will vest on the one year anniversary of his election to the Board, which is March 22, 2008.
During March 2007, we issued a total of 125,000 shares of our restricted common stock, valued at $32,500, as compensation incentives to three new managers, which will vest in equal shares on the six-month anniversary of their respective hire date over a period of three years. In addition, we issued 25,000 shares of fully vested common stock, valued at $6,000, to a non-employee consultant as partial payment for services provided to the Company.
During January 2007, we issued 2,111,886 shares of a21 common stock upon the conversion of 703,962 shares of SuperStock Seller Preferred with a respective adjustment to equity of $1,182,000 representing the allocable, original fair value of the SuperStock Seller Preferred as if it had been exchanged into a21’s common stock at the closing price on the day of the acquisition.
During January 2007, we issued 350,000 shares of our restricted common stock, valued at $81,000, as part of an employment agreement with our Executive Vice President, Sales and Marketing, of which 43,750 shares will vest on the six month anniversary of his employment agreement and the remainder will vest in forty-two equal monthly installments on the first day of each month thereafter such that all of such options and restricted stock will be vested by the forty-eight month anniversary of the date of the agreement. All unvested shares of restricted stock will immediately vest upon a change in control of a21.
On June 19, 2006, a21’s Board of Directors approved a merger agreement pursuant to which, among other things, the Company would merge with and into its wholly owned subsidiary, a21,Inc., a Delaware corporation. On June 23, 2006, we obtained the approval of the terms of the merger agreement by a majority of our outstanding shares of common stock. The reincorporation became effective on July 31, 2006.
Our reincorporation in Delaware has not resulted in any change to our business operations or the location of our principal executive offices. The financial condition and results of operations of the surviving corporation immediately after the consummation of the merger were identical to the Company’s immediately prior to the consummation of the merger. In addition, the board of directors of the surviving corporation consists of those persons who were the Company’s directors immediately prior to the merger and individuals serving as executive officers of the Company immediately prior to the merger continue to serve as executive officers of the surviving corporation after the merger.
Pursuant to the reincorporation, the number of the Company’s authorized shares of common stock was increased from 100,000,000 shares to 200,000,000 shares.
Page
During October 2006, we issued 219,000 shares of our restricted common stock, valued at $61,000, and vested immediately, to our directors for past performance of services. Additionally, each non-employee member of the Board of Directors received 72,727 restricted shares of our common stock in accordance with the adoption of a compensation plan for its non-employee directors for the annual Board term through September 2007.
During October 2006, we issued 1,000,000 shares of our restricted common stock to two of our officers pursuant to the terms of their employment agreements. Also during October 2006, the Company issued 275,000 shares of our restricted common stock, valued at $74,000, to our Chief Financial Officer; 45,833 restricted shares will vest on the six month anniversary date of the grant date and the remainder of the restricted stock will vest in thirty equal monthly installments on the first day of each month thereafter.
In connection with the July 2006 settlement of certain claims made by a stockholder and three of his affiliates against the Company, we issued 450,000 shares of our common stock in exchange for a general release of all claims such persons may have had against us. We have recognized the related fair value of such shares of $139,000 as settlement expense included in general operating expense in our Statement of Operations, with a corresponding increase to additional paid in capital during 2006. The fair value was determined based upon the prevailing common stock trading market price per share at the time the agreement was reached.
On June 30, 2006, we issued 375,012 shares of a21 common stock upon the conversion of 125,004 shares of SuperStock Seller Preferred with a respective adjustment to equity of $210,000 representing the allocable, original fair value of the SuperStock Seller Preferred as if it had been exchanged into a21’s common stock at the closing price on the day of the acquisition. On July 20, 2006, we issued 600,000 shares of a21 common stock upon the conversion of 200,000 shares of the SuperStock Seller Preferred with a respective adjustment to equity of $336,000 representing the allocable, original fair value of the SuperStock Seller Preferred as if it had been exchanged into a21’s common stock at the closing price on the day of acquisition.
