<PAGE>
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 October 31, 1998
OR
[ ] 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 0-20835
THE LEAP GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-4079500
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
22 West Hubbard Street, Chicago, Illinois 60610, (312) 494-0300
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
N/A
(Former Name, Former Address & 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 periods as 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
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Outstanding Shares at
Class December 9, 1998
------------------------------ ---------------------
Common Stock - $0.01 par value 13,598,866
1
<PAGE>
The Leap Group, Inc.
Form 10-Q
for the period ended
October 31, 1998
Index
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets --
October 31, 1998 (Unaudited)
and January 31, 1998 3
Consolidated Statements of Operations --
Three Months Ended and Nine Months Ended
October 31, 1998 and 1997 (Unaudited) 5
Consolidated Statements of Cash Flows --
Nine Months Ended
October 31, 1998 and 1997 (Unaudited) 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 17
2
<PAGE>
Part I. Financial Information
Item 1. Financial Statements
THE LEAP GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
October 31, January 31,
----------- -----------
1998 1998
---- ----
(unaudited)
ASSETS
<S> <C> <C>
Current Assets
Cash and cash equivalents.................................................. $12,346,377 $ 7,214,261
Accounts receivable (net of allowance of
$730,916 and $859,611, respectively)..................................... 6,466,635 6,348,071
Costs in excess of billings (net of allowance of
$10,374 and $85,374, respectively)....................................... 871,199 951,214
Prepaid expenses........................................................... 347,575 249,203
Refundable income taxes.................................................... 320,000 320,000
Deferred income tax asset (Note 5)......................................... - 530,000
----------- -----------
Total current assets..................................................... 20,351,786 15,612,749
----------- -----------
Property and Equipment
Land....................................................................... 158,921 158,921
Building and building improvements......................................... 493,473 504,472
Leasehold improvements..................................................... 933,870 1,255,062
Computer equipment......................................................... 1,702,161 3,606,318
Furniture and equipment.................................................... 396,448 1,197,926
----------- -----------
3,684,873 6,722,699
Less accumulated depreciation.............................................. (806,430) (1,528,867)
----------- -----------
Net property and equipment............................................... 2,878,443 5,193,832
----------- -----------
Other Assets
Building held for sale..................................................... - 2,321,689
Intangible assets.......................................................... - 17,596,464
Deferred income tax asset (Note 5)......................................... - 2,430,061
Other assets............................................................... 106,918 2,899,426
----------- -----------
Other assets............................................................. 106,918 25,247,640
----------- -----------
Total Assets................................................................. $23,337,147 $46,054,221
=========== ===========
</TABLE>
3
<PAGE>
THE LEAP GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
October 31, January 31,
----------- -----------
1998 1998
---- ----
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current Liabilities
Accounts payable........................................................... $ 2,155,223 $ 4,579,435
Accrued expenses........................................................... 752,123 1,207,237
Accrued restructuring (Note 4)............................................. 775,149 630,000
Billings in excess of costs................................................ 3,860 394,760
Notes payable (Note 6)..................................................... 4,729,186 7,613,478
Current portion of capital lease obligations............................... 363,651 368,006
------------ -----------
Total current liabilities................................................ 8,779,192 14,792,916
Long-Term Liabilities
Capital lease obligations.................................................. 142,971 420,591
------------ -----------
Total Liabilities............................................................ 8,922,163 15,213,507
------------ -----------
Commitments and Contingencies (Note 7)
Stockholders' Equity
Preferred stock, $.01 par value, 20,000,000 shares authorized,
no shares issued or outstanding.......................................... - -
Common stock, $.01 par value; 100,000,000 shares authorized,
13,648,866 and 13,636,866 shares issued and outstanding as of
October 31, 1998 and January 31, 1998, respectively...................... 136,489 136,369
Additional paid in capital................................................. 35,680,845 35,600,964
Retained earnings.......................................................... (21,251,220) (4,745,489)
less cost of 50,000 shares of common stock held in treasury................ (151,130) (151,130)
------------ -----------
Total Stockholders' Equity............................................. 14,414,984 30,840,714
------------ -----------
============ ===========
Total Liabilities and Stockholders' Equity................................... $ 23,337,147 $46,054,221
============ ===========
</TABLE>
The accompanying notes to the financial statements are an integral part of these
statements.
