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Silverstar Holdings 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31
  3. Ex-31
  4. Ex-32
  5. Ex-32
  6. Ex-32

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________to ______________

Commission File Number 0-27494

 

SILVERSTAR HOLDINGS, LTD.

(Exact name of Registrant as Specified in Its Charter)

Bermuda

Not Applicable

(State or Other Jurisdiction of
Incorporation or Organization)

(IRS Employer Identification No.)

Clarendon House, Church Street, Hamilton HM CX, Bermuda
(Address of Principal Executive Offices with Zip Code)

Registrant’s Telephone Number, Including Area Code: 809-295-1422

_____________________________________________________________________
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

o 

Accelerated filer

o

Non-accelerated filer

o

Smaller reporting company

x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o        No x

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes o      No x

 

As of November 7, 2008, there were 20,087,911 shares of the Registrant’s common stock outstanding.

 

 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

Item 1

Financial Statements

 

 

 

 

 

Condensed Consolidated Balance Sheets at September 30, 2008 (Unaudited) and June 30, 2008

 

 

 

 

 

Condensed Consolidated Statements of Operations (Unaudited) for the three months ended September 30, 2008 and 2007

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows (Unaudited) for three months ended September 30, 2008 and 2007

 

 

 

 

 

Notes to the Condensed Consolidated Financial Statements (Unaudited)

 

 

 

 

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

Item 4

Controls and Procedures

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

Item 1

Legal Proceedings

 

 

 

 

Item 1A

Risk Factors

 

 

 

 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

Item 3

Defaults upon Senior Securities

 

 

 

 

Item 4

Submission of Matters to a Vote of Security Holders

 

 

 

 

Item 5

Other Information

 

 

 

 

Item 6

Exhibits

 

 

 

 

 

SIGNATURES

 

 

 

2

 

 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

SILVERSTAR HOLDINGS, LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

 

September 30, 2008

 

June 30, 2008

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

969,061

 

$

2,215,109

 

Cash restricted for foreign tax estimated liability

 

 

658,084

 

 

677,344

 

Accounts receivable, net

 

 

2,277,002

 

 

2,232,343

 

Inventories, net

 

 

765,777

 

 

445,927

 

Current portion of long term notes receivable

 

 

144,410

 

 

216,633

 

Prepaid expenses and other current assets

 

 

520,093

 

 

364,576

 

Assets available for sale

 

 

--

 

 

80,205

 

Total current assets

 

$

5,334,427

 

$

6,232,137

 

Property, plant and equipment, net

 

 

375,052

 

 

403,723

 

Software development costs, net

 

 

7,195,107

 

 

8,045,698

 

Investments in non-marketable securities

 

 

1,131,066

 

 

1,131,066

 

Intangible assets, net

 

 

4,828,210

 

 

5,732,835

 

Deferred charges and other assets

 

 

695,087

 

 

864,689

 

Total assets

 

$

19,558,949

 

$

22,410,148

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Lines of credit

 

$

1,172,111

 

$

1,618,164

 

Loan payable - related party

 

 

260,000

 

 

--

 

Notes payable – acquisition

 

 

2,428

 

 

2,666

 

Earn out notes payable – acquisition

 

 

115,938

 

 

405,437

 

Accounts payable

 

 

1,722,791

 

 

5,041,603

 

Accrued royalty expense

 

 

1,624,443

 

 

1,472,424

 

Accrued payroll tax expense

 

 

640,753

 

 

817,269

 

Accrued expenses

 

 

4,090,252

 

 

2,276,573

 

Estimated liability for foreign tax

 

 

271,566

 

 

279,514

 

Total current liabilities

 

$

9,900,282

 

$

11,913,650

 

Convertible secured debenture

 

 

7,461,428

 

 

7,354,637

 

Other long term liabilities

 

 

416,200

 

 

421,363

 

Total liabilities

 

$

17,777,910

 

$

19,689,650

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

Preferred stock, $0.01 par value; 5,000,000 shares authorized; no shares issued and outstanding

 

 

--

 

 

--

 

Common stock, class A, $0.01 par value, 50,000,000 shares authorized; 20,129,611 and 19,956,177 shares issued and outstanding, respectively

 

 

199,945

 

 

198, 210

 

Common stock, class B, $0.01 par value, 2,000,000 shares authorized; no shares issued and outstanding

 

 

--

 

 

--

 

Common stock, FSAH class B, $0.001 par value, 10,000,000 shares no shares issued and outstanding

 

 

--

 

 

--

 

Additional paid-in capital

 

 

83,605,604

 

 

83,304,462

 

Accumulated deficit

 

 

(81,942,270

)

 

(81,282,895

)

Other comprehensive (loss) income

 

 

(82,240

)

 

500,721

 

Total stockholders’ equity

 

$

1,781,039

 

$

2,720,498

 

Total liabilities and stockholders’ equity

 

$

19,558,949

 

$

22,410,148

 



 

See notes to condensed consolidated financial statements

3



 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

SILVERSTAR HOLDINGS, LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

Three Months Ended
September 30,

 

 

2008

 

2007

 

Net revenues

$8,822,027

 

$3,878,677

 

Operating expenses:

 

 

 

 

Cost of sales

3,948,616

 

1,598,802

 

Development costs and royalties

612,004

 

613,504

 

Selling, general and administrative

3,091,280

 

2,958,380

 

Amortization of software development costs

1,109,457

 

590,106

 

Amortization of acquired intangibles

487,245

 

2,111,666

 

Depreciation

54,334

 

43,654

 

Total operating expenses

9,302,936

 

7,916,112

 

Operating loss

(480,909)

 

(4,037,435

)

Other income (expense)

302,306

 

(12,495)

 

Foreign currency gain (loss)

(161,094)

 

133,798

 

Amortization of convertible debt discounts and issuance costs

(276,394)

 

(431,169

)

Gain on sale of fixed assets

177,637

 

--

 

Interest expense

(242,964)

 

(168,457

)

Interest income

22,040

 

69,249

 

Net loss

($659,378)

 

($4,446,509

)

 

 

 

 

 

Loss per share:

 

 

 

 

Basic and diluted

($.03)

)

($.35

)

 

 

 

 

 

Weighted average common stock outstanding:

 

 

 

 

Basic and diluted

20,067,108

 

12,783,366

 

 

See notes to condensed consolidated financial statements

 

4

 

 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

SILVERSTAR HOLDINGS, LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(UNAUDITED)

 

 

Three Months Ended
September 30,

 

 

2008

 

2007

 

Cash flows from operating activities:

 

 

 

 

Net loss

($659,378)

 

($4,446,509)

 

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

-

 

Depreciation and amortization

1,927,429

 

3,176,595

 

Loss on disposal of marketable securities

-

 

12,500

 

Gain on disposal of fixed assets

(177,637)

 

--

 

Stock-based compensation

117,016

 

101,838

 

Stock-based obligations for consulting services

55,115

 

--

 

Unrealized foreign currency loss (gain)

554,117

 

(278,429)

 

Accrued interest income on notes receivable

(2,230)

 

(5,530)

 

Changes in operating assets and liabilities, net

(2,219,204)

 

485,871

 

Decrease in estimated liability for foreign tax

--

 

(291,829)

 

Increase in other assets

--

 

(7,166)

 

Net cash used in operating activities

($404,772)

 

($1,252,659)

 

  

 

 

 

 

Cash flows from investing activities:

 

 

 

 

Purchase of fixed assets

(56,956)

 

(137,603)

 