In partial consideration for the sale of ArtSelect to a21 (see Note C), the stockholders of ArtSelect received 10,000 shares of a21 convertible preferred stock valued at $3.15 million. The convertible preferred stock fair value was determined using the as-if converted value of $3.15 million. On May 16, 2006, the holders of convertible preferred stock elected to exchange all of the convertible preferred stock for an aggregate of 4,200,000 shares of a21’s common stock at a per share price of $0.75. Pursuant to the terms of the exchange agreement with such holders, the exchange stock was issued by a21 during August 2006 after the Company reincorporated in Delaware, and, in connection therewith, increased the number of authorized shares of its common stock, in part, to accommodate such exchange. The trading price of a21’s common stock was $0.83 at the closing date of the ArtSelect acquisition, which was the commitment date of the convertible preferred stock, compared to the conversion price of $0.75 per share, resulting in beneficial conversion value of $336,000 on the May 16, 2006 acquisition date, which was recorded as a deemed dividend on convertible preferred stock in 2006. The conversion was contingent on the increase in authorized shares which subsequently occurred on July 31, 2006.
During April 2006, we also issued 107,000 shares of our common stock for broker’s costs in connection with the issuance of the Senior Secured Convertible Notes discussed in Note J. These stock grants for broker’s costs were valued at fair value per the market trading price at the time of the grants, and charged to additional paid in capital for $62,000.
In partial consideration for the acquisition of the outstanding stock of Ingram during 2005, the stockholders of Ingram also received 14,480 shares of a21’s preferred stock. On March 14, 2006, we issued 2,522,648 shares of a21 common stock upon the conversion of the preferred stock by the holders thereof. The preferred shares were converted into a21 common stock at a price per share of the a21 common stock of $0.574, the average of the closing price of the a21’s common stock for the 20 trading day period ending on March 13, 2006. At December 31, 2007 and 2006, there were no shares of preferred stock issued and outstanding, respectively.
Page
On March 6, 2006, we received $1.2 million in connection with the exercise of warrants to purchase 4,000,000 shares of a21’s common stock held by one of a21’s significant stockholders. The stockholder previously acquired the warrants from another of our significant stockholders, through a prior transaction. In connection with the exercise of the warrants, we set the exercise price of the warrants to $0.30 per unregistered share, which was approximately 10% less than what the exercise price would have been pursuant to the original terms of the warrants, but higher than the minimum $0.25 per unregistered share as stated in the warrant modification agreement. This accommodation was granted by us in order to facilitate the transaction. As a result of the re-pricing of the warrants, we recorded a deemed dividend of $157,000, increasing the net loss attributed to common stockholders (see Note M[2]).
[2] Stock options, warrants and restricted stock:
Stock options and warrants have been granted to officers, directors and employees pursuant to employment agreements and other grants at the discretion of the Board of Directors. Warrants have been granted through other financing and investment agreements with certain of our investors.
Our 2005 Stock Incentive Plan (the “2005 Plan”) provides for the grant of options, stock appreciation rights (“SARs”), performance share awards, restricted stock, and unrestricted stock of up to an aggregate of 6,000,000 shares of a21 common stock to officers, employees, and independent contractors of ours or our affiliates. If any award expires, is cancelled, or terminates unexercised or is forfeited, the number of shares subject thereto is again available for grant under the 2005 Plan. A committee selected by our Board of Directors has the authority to approve option grants and the terms, which include the option price and the vesting terms. Stock options issued under the 2005 Plan typically have a five-year term and vest pro-rata over that term except when otherwise adapted to specific terms per executive management agreements and their respective terms. The exercise price typically shall be no less than the fair market value of a share of a21’s common stock on the date of grant of the options. See Note B [22]. As of December 31, 2007, there were 901,063 options available for grant under the 2005 Plan.
Our 2002 Directors, Officers And Consultants Stock Option, Stock Warrant And Stock Award Plan, as amended (the "2002 Plan"), provides for the grant of warrants, options, restricted or unrestricted common stock, and other awards of up to an aggregate of 3,000,000 shares of a21 common stock to our employees, consultants and directors and our affiliates. If any award expires, is cancelled, or terminates unexercised or is forfeited, the number of shares subject thereto is again available for grant under the 2002 Plan. A committee selected by our Board of Directors has the authority to approve option grants and the terms, which include the option price and the vesting terms. Options granted under the 2002 Plan typically expire after a ten-year period except when otherwise adapted to specific terms per executive employment agreements and their respective terms, and are subject to acceleration upon the occurrence of certain events. The exercise price typically shall be no less than the fair market value of a share of a21’s common stock on the date of grant of the options. See Note B [22]. As of December 31, 2007, there were 2,841,500 options available for grant under the 2002 Plan.