4
<PAGE>
THE LEAP GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
October 31, October 31,
----------- -----------
1998 1997 1998 1997
------------ ----------- ------------ -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues................................ $ 8,410,295 $ 7,182,491 $ 27,776,301 $19,226,576
Operating expenses:
Direct costs and related
Expenses............................. 3,389,358 2,779,777 11,004,189 7,850,803
Salaries and related expenses......... 3,967,401 4,970,052 12,425,255 12,937,968
General and administrative
Expenses............................. 2,533,471 3,225,856 6,695,381 7,052,889
Impairment of long-term assets........ 9,239,814 - 9,239,814 -
Restructuring expense................. 738,494 1,149,712 738,494 1,149,712
------------ ----------- ------------ -----------
Total operating expenses........... 19,868,538 12,125,397 40,103,133 28,991,372
------------ ----------- ------------ -----------
Operating loss.......................... (11,458,243) (4,942,906) (12,326,832) (9,764,796)
Loss on divestitures (1,802,306) - (1,802,306) -
Gain on sale of building - - 1,154,588 -
Net interest (expense) / (27,074) (45,657) (146,125) 347,067
income................... ------------ ----------- ------------ -----------
Loss before income taxes................ (13,287,623) (4,988,563) (13,120,675) (9,417,729)
Income tax benefit /
(expense)................ (3,306,988) 1,949,968 (3,385,056) 3,672,914
------------ ----------- ------------ -----------
Net loss................................ $(16,594,611) $(3,038,595) $(16,505,731) $(5,744,815)
============ =========== ============ ===========
Net loss per share
Basic & Diluted....................... $ (1.22) $ (0.22) $ (1.21) $ (.42)
============ =========== ============ ===========
</TABLE>
The accompanying notes to the financial statements are an
integral part of these statements.
5
<PAGE>
THE LEAP GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
October 31,
-----------
1998 1997
---- ----
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................ ($16,505,731) ($5,744,815)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization....................................... 2,743,424 1,356,767
Deferred income taxes (Note 5)...................................... 2,960,061 (3,672,314)
Loss on divestiture (Note 3)........................................ 1,802,306 -
Restructuring reserves (Note 4)..................................... 738,494 1,149,712
Gain on sale of building............................................ (1,154,588) -
Impairments of long-term assets (Note 4)............................ 9,239,814 -
Changes in operating assets and liabilities:
Accounts receivable............................................... (805,638) 4,064,593
Costs in excess of billings....................................... (295,036) (45,646)
Prepaid expenses.................................................. (98,372) (131,487)
Other assets...................................................... (76,172) 57,744
Accounts payable.................................................. (2,876,255) 1,102,056
Accrued expenses.................................................. 744,209 (1,504,260)
Billings in excess of costs....................................... (390,900) (251,052)
------------ ------------
Net cash used in operating activities.................................... (3,974,384) (3,618,702)
------------ ------------
Cash flows from investing activities:
Acquisition, net of cash................................................ - (22,667,891)
Business divestitures (Note 3).......................................... 5,300,000 -
Release of escrow monies in connection with YAR......................... 2,725,186 -
Proceeds from sale of LA building....................................... 3,476,277 -
Capital expenditures.................................................... (1,009,185) (3,579,751)
Capitalized software development costs.................................. (119,283) (524,512)
Repayment / issuance of notes receivable................................ 1,819,770 (1,773,778)
------------ ------------
Net cash provided by / (used in) investing activities................... 12,192,765 (28,545,932)
------------ ------------
Cash flows from financing activities:
Net outlays related to common stock issuance............................ 80,002 (1,544)
Payments for treasury stock............................................. - (151,130)
Net borrowings/(repayments) on:
Notes payable......................................................... (2,884,292) 6,116,240
Mortgage payable...................................................... - -
Repayment of capital lease financing.................................. (281,975) (48,881)
------------ ------------
Net cash (used in) / provided by financing activities................... (3,086,265) 5,914,685
------------ ------------
Net (decrease) / increase in cash and cash equivalents.................... 5,132,116 (26,249,949)
Cash and cash equivalents, at beginning of period......................... 7,214,261 32,312,749
------------ ------------
Cash and cash equivalents, at end of period............................... $ 12,346,377 $ 6,062,800
------------ ------------
Supplementary disclosure of cash paid during the period:
Interest paid........................................................... $ 432,571 $ 750,347
Taxes paid.............................................................. $ 299,418 $ -
Schedule of noncash investing and financing activities:
Equipment purchased under capital lease
Obligations........................................................... $ - $ 829,478
</TABLE>
- -----------
The accompanying notes to the financial statements are an integral part of these
statements.