Proceeds from sale of fixed assets

152,328

 

85,070

 

Proceeds from repayment of notes receivable

71,786

 

43,525

 

Decrease in cash restricted for foreign tax estimated liability

19,073

 

281,762

 

Net cash provided by investing

$186,231

 

$102,614

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

Short term borrowings (repayments), net

(444,549)

 

(3,394,650)

 

Proceeds from private placement sales of common stock, net of offering cost of $1,054,908

--

 

7,945,087

 

Proceeds from the exercise of stock options

--

 

104,500

 

Net cash (used in) provided by financing activities

(444,549)

 

4,654,937

 

Effect of exchange rates on cash

(582,958)

 

210,792

 

Net increase (decrease) in cash and cash equivalents

(1,246,048)

 

3,715,684

 

Cash and cash equivalents, beginning of period

2,215,109

 

3,693,149

 

Cash and cash equivalents, end of period

$969,061

 

$7,408,833

 

Supplemental cash flow information:

 

 

 

 

Cash paid for interest

$372,962

 

$148,395

 

Cash paid for income taxes

--

 

$800

 

 

See notes to condensed consolidated financial statements

 

 

 

 

5



 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

SILVERSTAR HOLDINGS, LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1.

FINANCIAL INFORMATION

Silverstar Holdings, Ltd. (the “Company”) is the parent company of Empire Interactive, PLC (“Empire”), a leading worldwide publisher of interactive entertainment software for all game platforms, as well as Strategy First, Inc. (“Strategy First”), a leading worldwide publisher of entertainment software for the Personal Computer (PC). The Company is also a minority shareholder in Magnolia Broadband Wireless, a development stage company which is developing mobile wireless broadband products.

NOTE 2.

GOING CONCERN


As shown in the accompanying condensed consolidated financial statements, the Company has incurred recurring losses from operations, negative cash flows from operations, and as of September 30, 2008, the Company’s current liabilities exceeded its current assets by $4.566 million. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company plans to meet its ongoing cash requirements as follows:

 

    Generate significant short term operating earnings and cash flow primarily through its Empire subsidiary. Empire’s title release schedule for the next 12 months includes several multi-platform games most notably Hello Kitty and sequels to its successful Animal Paradise DS game. The Company anticipates that the launch of these games, along with Empire’s ongoing business will generate operating profits and cash flow in the short term. Empire continues to explore European and US distribution agreements with major entertainment publishers which would provide significant short term cash flow.

 

    On September 9, 2008, the Company and Empire Interactive entered into a term sheet with Full Circle Partners, LP whereby Empire would have been provided a senior secured revolving loan of up to $8 million, the terms of which have not been finalized. On November 7, 2008, the Company‘s subsidiary, Empire Interactive Europe, Limited, closed on a short-term loan with a commitment of up to $2.1 million with Full Circle Partners LP. As of November 12, 2008, Empire was loaned $1.427 million of this amount. This loan is secured by certain receivables of Empire Interactive Europe, Limited and Empire Interactive, Inc. as well as the shares of these companies and of Empire Interactive Holdings, Limited. The Company continues discussions with Full Circle toward completion of the longer term facility as contemplated in the September 9, 2008 Term Sheet. Details of the Full Circle loan are contained in the Company’s 8-K filed on November 13, 2008.

 

    Raise additional capital through the possible sale of certain intellectual property. The Company will request a London based investment banker to value certain of its intellectual property to determine which assets can bring significant value.

 

    The Company has approximately $658,000 of restricted cash set aside to match its current South African tax assessment. The Company believes that it has strong arguments to set aside this assessment. If this assessment is set aside, this cash would be available for operations. A court hearing in this matter is scheduled for early December of 2008.

 

Management believes that these actions and others to be taken by the Company will provide the opportunity for it to improve liquidity and achieve profitability. In addition, the Company believes that if they close on the $8 million loan in 2008, they would be able to sustain operations through fiscal year 2009. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. However, there can be no assurance that any of these events will occur.

 

6

 

 


SILVERSTAR HOLDINGS LTD - 10-Q

 

NOTE 3. BASIS OF PREPARATION

The unaudited consolidated financial statements include the accounts of the Company and all of its subsidiaries in which it has a majority voting interest. Investments in affiliates are accounted for under the equity or cost method of accounting. All significant inter-company accounts and transactions have been eliminated in the consolidated financial statements.

Pursuant to the rules and regulations of the Securities and Exchange Commission for Form 10-Q, the financial statements, footnote disclosures and other information normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed. The financial statements contained in this report are unaudited but, in the opinion of the Company, reflect all adjustments, consisting of only normal recurring adjustments necessary to fairly present the financial position of the Company as of September 30, 2008 and the results of its operations and its cash flows for the interim periods of the fiscal year ended June 30, 2009 (“fiscal 2009”) and the fiscal year ended June 30, 2008 (“fiscal 2008”) presented herein. The results of operations for any interim period are not necessarily indicative of results for the full year. These financial statements, footnote disclosures and other information should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended June 30, 2008.

Net Income or Loss Per Share

Basic net income or loss per share is computed by dividing net income or loss by the weighted average number of shares of common stock outstanding. Diluted net income or loss per share is computed by dividing net income or loss by the weighted average number of shares of common stock outstanding and dilutive potential shares of common stock reflecting the dilutive effect of stock options, warrants, convertible debentures and shares to be issued in connection with prior acquisitions. Dilutive potential common shares, stock options, warrants and convertible debentures for all periods presented are computed utilizing the treasury stock method. The total number of shares that could potentially dilute earnings per share in the future, but which were not included in the calculation of diluted earnings per share because to do so would have been anti dilutive, were 570,491 and 739,896 in the quarter ended September 30, 2008 and in the same period in the prior fiscal year, respectively.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and all highly liquid investments with original maturities of three months or less. The vast majority of the Company’s cash balances are held in liquid accounts at two highly rated financial institutions. While these deposits are not insured, the quality of such financial institutions is such that the risks of loss on these funds are minimal. Restricted cash balances at September 30, 2008 totaled $592 which is used as collateral on the Company’s line of credit.

Software Development Cost

Under SFAS No. 86 software development cost should be capitalized once technical feasibility is achieved. In the case of Empire this would be when the product is commercially viable (“commercial feasibility”). The Company has determined to its satisfaction that there is a clearly defined decision point quite early in development where a product passes from concept to commercial feasibility. This decision point is either reached with the consent of outside parties such as Sony or Microsoft or through an internal process where management decides to move forward with a product’s development once a game concept has been approved. The Company also found that there has been no material instance where concept approval has been given and a game has not become a commercial product. The Company has, therefore, decided to capitalize software development costs after concept approval.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment.” This standard replaced SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” The standard

 

7

 

 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

requires companies to recognize all share-based payments to employees, including grants of employee stock options, in the financial statements based on their fair values on the grant date and is effective for annual periods beginning after June 15, 2005. In accordance with the revised statement, the Company recognizes the expenses attributable to stock options granted or vested subsequent to July 1, 2005. During the three month periods ended September 30, 2008 and 2007 and the Company recognized expenses of $88,712 and $61,838, respectively, for employee stock options that vested. The Company also recognized expenses of $28,304 and $40,000, respectively, for the vesting of restricted shares. Based on existing unvested option agreements the Company anticipates an additional expense of approximately $300,176 in fiscal year 2009 which could increase if additional options are granted during the fiscal year. As of September 30, 2008, $563,901 of total unrecognized compensation costs related to non-vested options is scheduled to be recognized over a weighted average period of 2.16 years.