Certain options and warrants to be granted under the 2005 Plan and the 2002 Plan are intended to qualify as Incentive Stock Options (“ISOs”) pursuant to Section 422 of the Internal Revenue Code of 1986, as amended, while other options granted under the plans will be nonqualified options that are not intended to qualify as ISOs.
During October 2007, we granted 230,000 options to purchase a21 common stock as retention incentives for four ArtSelect managers in conjunction with the restructuring of the Company initiated during the third quarter of 2007. These options will vest upon the earlier of the end of their retention period or December 31, 2008 (see Note B[22]).
Page
The following table summarizes the Company’s stock warrant activity:
As a result of the re-pricing of the warrants to purchase 21,114,000 shares of the Company's common stock, which included the exercise of warrants to purchase 17,114,000 shares of common stock during 2005, and the exercise of the remaining warrants to purchase 4,000,000 shares of the Company’s common stock during 2006, the Company recorded a deemed dividend during 2006 of approximately $157,000, increasing the net loss available to common stockholders.
The fair value of each warrant grant on the date of grant is estimated using a Black-Scholes option-pricing model reflecting the following weighted average assumptions for the year ended December 31, 2006: no annual dividends; expected volatility of 129%; risk free interest rate of 4.9%, and expected life of four years (contractual term for warrants). No warrants were granted during 2007. The weighted average fair value of warrants granted during 2006 was $0.50.
The following table summarizes information about warrants at December 31, 2007:
Page
The aggregate intrinsic value of warrants outstanding and exercisable at December 31, 2007, was $0. This amount represents the total pre-tax intrinsic value (the difference between our closing stock price on the last trading day of the year ended December 31, 2007, and the exercise price, multiplied by the number of in-the-money warrants) that would have been received by the warrant holders if all warrant holders had exercised their warrants on December 31, 2007.
NOTE N - COMMITMENTS AND OTHER MATTERS
[1] Lease commitments
As described in Notes E and J above, we have capitalized our facility under the terms of a sale and leaseback transaction. In September 2004, we entered into an agreement to sublease a significant portion of our facility for a term of six years with an option to renew for an additional two-year term. The sublease requires monthly rent payments to us beginning in November 2004 with annual increases through the term of the sublease. The total lease payments in accordance with the terms of the agreement are $3.5 million. Sublease payments of $680,000 and $550,000 were received for 2007 and 2006, respectively. Sublease payments are scheduled as follows for each of the following years: 2008: $701,000, 2009: $722,000, and 2010: $616,000, which is when the current lease terminates. Rental income is recognized on a straight-line basis over the term of the sublease, and the excess of rental income recognized over rental payments received is recorded as deferred rent receivable, which was $435,000 and $549,000 as of December 31, 2007 and 2006, respectively.
In connection with our operating lease agreement for SuperStock Limited in the UK, we sublet the entire facility to a third party as of June 2002, until the expiration of the lease in 2014. In accordance with the lease agreement, our UK subsidiary would be liable for approximately $90,000 per year under the covenants in the lease in the event the lessee who has sublet the facility is unable to perform under such terms.
Under the terms of our operating lease agreement for ArtSelect, Inc., we have leased 24,000 square feet of mixed use space for use in our framing operations. The lease term ends in December 2009.
Total rent expense under operating leases charged to operations was approximately $253,000 and $222,000 for the years ended December 31, 2007 and 2006, respectively. Future minimum operating lease payments as of December 31, 2007, are as follows: 2008 - $183,000, 2009 - $126,000, and $0 for the years 2010, 2011 and 2012. See Note K for future minimum lease payments under capital leases.
[2] Lease Deposit Arrangement
A security deposit is required under the capital lease agreement for our facility in Florida. The lease deposit of $750,000 is included in restricted cash non-current assets as of December 31, 2007 and 2006.