6
<PAGE>
THE LEAP GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- Basis of Presentation
The accompanying unaudited consolidated financial statements and related notes
to the consolidated financial statements include the results of The Leap Group,
Inc. (the "Company") and its wholly-owned subsidiaries.
The unaudited consolidated financial statements for the three and nine month
periods ended October 31, 1998 and 1997, respectively, reflect all adjustments
(consisting only of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of the financial position and
operating results for the interim periods.
The consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto, together with management's
discussion and analysis of financial condition and results of operations,
contained in the Company's Annual Report on Form 10-K as filed with the
Securities and Exchange Commission on May 1, 1998.
In April 1997, the Company acquired YAR Communications, Inc. ("YAR") and in
November 1997, the Company also acquired One World Communications, Inc., which
consists of Kang & Lee Advertising and K&L West Advertising (jointly referred to
as "Kang & Lee" or "One World"). In accordance with the purchase accounting
method, YAR's and One World's results have been included within the Company's
results since their respective acquisition dates of April 1, 1997 and November
1, 1997. Due to the sale of One World as described in Note 3, One World's
results have only been included through the effective closing date of September
30, 1998.
The results of operations for the three and nine month periods ended October 31,
1998 are not necessarily indicative of the results of operations to be expected
for the entire fiscal year ending January 31, 1999.
NOTE 2 -- Net Income Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128,
Earnings Per Share. SFAS No. 128 changed the methodology of calculating earnings
per share and requires the disclosure of basic earnings per share and diluted
earnings per share. The calculation of basic earnings per share excludes
dilutive common stock equivalents and convertible securities (such as stock
options, warrants and convertible preferred stock) which are included in the
diluted earnings per share calculation under the treasury method.
The Company adopted SFAS No. 128 in fiscal 1998 and has retroactively restated
all periods presented. The weighted average number of common shares used in
determining basic and diluted income (loss) per share attributable to common
stockholders for the three and nine months ended October 31, 1998 and 1997 is as
follows:
<TABLE>
<CAPTION>
Three Months Ended October 31, Nine Months Ended October 31,
------------------------------ -----------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Common shares outstanding--Basic 13,648,866 13,614,667 13,646,199 13,613,037
Common stock equivalents - - - -
---------- ---------- ---------- ----------
Common shares outstanding--Diluted 13,648,866 13,614,667 13,646,199 13,613,037
</TABLE>
NOTE 3 -- Divestitures
During the current quarter, the Company completed the sale of various assets of
its One World subsidiary and the transfer of the AT&T account of YAR
Communications, Inc. (see Note 4). This transaction resulted in a combined
pretax loss of $1.8 million in the current quarter, which reflects the sale of
various assets of the One World subsidiary and approximately $6.5 million of YAR
goodwill related to the AT&T account. As consideration for the sale, the Company
received $5.3 million in cash on October 22, 1998. Additional consideration of
up to $1.5 million may be received in the fourth quarter after the resolution of
a net tangible assets audit.
7
<PAGE>
NOTE 4 -- Restructuring Plan and Other Unusual Charges
The Company recorded pretax restructuring charges of $738,000 during the three
months ended October 31, 1998. The cost of the plan has been accounted for in
accordance with the guidance set forth in Emerging Issues Task Force issue 94-3
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (Including Certain Costs Incurred in a Restructuring)". The
Company implemented the plan to restructure the YAR operations as a result of
losses and due to the transfer of the account of its largest client (see Note 3
and below). As a result of the plan, a layer of executive management was
replaced with officers from the holding company. Under the new management,
office space was consolidated, property and other long-lived assets were
reviewed for future utility, and additional cost saving opportunities have been
identified and are currently being pursued. The pretax charge of $738,000 is
comprised of employee termination costs, lease termination costs, asset write-
downs, and other related costs that have been or are anticipated to be incurred
as a direct result of the plan. The unpaid restructuring costs are expected to
be paid out within the next year.