The weighted average grant date fair value of options granted during the three months ended September 30, 2008 and the significant assumptions used in determining the underlying fair value of each option grant on the date of the grant utilizing the Black Scholes option pricing model are noted in the following table. Expected volatility is based on historical volatility data of the Company’s stock. As a result of the acquisition of Empire which significantly changed the size and complexity of the Company, the volatility of options granted after March 31, 2007 were computed using the average volatility of competitor companies in the entertainment software industry. Historical stock prices would not be indicative of their future prices, since the Company itself is so different from what it was historically. SFAS 123(R) requires the use of expected volatility in the calculation of the compensation expense of a stock option. While it allows the use of historical volatility in calculating expected volatility, it does not require the use of historical volatility only and encourages the use of other factors. The Company will continue to use the average volatility of competitor companies until such time there is sufficient historical volatility data (post Empire acquisition) that equals or exceeds the expected term of the options granted. The expected term of stock options granted is based on historical data and represents the period of time that stock options are expected to be outstanding. The risk-free rate of the stock options is based on the US Treasury rate in effect at the time of grant. The risk-free rate of the stock options is based on the US Treasury rate in effect at the time of grant. For the three months ended September 30, 2007, the Company did not grant stock options.

 

Details of the option activity for the three months ended September 30, 2008 were as follows:

 

 

2008

Weighted average grant-date fair value of options granted

$.11

Assumptions:

 

Risk free interest rate

3.12%

Expected life

4 Years

Expected volatility

43%

Expected dividend yield

0

 

As of September 30, 2008, the Company had 3,214,167 stock options outstanding, of which 1,945,278 are fully vested with an intrinsic value of $56,000. A summary of the activity in the Company’s stock option plans is as follows for the three months ended September 30, 2008:

 

 

Share Options
Outstanding

 

Weighted Average
Exercise

Outstanding, June 30, 2008

2,589,167

 

 

$1.58

 

Granted

625,000

 

 

$0.55

 

Outstanding, September 30, 2008

3,214,167

 

 

$1.38

 

 

NOTE 4.

SOFTWARE DEVELOPMENT COSTS

 

As of September 30, 2008 and June 30, 2008, net capitalized software development costs totaled $7,195,107 and $8,045,698, respectively. Total costs capitalized during the three months ended September 30, 2008 were $970,358. Accumulated amortization at September 30, 2008 and at June 30, 2008 totaled $5,051,968 and $4,499,108, respectively. Capitalized software development costs are amortized over a five-year period based on weighted average expected sales from the date the title is launched.

 

8



 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

NOTE 5.

INTANGIBLE ASSETS



 

The components of amortizable intangible assets as of September 30, 2008 and June 30, 2008 are as follows:

 

 

 

Estimated
Useful Life

 

Gross
Carrying Amount

 

Accumulated Amortization

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Game titles -- Strategy First

 

10 years

 

$

1,668,792

 

($549,451

)

$

1,119,341

 

Game titles – Empire Interactive

 

5 years

 

$

21,130,328

 

(17,421,459

)

$

3,708,869

 

Balance on September 30, 2008

 

 

 

$

22,799,120

 

($17,970,910

)

$

4,828,210

 



 

 

 

Estimated
Useful Life

 

Gross Carrying Amount

 

Accumulated Amortization

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Game titles -- Strategy First

 

10 years

 

$

1,713,520

 

($521,333

)

$

1,192,187

 

Game titles – Empire Interactive

 

5 years

 

$

23,198,600

 

(18,657,952

)

$

4,540,648

 

Balance on June 30, 2008

 

 

 

$

24,912,120

 

($19,179,285

)

$

5,732,835

 

 

Intangible assets that are subject to amortization are reviewed for potential impairment whenever events or circumstances indicate that carrying amounts may not be recoverable. Assets not subject to amortization are tested for impairment at least annually.

Amortization expense for intangible assets for the three month periods ended September 30, 2008 and September 30, 2007 were $487,245 and $2,111,666, respectively. Estimated amortization expense for the rest of fiscal year 2009 and for the succeeding five fiscal years is as follows:

 

2009

$1,001,980

2010

1,234,583

2011

1,107,898

2012

666,029

2013

357,862

2014

255,548

Thereafter

204,310

 

$4,828,210

 

NOTE 6.

CASH FLOWS

 

Changes in operating assets and liabilities consist of the following:

 

 

 

Three Months Ended September 30,

 

 

 

2008

 

2007

 

Decrease in accounts receivable

 

$

44,659

 

$

4,925,639

 

Increase in inventories

 

 

(319,850

)

 

(11,730

)

(Increase) decrease in prepaid expenses and current assets

 

 

(155,517

)

 

271,946

 

Software development costs capitalized

 

 

(258,866

)

 

(1,239,706

)

Decrease in accounts payable

 

 

(3,318,812

)

 

(1,985,620

)

Decrease in refundable deposits

 

 

--

 

 

(630,403

)

Increase (decrease) in accrued expenses

 

 

1,789,182

 

 

(844,255

)

 

 

 

($2,219,204

)

$

485,871

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

Issuance of shares of common stock for payment of accrued expenses

 

$

159,050

 

$

2,850,000

 



 

 

9



 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

ITEM 7.

 DEBT



Lines of Credit

In June 2002, the Company obtained a secured line of credit facility for borrowings up to $1.0 million, which is fully secured by cash balances held in the Company’s account. This liability is due on demand and has a floating interest rate that is based on the prime rate minus 1.75%. On September 30, 2008, the prime rate was 5.0%. The balance outstanding under this line of credit at September 30, 2008 and June 30, 2008 was $592 and $985,995, respectively.

Empire has a line of credit secured by its receivables, inventory, real property and intangible assets. As of September 30, 2008 and June 30, 2008 the amount outstanding under this facility was $1,171,519 (£644,517) and $632,169 (£316,813), respectively. The line of credit accrues interest at an annual rate of 9.5%. This line expired on June 30, 2008; however , it was extended to December 31, 2008.

Loan Payable – Related Party

 

On September 19, 2008, Clive Kabatznik, our Chief Executive Officer, loaned $260,000 to the Company to meet its short term needs.  The Company needed the loan because funds coming from its South African subsidiary were delayed. The unsecured loan was approved by the Company's Audit Committee, bears interest at a rate of 6% per annum, and was callable on demand. The Company received the funds from South Africa on October 31, 2008 and repaid the principal amount of the loan and accrued interest of $261,863.33 in full.

 

Notes Payable

 

At September 30, 2008 and June 30, 2008 the Company owed $2,428 and $2,666 in notes payable to former shareholders of Empire pursuant to the Offer made for the acquisition of Empire. This amount accrues interest at 4% per annum was payable on October 31, 2007. All note holders who have tended their notes have been paid in full.

The Company owed $115,938 as of September 30, 2008 as earn out consideration based on Empire’s EBITDA for the fiscal year ended June 30, 2007 that was payable on April 30, 2008. The balance on these notes at June 30, 2008 was $405,437 Interest accrued at 4% per annum beginning November 1, 2007.

NOTE 8.

CONVERTIBLE SECURED DEBENTURES

 

On October 19, 2006, the Company issued to DKR SoundShore Oasis Holding Fund Ltd. (the “Purchaser”) in the principal amount of $1,400,000 due October 31, 2008 (the “2006 Debenture”) which was extended to April 30, 2010. The 2006 Debenture is convertible at the option of the Purchaser, into shares of common stock at a conversion price of $1.738 per share.