[3] Legal:
We are involved in various claims and lawsuits in the ordinary course of business. Management believes that there are no such matters outstanding that would have a material adverse effect on our results of operations and financial position.
[4] Restructure:
On September 12, 2007, we consolidated the support positions at ArtSelect from Fairfield, Iowa, into the Company’s Jacksonville, Florida, headquarters. In addition, SuperStock, Inc. was reorganized to support the Company’s growth initiatives. This restructure resulted in a net reduction of approximately 20 positions. The affected employees received severance payments. In addition, key employees were identified to assist with the transition and were deemed eligible to receive a retention bonus based on
Page
meeting certain service and performance-based objectives. The restructure activity was substantially completed during the first quarter of 2008. Based on the provisions of SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the Company has accrued total liabilities as of December 31, 2007, of $138,000, primarily related to one-time termination benefits; all other restructure costs will be expensed in the period incurred.
Total expected restructure costs by segment are summarized below; these amounts are expected to be incurred through the period ended June 30, 2008:
At December 31, 2007, the Company recorded an accrued liability associated with the restructuring and other related charges which are summarized in the table given below; amounts associated with these liabilities are expected to be incurred through the period ended June 30, 2008:
[5] Software Development Agreement:
During 2007, the Company entered into a software development agreement with an unrelated third party to pay approximately $525,000 in fees for the development of a new online stock photography e-commerce website. As of December 31, 2007, $443,000 of such fees have been incurred and capitalized as software development in process, which is included in intangible assets, net, in the accompanying consolidated balance sheet. Up to approximately $162,000 of remaining payments are expected to be paid during 2008.
[6] SuperStock Earn-out:
As part of the original 2004 SuperStock, Inc. purchase agreement, the sellers may also receive up to $1.5 million should SuperStock achieve certain revenue milestones during the four-year period after closing. Total payments made to date as of December 31, 2007, were $692,000, including $285,000 and $206,000 paid in 2007 and 2006, respectively. As of December 31, 2007, the estimated amount due for the fourth year (March 1, 2007, through February 28, 2008) calculated for the ten months ended December 31, 2007, is $180,000 and has been accrued as of December 31, 2007.
[7] Employment Agreements:
On January 8, 2007, we entered into an employment agreement our Executive Vice President, Sales and Marketing. He will receive a salary of $185,000 per year and a signing bonus of $15,000. Per the agreement, he was entitled to an annual bonus based on certain performance criteria established by the Board of Directors and a minimum bonus of $25,000 for 2007. In addition, only with respect to the fiscal year ending December 31, 2007, he will be entitled to an additional bonus equal to 2% of our net sales above a certain net sales threshold to be established by our Board of Directors. However, based on the Company’s 2007 performance, the minimum performance bonus and the additional sales bonus was not paid during 2007. We granted him 350,000 restricted shares of a21’s common stock, of which 43,750 shares will vest on the six month anniversary of his employment agreement and the remainder of which
Page
will vest in forty-two equal monthly installments on the first day of each month thereafter such that all of such options and restricted stock will be vested by the forty-eight month anniversary of the date of the agreement. All unvested shares of restricted stock will immediately vest upon a change in control of a21. We will also pay up to $800 per month for his employee benefits, whether he chooses to use our benefit plans or benefit plans of his choosing. The employment agreement may be terminated by either party without cause on 30 days written notice to the other party. In addition, we may terminate the employment agreement immediately for cause, as defined in the employment agreement, and he may terminate the employment agreement for good reason, as defined in the employment agreement. If we terminate the agreement or he terminates the agreement for good reason, we are obligated to make certain payments to him, as outlined in the agreement.
The total compensation payable in the future under all existing employment agreements is as follows: 2008 - $689,000 and 2009 - $373,000.
NOTE O - SUBSEQUENT EVENTS
On January 31, 2008, we entered into a waiver agreement with the holders of a majority of the outstanding principal amount of the Secured Convertible Notes, to waive quarterly cash interest payments until March 31, 2008. Instead of paying in cash, the agreement provides that we will settle quarterly interest payments due in January and April 2008 with new notes in the aggregate principal amount equal to the interest due, having substantially the same terms as the original notes. We would resume paying quarterly interest in cash beginning with the quarterly interest due in July 2008.