During the current quarter, the Company continued to review its strategies
related to YAR. The Company evaluated the recoverability of certain long-lived
assets pursuant to the provisions of Financial Accounting Standards Board (FASB)
Statement No. 121 for impaired assets held for use. A non-cash pre-tax charge of
$7.0 million was recognized for the impairment of the remaining YAR business and
goodwill due to the transfer of its AT&T account. AT&T Corporation, a major
client of both YAR and One World, made across the board reductions in its
marketing programs in 1998 to reduce costs and had indicated that cost control
pressures were likely to continue in the future. In connection with AT&T's plan
to transfer its YAR business to Young & Rubicam, another AT&T agency, the
Company negotiated a definitive agreement to sell and transfer various assets of
One World and the AT&T business of YAR Communications, Inc. to Young & Rubicam.
The AT&T account had represented approximately 55% of YAR's revenue for the last
fiscal year ended January 31, 1998 and approximately 36% of YAR's revenue for
the nine months ended October 31, 1998. As a result of the transfer of the AT&T
account and the restructuring of the remaining YAR business, the Company
recognized the impairment loss of the remaining $7.0 million in YAR goodwill.
Further, in accordance with FASB Statement No. 121, the Company recorded an
impairment loss of approximately $1.5 million in order to adjust the book value
of property and equipment associated with the YAR business to its fair value
based on an appraisal. Finally, the Company wrote off approximately $742,000 of
unamortized capitalized software costs as events occurred which led management
to determine that such costs were likely not realizable.
NOTE 5 -- Income Taxes
As of October 31, 1998, the Company has a deferred tax asset of approximately
$8.1 million. Approximately $5.2 million of the deferred tax assets relates to
operating loss carryforwards for federal and state income tax purposes. The
remaining $2.9 million of the deferred tax asset relates to differences between
the financial reporting basis and the tax reporting basis of assets and
liabilities. The most significant of these is the goodwill attributable to the
YAR acquisition of approximately $7.0 million which was written off for
financial reporting purposes during the quarter ended October 31, 1998. This
goodwill continues to have tax basis and the Company will continue to receive
tax deductions associated with this goodwill amortization.
The Company has provided a valuation reserve against the entire deferred tax
asset primarily due to the transfer of the AT&T business and the YAR
restructuring. Management is optimistic about the future operations of the
business, has undertaken a restructuring at YAR in an effort to improve its
operating results, has won a significant new account, Hardees, at Leap
Partnership, and continues to pursue a variety of new business opportunities at
all of its subsidiaries. For these reasons, management is optimistic about the
Company's ability to realize the benefits of the deferred tax asset and, in
fact, expects to realize those benefits.
However, the Company has provided the full valuation reserve due to its limited
operating history and recent operating losses, the volatility of the industry,
and the transfer of the AT&T account. For these reasons, management considered
the events which have occurred during the quarter, coupled with its philosophy
of conservative accounting, and has supported the establishment of a valuation
reserve. To the extent that the Company achieves future taxable income, no
provision will be recorded until the operating losses have been fully utilized.
NOTE 6 -- Line of Credit
In September 1998, repayment of the Company's outstanding balance on a $5
million line of credit was extended to October 31, 1998. On October 22, 1998,
the $1,895,000 outstanding balance on this line of credit, including accrued
interest, was paid in full and this line of credit was retired.
NOTE 7 -- Litigation
In November 1998, the Company filed a complaint in the Supreme Court of the
State of New York against Finkle, Ross & Rost, L.L.P., the former accountants
for Yurianna, Inc. (the company from which YAR acquired various assets),
alleging breach of contract and accountant malpractice. The action seeks damages
in excess of $13,500,000 and such other relief as the court deems just and
equitable.
8
<PAGE>
In December 1998, Finkle, Ross & Rost,L.L.P. filed a complaint in the Supreme
Court of the State of New York against the Company for $28,750 for accounting
services rendered. Although Finkle, Ross & Rost, L.L.P. has performed services
for the Company, the Company intends to vigorously oppose this claim due to the
quality of services provided.