The Company pays monthly interest on the outstanding principal amount of the 2006 Debenture at a rate per annum equal to the prime rate for the applicable interest period plus 1.5%.

The Purchaser and the Company amended the terms of the 2006 Debenture in June 2007. Under the terms of the amendment (i) there will be no amortization of principal under the 2006 Debenture; and (iii) the 2006 Debenture will be mandatorily convertible if the closing sale price of the Company’s common stock equals or exceeds $3.48 per share. This mandatory conversion is subject to volume requirements.

The Company’s obligations under the 2006 Debenture are secured by a lien on certain assets of the Company in favor of the Purchaser, and guaranteed by certain subsidiaries of the Company. In addition, the obligations of the Company under the 2006 Debenture are personally guaranteed by Mr. George Karfunkel. Mr. Karfunkel is compensated in the amount of 5% of the current principal outstanding amount of the 2006 Debenture per annum.

On March 19, 2008, the Company issued to accredited investors 9% Secured Convertible Debentures in the aggregate principal amount of $7,500,000 due March 19, 2012 and warrants to purchase an aggregate of 3,124,999 shares of the Company’s common stock, par value $.01 per share at an exercise price of $1.50 per share. The term of the warrants is five years.

 

The Debentures are convertible at any time, at the option of the purchasers, into shares of common stock at a conversion price of $1.2026 per share. However, if after the date that a registration statement covering the resale of the shares issuable upon conversion of the Debentures is effective, the average daily volume weighted average price of the common stock for 30 consecutive trading days exceeds $2.40, the Company may require the purchasers to convert all or part of their outstanding Debentures.

 

10



 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

The value of the warrants and the conversion feature of the debentures using the using the Black-Scholes option pricing model using the following weighted average assumptions: risk-free interest rate of 2.36%, dividend yields of 0% and a volatility factor of the expected market price of the Company’s common stock of 43.21% which resulted in the warrants being valued at $996,480 and the conversion feature being valued at $621,480. The warrants and the conversion feature are both being amortized using the straight line method over the term of the 2008 Debenture.

 

The Company’s obligations under the 2008 Debenture are secured by a lien on certain assets of the Company in favor of the Purchaser (except Empire Interactive PLC and Strategy First Inc.) and the Purchasers, and guaranteed by the shares and assets of certain subsidiaries of the Company. In addition, the obligations of the Company under the 2008 Debenture are personally guaranteed by Mr. George Karfunkel. Mr. Karfunkel is compensated in the amount of 6% of the current principal outstanding amount of the 2008 Debenture per annum.

 

The balance of the debentures as of September 30, 2008 and June 30, 2008, net of unamortized discounts was as follows:

 

 

September 30, 2008

 

June 30,
2008

 

Principal amount of debentures

$8,900,000

 

$8,900,000

 

Discounts for beneficial conversion features

(548,868)

 

(589,303)

 

Discounts for fair value of warrants and options

(889,704)

 

(956,060)

 

Balance, net of unamortized discounts

$7,461,428

 

$7,354,637

 

Less current portion

--

 

--

 

Long-term portion

$7,461,428

 

$7,354,637

 

 

Scheduled maturities of the convertible debentures as of September 30, 2008 are as follows:

 

1 Year or less

$  --  

April 30, 2010

1,400,000

March 19, 2012

 

7,500,000

Total

 

$8,900,000

 

Interest expense related to the debentures amounted to $197,126 and $63,892 during the quarters ended September 30, 2008 and 2007, respectively.

 

Amortization of discounts for the beneficial conversion features and warrants resulted in charges to Amortization of Convertible Debt Discounts and Issuance Costs totaling $106,792 and $127,194 during the fiscal quarters ended September 30, 2008 and 2007, respectively. The Company also incurred loan costs of $2,192,311 directly related to securing these debentures, which includes $1,020,000 paid for personal guarantees on the outstanding balances. The annual guarantees are equal to 5% of the outstanding loan balance on the 2006 Debentures and 6% of the 2008 Debentures. The loan costs were originally amortized over the term of the debentures. As a result of the amendment to the 2006 Debentures the remaining loan issuance costs are being amortized on a straight line method through April 30, 2010. Loan costs incurred in connection with the 2008 Debentures are being amortized on a straight line method through March 19, 2012. The annual guarantee fees are amortized over twelve months. Amortization expenses for the guarantee and debt issuance costs totaled $169,602 and $303,975 for the fiscal quarters ended September 30, 2008 and 2007, respectively.

 

Estimated amortization expense related to the warrants, beneficial conversion feature and costs related to securing these debentures through debt maturities is as follows:

 

2009

$655,500

2010

575,112

2011

522,788

2012

 

375,226

Total

 

$2,128,626

 

 

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SILVERSTAR HOLDINGS LTD - 10-Q

 

 

NOTE 9. 

COMMITMENTS, CONTINGENCIES AND LEGAL MATTERS

 

Other than as set forth below the Company is not currently a party to any material legal proceedings. The Company may from time to time become involved in legal proceedings in the ordinary course of business. It may not be successful in defending these or other claims. Regardless of the outcome, litigation can result in substantial expense and could divert the efforts of management.

 

In April 2006, the First South African subsidiary received a letter from the South African Revenue Service (“SARS”) challenging certain tax treatment of dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently SARS issued two tax assessments for approximately $2.9 million. The Company had contended that its South African tax filings were in full compliance with all applicable laws and had vigorously defended its position in this regard. The Company had retained an amount of cash equal to the assessments in South Africa to satisfy any potential liability that may arise.

In May, 2007, the Company through an arbitration procedure with SARS reached an agreement whereby SARS agreed in principle to drop the larger of its two assessments. The Company conceded the principle of SARS second assessment. On August 31, 2007, the Company paid approximately $300,000 to SARS in regard to this assessment. The Company is vigorously disputing a further amount of R5,394,708 (approximately $658,373 based on the March 31, 2008 foreign exchange of $.1235 US dollars to one South African Rand) and believes it has strong arguments in this regard based on among other factors, computational errors made by SARS in its assessment. Based on its payments to SARS, the Company has reduced its estimated liability to R2,216,286 (approximately $271,566) as of September 30, 2008. The Company believes its remaining liability to SARS is lower than this amount; however, in the event its arguments are unsuccessful, it may be forced to increase this liability. A court date has been set for December 2008 where this matter will be decided.

On March 29, 2006, Strategy First entered into an agreement to acquire certain intellectual property rights for $200,000 in cash and the issuance of options to acquire 100,000 shares of the Company’s common stock at an exercise price of $1.50. The options vest when net sales, as defined in the purchase agreement, exceed $750,000 and expire on December 31, 2008. The agreement also provides for commissions of twenty-five percent of net revenues in the event they exceed $500,000 through December 31, 2008. In August 2008, Strategy First entered into an early termination of this agreement for a net payment of $50,000. The Company does not anticipate any further payments or exercise of options under this agreement.

In August 2007, Empire was served with a lawsuit brought by a former distributor in Portugal. The lawsuit claims that Empire had no right to utilize other distributors in Portugal and seeks 630,000 Euros in damages. Empire believes this claim has no merit as its distribution agreements are tailored for individual products only and do not give blanket distribution rights to outside distributors. Empire has moved to dismiss the claim. A hearing is scheduled for November 2008.

On September 30, 2008, Empire owed approximately $580,117 (£319,184) for UK payroll taxes of which approximately $468,153 (£257,586) was past due. Payroll liabilities totaling approximately $115,444 (£63,518) for the month of August was paid in October with the agreement of the tax authorities and were not subject to penalties. As of September 30, 2008, the interest rate in effect for late tax payments was 7.50%. Interest is automatically charged for the period following April 19, 2007 on the amount that was still due at that date. In addition, the UK tax authorities have the power to charge this rate of interest on overdue payroll taxes in respect to periods prior to April 19, 2007; however in practice, this is rare.

On June 30,2008, the Company and Strategy First, Inc. entered into a settlement and termination agreement with 3A Entertainment, Inc. and Akella whereby we will receive a sum of $1.1 million paid over ten months beginning August 1, 2008, in lieu of claims that we might have had against Akella and 3A Entertainment. Additionally, should these settlement payments be made in a timely fashion, Akella and 3A Entertainment have the option to acquire certain intellectual property rights for the Jagged Alliance and Disciples franchises for an additional $200,000. The parties have also agreed to enter into further distribution agreements for these properties going forward. Due to the uncertainty of payment of these amounts, the Company will record the settlement payments as they are received. The Company through September 30, 2008 has received all scheduled payments to date.

 

In August 2008, the Company’s subsidiary, Silverstar Acquisitions, Ltd., received a demand notice from Ian Higgins and Simon Jeffrey for payment of approximately £180,000 ($340,000) in additional punitive interest in regards to the payment of their loan notes which were fully discharged in November 2007. The claim relates to penalty interest for an alleged failure to make timely payment on the amounts owed to them. The Company disputes the fact that these payments were late. No legal papers have been received in this matter. However, should the Company need to respond to a legal claim, it will vigorously defend itself in this regard.

 

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SILVERSTAR HOLDINGS LTD - 10-Q

 

 

During the quarter ended September, 2008, Empire Interactive, Inc. agreed to commit $265,000 for advertising and marketing expenses under a distribution agreement with Atari. The company has approximately $190,000 further to spend under this contract commitment as of September 30, 2008.

 

NOTE 10.

NEW ACCOUNTING PRONOUNCEMENTS

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measures. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.

 

Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes how to measure fair value based on a three-level hierarchy of inputs, of which the first two are considered observable and the last unobservable.

 

Level 1- Quoted prices in active markets for identical assets or liabilities.

 

Level 2- Inputs other than level1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

SFAS is effective for the Company’s fiscal year ended June 30, 2009. The Company adopted the provisions of SFAS No. 157 effective July 1, 2008. The adoption of SFAS No. 157 did not have a material impact on our fair value measurements.

 

In February 2008 the FASB issued FASB Staff Position No. 157-2 which provides for a one year deferral of the effective date of SFAS 157 for non- financial assets and non- financial liabilities, except for those that are recognized or disclosed in the financial statements at fair value at least annually.

 

On February 15, 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – including an Amendment of FASB Statement No. 115” (“FASB 159”). This standard permits an entity to measure financial instruments and certain other items at the estimated fair value. Most of the provisions of SFAS No. 159 are elective; however, the amendment to FASB No. 15, “Accounting for Certain Investments in Debt and Equity Securities,” applies to all entities that own trading and available-for-sale securities. The fair value option created by SFAS 159 permits an entity to measure eligible items at fair value as of specified election dates. The fair value option (a) may generally be applied instrument by instrument, (b) is irrevocable unless a new election date occurs, and (c) must be applied to the entire instrument and not to only a portion of the instrument. SFAS 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity (i) makes that choice in the first 120 days of that year, (ii) has not yet issued financial statements for any interim period of such year, and (iii) elects to apply the provisions of FASB 157. SFAS No. 159 is effective for the Company’s fiscal year ending June 30, 2009. The Company adopted the provision of SFAS No. 159 effective July 1, 2008. The adoption of SFAS No. 159 did not have a material impact on our condensed consolidated financial statements.

 

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SILVERSTAR HOLDINGS LTD - 10-Q

 

 

In December 2007, the FASB issued SFAS No. 141R, Business Combinations, or SFAS 141R. SFAS 141R  establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The provisions of SFAS 141R are effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company is currently assessing the financial impact of SFAS 141R on its consolidated financial statements.

 

In December 2007, the FASB issued SFAS 160, Non-controlling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51, or SFAS 160. SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” or ARB 51, to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement also amends certain of ARB 51’s consolidation procedures for consistency with the requirements of SFAS 141R. In addition, SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. The provisions of SFAS 160 are effective for fiscal years after December 15, 2008. Earlier adoption is prohibited. The Company is currently assessing the financial impact of SFAS 160 on the consolidated financial statements.

 

In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133. SFAS 161 amends SFAS 133 and changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently assessing the financial impact of SFAS 161 on the consolidated statements.

 

In May 2008, the FASB issued SAFS No. 162, The Hierarchy of Generally Accepted accounting Principles. The current GAAP hierarchy as set forth in the American Institutes of Certified Public Accountants (AICPA) Statement on Auditing Standards No.60, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, has been criticized because (1) it is directed to the auditor rather than the entity (2) it is complex and (3) it ranks FASB Statements of Financial Accounting Concepts. The FASB believes that the GAAP hierarchy should be directed to entities because it is the entity (not the auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. Accordingly, the FASB concluded that the GAAP hierarchy should reside in the accounting literature established by the FASB and is issuing SFAS to achieve that result. SFAS 161 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company is currently reviewing the provisions of SFAS162 to determine the impact, if any, on our consolidated financial statements

 

NOTE 11.

SUBSEQUENT EVENTS

 

On September 9, 2008, the Company and Empire Interactive entered into a term sheet with Full Circle Partners, LP whereby Empire would have been provided a senior secured revolving loan of up to $8 million, the terms of which have not been finalized. On November 7, 2008, the Company‘s subsidiary, Empire Interactive Europe, Limited, closed on a short-term loan with a commitment of up to $2.1 million with Full Circle Partners LP. As of November 12, 2008, Empire was loaned $1.427 million of this amount. This loan is secured by certain receivables of Empire Interactive Europe, Limited and Empire Interactive, Inc. as well as the shares of these companies and of Empire Interactive Holdings, Limited. The Company continues discussions with Full Circle toward completion of the longer term facility as contemplated in the September 9, 2008 Term Sheet. Details of the Full Circle loan are contained in the Company’s 8-K filed on November 13, 2008.

 

14



 


SILVERSTAR HOLDINGS LTD - 10-Q

 

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



 

The following discussion should be read in conjunction with the Company’s condensed consolidated financial statements and the related notes included therein and the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations include forward-looking statements. We have based these forward-looking statements on our current plans, expectations and beliefs about future events. Actual results could differ materially because of factors discussed in “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended June 30, 2008.

Background and History

We were incorporated in September 1995. Our business plan is to actively manage and grow our presence in the interactive software entertainment industry both organically and through acquisitions.

We sold our last remaining South African operations in November 2000 although we still have significant assets that are denominated in South African Rand. The assets include cash and notes receivables. Currently we do not have a financial hedging program to protect against the depreciation of the South African Rand against the US dollar and, therefore, as long as we hold assets denominated in South African Rand we will continue to record income statement gains or losses to the extent that the South African Rand’s value fluctuates relative to the US dollar.

On April 21, 2005, we acquired Strategy First, a leading worldwide publisher of entertainment software for the PC. We acquired Strategy First through the approval and jurisdiction of the Montreal bankruptcy court.