On December 4, 1998, Yuri and Anna Radzievsky (the Radzievskys), former
employees of YAR Communications, Inc. (YAR), filed a multi-count Demand for
Arbitration with the American Arbitration Association (AAA) against the Company
and YAR. The Demand seeks: (1) a declaration that the Radzievskys' termination
from YAR was allegedly "without cause", and that failure to continue to pay each
of the Radzievskys' Base Salary violates their respective employment agreements;
and (2) a declaration of various rights that flow from the foregoing
determinations, under the Radzievskys' Employment Agreements and Stock Option
Agreements. The Demand also asserts, inter alia, various other breaches of the
Radzievskys' Employment Agreements and of the Asset Purchase Agreement between
YAR, the Company, and the Radzievskys; unfair competition; and tortious
interference with business relations and prospective business relations. The
Demand seeks compensatory damages in excess of $3.5 million and punitive damages
in excess of $3.5 million. The Company and YAR deny that any of the claims have
merit and intend to vigorously defend against the Demand.
On December 10, 1998, the Company and YAR filed a Complaint in the Supreme Court
of the State of New York against the Radzievskys and Greg Fomin, also a former
employee of YAR, alleging (1) multiple breaches of fiduciary duty by the
Radzievskys and by Fomin, and seeking compensatory damages as the result; and
(2) tortious interference by the Radzievskys with the Company's business
relations regarding its transaction with Young & Rubicam, and claiming
compensatory damages in excess of $4.2 million and punitive damages of $9
million.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following presentation of management's discussion and analysis of the
Company's financial condition and results of operations should be read in
conjunction with the Company's consolidated financial statements, accompanying
notes thereto and other financial information appearing in the Company's Annual
Report on Form 10-K which was filed with the Securities and Exchange Commission
on May 1, 1998.
In reviewing the Company's consolidated financial statements and the discussion
of the Results of Operations that appears below, the following should be taken
into consideration.
In April 1997, the Company acquired YAR Communications, Inc. ("YAR") and in
November 1997, the Company also acquired One World Communications, Inc., which
consists of Kang & Lee Advertising and K&L West Advertising (jointly referred to
as "Kang & Lee" or "One World"). Both business combinations were accounted for
using the purchase accounting method. In accordance with the purchase accounting
method, YAR's and One World's results have been included within the Company's
results since their respective acquisition dates of April 1, 1997 and November
1, 1997. Due to the sale of One World, One World's results have only been
included through the effective closing date of September 30, 1998.
Results of Operations
THREE MONTHS ENDED OCTOBER 31, 1998 AND OCTOBER 31, 1997
Revenues
- --------
Revenues increased to $8.4 million for the three months ended October 31, 1998
from $7.2 million for the three months ended October 31, 1997, an increase of
$1.2 million or 17%. The net increase of $1.2 million is primarily due to the
addition of Kang and Lee revenues of approximately $2.6 million. Per above,
Kang and Lee was acquired in November 1997 and so its results are not included
in the prior year quarter. Additionally, there was an increase in Leap's
existing client revenue of approximately $113,000, offset by a decrease of
approximately $1.5 million in existing business of YAR (See Note 3).
Direct Costs and Related Expenses
- ---------------------------------
Direct costs and related expenses generally consist of production costs which
include services such as filming, animation, editing, special effects,
photography and illustrations, artwork, computer design and various related
production services which are generally outsourced, talent and other costs
related to creative executions which may include traditional media as well as
new technologies and multimedia. Direct costs and related expenses increased to
$3.4 million for the three months ended October 31, 1998 from $2.8 million for
the three months ended October 31,1997, an increase of $610,000 or 22%. The
increase was primarily due to the addition of $1.5 million in Kang and Lee's
direct expenses. As per above, Kang and Lee's results are not included in the
prior year quarter. The increase from Kang and Lee was offset by decreases in
direct expenses at YAR of approximately $380,000 and at Leap of approximately
$526,000 due to a change in the mix of services.
Salaries and Related Expenses
- -----------------------------
Salaries and related expenses consist primarily of salaries and wages for
employees and freelancers, related payroll tax expenses, group medical and
dental insurance coverages and recruiting expenses. Salaries and related
expenses decreased to $4.0 million for the three months ended October 31, 1998
from $5.0 million for the three months ended October 31, 1997, a decrease of
approximately $1.0 million or 20%. The decrease in expense reflects a reduction
of approximately $2 million in salaries and related expenses due to cost
containment measures at the Company, offset by the addition of Kang and Lee's
75 employees which represents $946,000 in salaries and related expenses for the
three months ended October 31, 1998.
10
<PAGE>
General and Administrative Expenses
- -----------------------------------
General and administrative expenses include space and facilities expenses,
corporate expenses, depreciation, insurance, legal and accounting fees and
management information system expenses. General and administrative expenses
decreased to $2.5 million for the three months ended October 31, 1998 from $3.2
million for the three months ended October 31, 1997, a decrease of $692,000 or
22%. The decrease is primarily due to reductions in expenses of $1.6 million
at Leap, offset by the addition of Kang and Lee's general and administrative
expenses of approximately $932,000 for the three months ended October 31, 1998.
Other Income and Expense
- ------------------------
Other income consists of interest income of $69,000 and $334,000 for the three
months ended October 31, 1998 and 1997, respectively. During the three months
ended October 31, 1998, the interest income was offset by interest expense of
$96,000 and by the loss on the divestiture of the One World subsidiary and YAR
AT&T account of $1.8 million (see Note 3). During the three months ended
October 31, 1997, the interest income was offset by interest expense of
approximately $380,000.
Income Taxes
- ------------
The combined federal and state effective income tax rates were 24.9% and 39.1%
for the three months ended October 31, 1998 and 1997, respectively. As of
October 31, 1998, the Company has a deferred tax asset of approximately $8.1
million. Approximately $5.2 million of the deferred tax assets relates to
operating loss carryforwards for federal and state income tax purposes. The
remaining $2.9 million of the deferred tax asset relates to differences between
the financial reporting basis and the tax reporting basis of assets and
liabilities. The most significant of these is the goodwill attributable to the
YAR acquisition of approximately $7.0 million which was written off for
financial reporting purposes during the quarter ended October 31, 1998. This
goodwill continues to have tax basis and the Company will continue to receive
tax deductions associated with this goodwill amortization.
The Company has provided a valuation reserve against the entire deferred tax
asset primarily due to the transfer of the AT&T business and the YAR
restructuring. Management is optimistic about the future operations of the
business, has undertaken a restructuring at YAR in an effort to improve its
operating results, has won a significant new account, Hardees, at Leap
Partnership, and continues to pursue a variety of new business opportunities at
all of its subsidiaries. For these reasons, management is optimistic about the
Company's ability to realize the benefits of the deferred tax asset and, in
fact, expects to realize those benefits.
However, the Company has provided the full valuation reserve due to its limited
operating history and recent operating losses, the volatility of the industry,
and the transfer of the AT&T account. For these reasons, management considered
the events which have occurred during the quarter, coupled with its philosophy
of conservative accounting, and has supported the establishment of a valuation
reserve. To the extent that the Company achieves future taxable income, no
provision will be recorded until the operating losses have been fully utilized.
NINE MONTHS ENDED OCTOBER 31, 1998 AND OCTOBER 31, 1997
Revenues
- --------
Revenues increased to $27.8 million for the nine months ended October 31, 1998
from $19.2 million for the nine months ended October 31, 1997, an increase of
$8.5 million or 45%. The net increase of $8.5 million is primarily attributable
to the addition of $7.7 million of Kang and Lee revenues. Per above, Kang and
Lee was acquired in November 1997, and so its results are not included in the
prior period. Additionally, there were increases in new and existing business at
Leap of $608,000 and at YAR of $241,000 because of two additional months of
revenue in the current period, as YAR was acquired in April 1997.
Direct Costs and Related Expenses
- ---------------------------------
Direct costs and related expenses increased to $11.0 million for the nine months
ended October 31, 1998 from $7.9 million for the nine months ended October 31,
1997, an increase of $3.1 million or 40%. The increase was primarily
attributable to the addition of $3.5 million of Kang and Lee's direct expenses.