On December 4, 2006, we announced that we had achieved more than 90% acceptance of our offer to acquire the shares of Empire. Based on these acceptances, we announced a formal closing of the offer to Empire shareholders effective December 1, 2006.

 

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SILVERSTAR HOLDINGS LTD - 10-Q

 

 

Quarter Ended September 30, 2008 As Compared to Quarter Ended September 30, 2007

Revenues

Revenues increased $4.943 million to $8.822 million during the first quarter of fiscal year 2009 as compared to $3.879 million in the comparable quarter of the previous year. This increase was primarily the result of increased revenues of Empire of $ 5.117 million versus $3.367 in the same period in the prior year. The increase was driven by an increase in both European and US sales. Most notably we sold approximately $2.5 million in the US during this quarter as opposed to no sales in the comparable period in fiscal year 2008. Strategy First’s revenue decreased in the same period in the prior year from $.512 million to $.337 million primarily due to lower retail sales. Empire’s revenue is derived primarily from sales of console games and PC games while Strategy First solely sells PC games.

Cost of Sales

The cost of sales was $3.949 million in the first quarter of fiscal year 2009, or 44.8% of total revenues. For the comparable quarter of the previous year, cost of sales was $1.599 million or 40.9% of revenues. Of this $2.457 million increase $2.388 million was primarily the result of increased sales of Empire. The higher percentage of cost of sales is primarily due to the increased proportion of Nintendo DS sales which carry lower gross margins than other console or PC products. The cost of goods sold consists primarily of the actual tangible costs of the product along with any labor and overhead costs.

Development and Royalties

Development and royalty costs decreased $15,000 for the first quarter of fiscal year 2009 to $.612 million as compared to $.614 million in the comparable quarter of the previous year. Empire’s development and royalty costs decreased by $19,000 during the quarter. This was primarily due to the sale of its Razorworks development studio in July 2008. The development and royalty expense consists primarily of royalty expenses due to third party holders of intellectual property rights. Additionally, it includes certain development costs which are not capitalized. These costs are primarily related to the oversight and quality control of development projects. These costs are primarily reflected in the Company’s payroll expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the first quarter of fiscal year 2009 were $3.091 million, or 35.04% of sales, as compared to $2.958 million, or 76.27% of sales, for the comparable quarter of the previous year. Of this variance, Empire showed an increase of $.216 million which was primarily due to an increase in selling costs due to increased sales. Selling expenses increased $.142 million to $.520 million this quarter versus $.378 million in the comparable quarter in the prior year. Empire’s SG&A consists primarily of administrative, marketing and sales staff primarily in the UK. Strategy First’s sales general and administrative expense decreased by $.086 million primarily as the result of decreased staff and lower sales.

Amortization and Depreciation

Amortization of software development costs increased $.520 million to $1.109 million in the first quarter of fiscal year 2009 as compared to $.59 million in the comparable period last year. This increase is primarily due to the change in accounting policy whereby we began capitalizing software development costs when we acquired Empire in December 2006. The accumulated capitalization of such costs was lower in the first quarter last year and, therefore, the amortized expense was commensurately lower as well.  Amortization of intangible assets in the first quarter of fiscal year 2009 decreased $1.624 million to $.487 million as compared to $2.12 million in the comparable quarter of the previous year. This decrease was caused by an impairment charge to the intangible assets of Empire in the amount of $8.605 million during the last quarter of the prior fiscal year. The current carrying value of the Company’s intangible assets at September 30, 2008 is $4.828 million as compared to $19.117 million at the same time last year. Depreciation expense was $.054 million for the first quarter of fiscal 2009 and $.043 million in the comparable quarter of the previous year.

 

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SILVERSTAR HOLDINGS LTD - 10-Q

 

 

Foreign Currency Gains (Losses)

Foreign currency gains or losses are primarily related to the financial assets remaining in South Africa and the operating results of our subsidiaries which sell products in different international currencies. Foreign currency losses during the first quarter of fiscal year 2009 were $.161 million of which $.033 million is related to the remaining assets of $1.41 million we have in South Africa and $.128 million relates to our operating subsidiaries. The foreign currency gains during the comparable quarter of the previous fiscal year were $.134 million and consisted of $.045 million related to the remaining assets from the sale of discontinued South African operation and $.089 million recognized by our operating subsidiaries. The functional currency of Empire Interactive and Strategy First are the British pound and the Canadian dollar, respectively. Their products are sold throughout North America and Europe. Gains (losses) from discontinued South African operations are the result of fluctuations of the South African Rand against the US dollar. The UK pound depreciated 8.92% against the US dollar for the quarter ended September 30, 2008, while it appreciated 2.19% in the corresponding period last year. For the first quarter of fiscal year 2009 the Rand depreciated 2.93% against the US dollar while it appreciated approximately 2% in the corresponding period last year. These foreign currency gains or losses are non-cash items until converted into US dollars or the domestic currencies of our operating subsidiaries, when any accumulated gains or losses will be converted to cash.

Amortization of Convertible Debt Discounts and Issuance Costs

Amortization of convertible debt discounts and issuance costs were $.276 million in the first quarter of fiscal 2009 as compared with $.431 million during the comparable quarter in the previous year. This decrease was primarily due to one time non-cash charges associated with the conversion of a substantial portion of our $5 million convertible debenture to DKR SoundShore which occurred in the first quarter of fiscal year 2008.

Interest Income

Interest income of $.022 million was recorded for the first quarter of fiscal year 2009 as compared to interest income of $.069 million for the comparable quarter of the previous year. The decrease is primarily the result of the Company’s average lower cash balances.

Interest Expense

Interest expense of $.243 million was recorded for the first quarter of fiscal year 2009 as compared to $.168 million in the comparable quarter of the previous year. Interest expense increased primarily as the result of an increase in the Company’s convertible debt. At September 30, 2008, this amount was $7.461 million of convertible debt as compared to $6.960 million at the same time last year, which was primarily acquisition debt.

Provision for Income Taxes

The Company is registered in Bermuda, where no income tax laws are applicable. Two subsidiaries are subject to US income taxes, four subsidiaries are subject to UK income taxes, one subsidiary is subject to Canadian income taxes and one of the subsidiaries is subject to South African income taxes. None of them has had taxable income because each of them has incurred losses for tax purposes. The deferred tax asset generated by the tax losses and temporary differences has been fully reserved including those of Empire in the UK.

In April 2006, the First South African subsidiary received a letter from the South African Revenue Service (“SARS”) challenging certain tax treatment of dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently SARS issued two tax assessments for approximately $2.9 million. The Company had contended that its South African tax filings were in full compliance with all applicable laws and had vigorously defended its position in this regard. The Company had retained an amount of cash equal to the assessments in South Africa to satisfy any potential liability that may arise.

In May 2007, the Company through an arbitration procedure with SARS reached an agreement whereby SARS agreed in principle to drop the larger of its two assessments. The Company conceded the principle of SARS second assessment. On August 31, 2007, the Company paid approximately $300,000 to SARS in regard to this assessment. The Company is vigorously disputing a further amount of approximately $770,000 and believes it has strong arguments in this regard based on among other factors, computational errors made by SARS in its assessment. Based on its payments to SARS, the Company has reduced its estimated liability to approximately $271,000 as of September 30, 2008. The Company believes its remaining liability to SARS is lower than this amount, however, in the event its arguments are unsuccessful, it may be forced to increase this liability. The case is scheduled to be heard in court in December 2008 when the matter should be decided.

 

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SILVERSTAR HOLDINGS LTD - 10-Q

 

 

Net Loss

 

We have recognized a net loss of $.659 million during first quarter of fiscal year 2009 compared to a net loss of $4.447 million during the same comparable quarter in the previous year. The decrease was primarily driven by an operating profit of $.097 million at Empire Interactive as compared to an operating loss of $3.4 million in the comparable period in fiscal year 2008. Empire’s operating improvement was primarily caused by significantly increased sales and lower overhead as well as a decrease of approximately $1.5 million in the amortization of Empire’s intangible assets. This was partially offset by an increase of approximately $.520 million in the amortization of development costs at Empire. Adjusted operating EBITDA (earnings before interest, taxes, depreciation and amortization and non-cash compensation expenses) was $1.3 million as compared to a loss of $1.190 million in the comparable period in fiscal year 2008

 

 

Quarters Ended
September 30,

 

(000s except per share amounts)

2008

 

2007

 

Operating EBITDA reconciliation:

 

 

 

 

Operating loss

($481

)

($4,037

)

Depreciation

54

 

44

 

Amortization of intangibles

487

 

2,112

 

Amortization of software development costs

1,109

 

590

 

Non-cash compensation

   117

 

102

 

Operating EBITDA

$1,286

 

($1,190

)

Operating EBITDA per share

.06

 

(0.09

)

Weighted average number of shares outstanding

20,067

 

12,783

 

 

Financial Condition, Liquidity and Capital Resources

Cash decreased by $1.265 million from $2.892 million at June 30, 2008 to $1.627 million at September 30, 2008. This was primarily the result of repayment of a working capital line of approximately $1 million held by Strategy First, which was secured by like corporate cash balances.

Cash balances are being held for working capital purposes. Included in this amount is $.658 million which is classified as restricted cash. This amount relates to money retained in South Africa to satisfy any potential liability that may result from our tax dispute with the South Africa Revenue Service.

Working capital deficit decreased by $.948 million from a deficit $5.453 million at June 30, 2008 to a deficit of $4.566 million at September 30, 2008. This decrease is primarily due to the result of significant reductions in net current liabilities due to improved operation performance of Empire Interactive as well as a decrease in the exchange rate of the UK pound to the US dollar.

At September 30, 2008, we had net borrowings of $1.172 million which consisted of Empire’s outstanding line of credit at Barclays Bank. Additionally, we have $8.900 million face amount outstanding of our convertible debentures. The carrying value of these debentures at September 30, 2008 net of unamortized warrants and stock conversion features is approximately $7.461 million. We currently pay monthly interest on our debentures. $1.4 million of this amount carries an annual rate of prime plus 1.5%, with the remainder at an annual rate of 9%.

As shown in the condensed consolidated financial statements, the Company has incurred recurring losses from operations, negative cash flows from operation, and as of September 30, 2008, the Company’s current liabilities exceeded its current assets by $4.57 million. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company plans to meet its ongoing cash requirements as follows:

 

Generate significant short term operating earnings and cash flow primarily through its Empire subsidiary. Empire’s title release schedule for the next 12 months includes several multi-platform games most notably Hello Kitty and sequels to its successful Animal Paradise DS game. The Company anticipates that the launch of these games, along with Empire’s ongoing business will generate operating profits and cash flow in the short term. Empire continues to explore European and US distribution agreements with major entertainment publishers which would provide significant short term cash flow.

 

 

 

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On September 9, 2008, the Company and Empire Interactive entered into a term sheet with Full Circle Partners, LP whereby Empire would have been provided a senior secured revolving loan of up to $8 million, the terms of which have not been finalized. On November 7, 2008, the Company‘s subsidiary, Empire Interactive Europe, Limited, closed on a short-term loan with a commitment of up to $2.1 million with Full Circle Partners LP. As of November 12, 2008, Empire was loaned $1.427 million of this amount. This loan is secured by certain receivables of Empire Interactive Europe, Limited and Empire Interactive, Inc. as well as the shares of these companies and of Empire Interactive Holdings, Limited. The Company continues discussions with Full Circle toward completion of the longer term facility as contemplated in the September 9, 2008 Term Sheet. Details of the Full Circle loan are contained in the Company’s 8-K filed on November 13, 2008.

 

 

Raise additional capital through the sale of certain intellectual property. The Company will retain a London based investment banker to sell certain of its intellectual property.

 

 

The Company has approximately $.658 million of restricted cash set aside to match its current South African tax assessment. The Company believes that it has strong arguments to set aside this assessment. If this assessment is set aside, this cash would be available for operations. A court hearing in this matter is scheduled for early December of 2008.

 

Management believes that these actions and others to be taken by the Company will provide the opportunity for it to improve liquidity and achieve profitability. In addition, the Company believes that if they close on the $8 million loan in calendar year 2008, they would be able to sustain operations through fiscal year 2009. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. However, there can be no assurance that any of these events will occur.

 

Critical Accounting Policies

The following is a discussion of the accounting policies that we believe are critical to our operations:

Revenue Recognition

The company distributes the majority of its products through third-party software distributors to mass-merchant and major retailers and directly to certain PC software retailers, all of which have traditionally sold consumer entertainment software products. Additionally, the Company may license its products to distributors in exchange for royalty payments. The distribution of products is governed by purchase orders, distribution agreements or direct sale agreements, most of which allow for product returns and price markdowns. On a product by product basis, based on historical data the Company records a provision from 4% to 30% for product returns and price markdowns as a reduction of gross sales at the time the product passes to these distributors or retailers.

The provision for anticipated product returns and price markdowns is primarily based upon the Company’s analysis of historical product return and price markdown results. Should product sell-through results at retail store locations fall significantly below anticipated levels the adequacy of this allowance may be insufficient. The Company will review the adequacy of its allowance for product returns and price markdowns and if necessary will make adjustments to this allowance on a quarterly basis. In the case of royalty income, the Company will record this income when earned based on sales reports from its distributors. In many cases, the company receives guaranteed royalty income and these revenues are recorded upon signing of the royalty agreements. These amounts are carried as accounts receivable until paid.

Development Costs

Under SFAS No. 86 software development cost should be capitalized once technical feasibility is achieved. In the case of Empire this would be when the product is commercially viable (“commercial feasibility), The Company has determined to its satisfaction that there is a clearly defined decision point quite early in development where a product passes from concept to commercial feasibility. This decision point is either reached with the consent of outside parties such as Sony or Microsoft or through an internal process where management decides to move

 

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forward with a product’s development once a game concept has been approved. The Company also found that there has been no material instance where concept approval has been given and a game has not become a commercial product. The Company has, therefore, decided to capitalize software development costs after concept approval.

Goodwill Valuation

Goodwill represents the excess of the purchase price over the fair market value of net assets acquired. The process of determining goodwill requires judgment. Evaluating goodwill for impairment involves the determination of the fair value of our reporting units. Inherent in such fair value determinations are certain judgments and estimates, including the interpretation of current economic indicators and market valuations, and our strategic plans with regard to our operations. To the extent additional information arises or our strategies change, it is possible that our conclusion regarding goodwill impairment could change, which could have a material effect on our financial position and results of operations. For those reasons, we believe that the accounting estimate related to goodwill impairment is a critical accounting estimate.

The Company reviews goodwill annually (or more frequently under certain conditions) for impairment in accordance with SFAS No. 142, goodwill and other intangible assets. The Company performed its annual impairment test of goodwill as of June 30, 2008 and determined that goodwill was impaired which resulted in the Company writing down to zero the Goodwill that was recognized as a component of the Strategy First acquisition.

Intangible Assets

Intangible assets include software game titles. Intangible assets, excluding goodwill and Empire game titles are stated on the basis of cost and are amortized on a straight-line basis over estimated lives of three to ten years. Empire game titles are amortized over a five-year period based on weighted average expected sales from the date the title is launched. For titles that have not yet been launched as of September 30, 2008 a launch date was estimated to project future amortization.

Intangible assets with indefinite lives are not amortized but are evaluated for impairment annually unless circumstances dictate otherwise. Management periodically reviews intangible assets for impairment based on an assessment of undiscounted future cash flows, which are compared to the carrying value of the intangible assets. Should these cash flows not equal or exceed the carrying value of the intangible, a discounted cash flow model is used to determine the extent of any impairment charge required.

Forward-Looking Information

We make numerous forward-looking statements throughout this report including statements with respect to our expected income, acquisitions and other growth opportunities, performance of investments that we have made, and operating expenses. Frequently these statements are introduced with words such as “expect,” “likely,” “will,” “believe,” “estimate,” “project,” “anticipate,” or “predict.” Actual results may differ materially from those suggested by the forward-looking statements that we make for a number of reasons including those described in Part I, Item 1A, “Risk Factors” of our report on Form 10-K for the year ended June 30, 2008.

We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

 

 

The Company does not ordinarily hold market risk sensitive instruments for trading purposes. The Company does, however, recognize market risk from interest rate and foreign currency exchange exposure.

 

Interest Rate Risk

 

On September 30, 2008, the cash resources earned interest at variable rates. Accordingly, the Company’s return on these funds is affected by fluctuations in interest rates. The Company also has significant debt that is tied to interest rates and, therefore, any increase in interest rates will have a negative effect on the Company’s interest payments. At September 30, 2008, the Company had two convertible notes outstanding with a combined balance

 

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of approximately $8.9 million. Interest on $1.4 million of these convertible notes is based on a floating rate equal to prime plus 1.5%. A hypothetical 100 basis point change in interest rates would result in an approximate $89,000 change in annual interest expense.

In addition to the convertible debentures the Company had a secured line of credit facility at September 30, 2008. Based on the September 30, 2008 balance on this facility, a hypothetical 100 basis point change in interest rates would result in an approximately $10,000 change in annual interest expense.

Empire has a line of credit secured by its receivables, inventory, real property and intangible assets. As of September 30, 2008, the amount outstanding under this facility was approximately $1,172,000. The line of credit accrues interest at an annual rate of 8.25%. A hypothetical 100 basis point change in interest rates would result in an approximately $11,720 change in annual interest expense.

Foreign Currency Risk

Empire is incorporated in the UK and sells products throughout Europe, the US and Canada. Its functional currency is the British pound. This has exposed the Company to market risk with respect to fluctuations in the relative value of the Euro, the Canadian dollar, and the US dollar.

Strategy First is incorporated in Canada and sells products throughout the US and Europe. Its functional currency is the Canadian dollar. This has exposed the company to market risk with respect to fluctuations in the relative value of the Euro, British Pound, the Canadian dollar, and the US dollar.

Certain of the Company’s cash balances and the remaining proceeds from the sale of its South African subsidiaries are denominated in South African Rand. This has exposed the Company to market risk with respect to fluctuations in the relative value of the South African Rand against the US dollar.

The Company currently does not hedge its South African Rand exposure. At September 30, 2008, we had assets denominated in South African Rand of R 17.6 million ($2.5 million).

 

 

Disclosure of Controls and Procedures

 

The Company maintains disclosure controls and procedures designed to ensure that it is able to collect the information it is required to disclose in the reports it files with the SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on an evaluation of its disclosure controls and procedures as of the end of the period covered by this report conducted by management, with the participation of the Chief Executive Officer and Chief Financial Officer, the Chief Executive Officer and Chief Financial Officer believe that these controls and procedures are effective.

 

Changes in Internal Controls

 

There have been no changes in the Company’s internal controls over financial reporting for the quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

 

Except as set forth below, there were no new material legal proceedings or material developments to the pending legal proceedings that have been previously reported in Part I, Item 3 of our Annual Report on Form 10-K for the fiscal year ended June 30, 2008. A full discussion of our pending legal proceedings is also contained in Part I, Item 1, "Notes to Condensed Consolidated Financial Statements (Unaudited),” Note 10, of this Report.

 

In August 2008 the Company’s subsidiary, Silverstar Acquisitions, Ltd., received a demand notice from Ian Higgins and Simon Jeffrey for payment of approximately £180,000 ($340,000) in additional punitive interest in regards to the payment of their loan notes which were fully discharged in November 2007. The claim relates to penalty interest for an alleged failure to make timely payment on the amounts owed to them. The Company disputes the fact that these payments were late and that this punitive interest is enforceable under English law. No legal papers have been received in this matter. However, should the Company need to respond to a legal claim, it will vigorously defend itself in this regard.

 

ITEM 1A.

RISK FACTORS

 

There have been no material changes in the risks facing the Company as described in the Company’s Form 10-K for the year ended June 30, 2008 except as follows:

 

Uncertainty and adverse changes in the economy could have a material adverse impact on our business and operating results.

 

Uncertainty or adverse changes in the economy could lead to a significant decline in discretionary consumer spending, which, in turn, could result in a decline in the demand for our products. As a result of the recent national and global economic downturn, overall consumer spending has declined. Retailers globally, and particularly in North America, appear to be taking a more conservative stance in ordering game inventory. Any decrease in demand for our products, particularly during the critical holiday selling season or other key product launch windows, could have a material adverse impact on our operating results and financial condition. Uncertainty and adverse changes in the economy could also increase the risk of material losses on our investments, increase the cost and decrease the availability of potential sources of financing, and increase our exposure to material losses from bad debts, any of which could have a material adverse impact on our financial condition and operating results.

 

In addition, periods of economic uncertainty and changes may result in increased volatility in our stock price.

We are exposed to exchange rate fluctuations.

 

The Company's reporting currency is the United States dollar.  Historically, the Company's foreign operations, including assets and liabilities and revenues and expenses, have been denominated in various currencies other than the United States dollar, and we expect that our foreign operations will continue to be so denominated. As a result, the United States dollar value of the Company's foreign operations has varied, and will continue to vary, with exchange rate fluctuations. The Company has been, and is presently, primarily exposed to fluctuations in the exchange rate of the Euro, British Pound, Pound Sterling, South African Rand and Canadian Dollar.  A decrease in the value of any of these currencies relative to the United States could reduce the Company's profits from foreign operations and the value of the net assets of its foreign operations when reported in United States dollars in its financial statements. This could have a material adverse effect on the Company's business, financial condition or results of operations as reported in United States dollars.  In addition fluctuations in currencies relative to currencies in which the earnings are generated may make it more difficult to perform period-to-period comparisons of the Company's reported results of operations.

 

 

None.

 

 

None.

 

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ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



 

None.

 

 

None.

 

ITEM 6.

EXHIBITS

 

 

 

 

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SILVERSTAR HOLDINGS LTD - 10-Q

 

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned duly authorized.

Date: November 14, 2008

SILVERSTAR HOLDINGS, LTD.
 

/s/ Clive Kabatznik

Clive Kabatznik

Chief Executive Officer
 
 

/s/ Lawrence R. Litowitz

Lawrence R. Litowitz

Chief Financial Officer



 

 

 

 

 

 

 

 

 

 



 

 

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