Additionally, there was an increase of $437,000 at YAR because it was acquired
in April 1997 and so the months of February and March 1997 are not included in
the prior year period. Also, the increase in direct expenses was offset by a
decrease of approximately $840,000 in direct expenses at Leap as a result of a
change in the mix of services.
Salaries and Related Expenses
- -----------------------------
Salaries and related expenses decreased to $12.4 million for the nine months
ended October 31, 1998, from $12.9 million for the nine months ended October 31,
1997, a decrease of approximately $500,000 or 4%. During the nine months ended
October 31, 1998, salaries expense decreased $3.9 million due to overall cost
management efforts at Leap, which was offset by an increase of $2.9 million due
to the addition of 75 employees at Kang and Lee and by an increase of $441,000
at YAR because of the two additional months of salaries and related expense in
the current period, as YAR did not contribute expenses in February and March of
1997 because it was acquired in April of 1997.
11
<PAGE>
General and Administrative Expenses
- -----------------------------------
General and administrative expenses decreased to $6.7 million for the nine
months ended October 31, 1998 from $7.1 million for the nine months ended
October 31, 1997, a decrease of $358,000 or 5%. The decrease is primarily due to
a reduction of $2.5 million of general and administrative expenses at Leap as a
result of continued cost reduction measures, offset by the addition of $1.8
million of Kang and Lee's expenses and an increase of $331,000 of YAR expenses
prior to the Restructuring (see Note 4).
Interest Income and Expense
- ---------------------------
Other income during the nine months ended October 31, 1998, consists of interest
income of $297,000 and a gain on the sale of The Leap Partnership's Los Angeles
office building of $1.2 million. This income was offset by interest expense of
$443,000 and by the loss on the divestiture of the One World subsidiary and YAR
AT&T account of $1.8 million (see Note 3). During the nine months ended October
31, 1997, interest income of $1.2 million was offset by interest expense of
approximately $858,000.
Income Taxes
- ------------
The combined federal and state effective income tax rates were 24.9% and 39.1%
for the nine months ended October 31, 1998 and 1997, respectively. As of
October 31, 1998, the Company has a deferred tax asset of approximately $8.1
million. Approximately $5.2 million of the deferred tax assets relates to
operating loss carryforwards for federal and state income tax purposes. The
remaining $2.9 million of the deferred tax asset relates to differences between
the financial reporting basis and the tax reporting basis of assets and
liabilities. The most significant of these is the goodwill attributable to the
YAR acquisition of approximately $7.0 million which was written off for
financial reporting purposes during the quarter ended October 31, 1998. This
goodwill continues to have tax basis and the Company will continue to receive
tax deductions associated with this goodwill amortization.
The Company has provided a valuation reserve against the entire deferred tax
asset primarily due to the transfer of the AT&T business and the YAR
restructuring. Management is optimistic about the future operations of the
business, has undertaken a restructuring at YAR in an effort to improve its
operating results, has won a significant new account, Hardees, at Leap
Partnership, and continues to pursue a variety of new business opportunities at
all of its subsidiaries. For these reasons, management is optimistic about the
Company's ability to realize the benefits of the deferred tax asset and, in
fact, expects to realize those benefits.
However, the Company has provided the full valuation reserve due to its limited
operating history and recent operating losses, the volatility of the industry,
and the transfer of the AT&T account. For these reasons, management considered
the events which have occurred during the quarter, coupled with its philosophy
of conservative accounting, and has supported the establishment of a valuation
reserve. To the extent that the Company achieves future taxable income, no
provision will be recorded until the operating losses have been fully utilized.
Liquidity and Capital Resources
- -------------------------------
Since its inception, the Company has primarily financed its operations and
investments in property and equipment through cash generated from bank
borrowings, proceeds from the Company's initial public offering, loans from a
Company officer and equipment leases.
At October 31, 1998 the Company had $11.6 million of working capital, inclusive
of $12.3 million in cash and cash equivalents, compared to working capital of
$820,000 at January 31, 1998. Cash and cash equivalents increased $5.1 million
during the nine months ended October 31, 1998, and decreased $26.2 million
during the prior nine months. The increase in cash in the current fiscal year is
primarily attributable to: (1) the $5.3 million in proceeds from the sale of the
One World subsidiary and the transfer of the YAR AT&T account (see Note 3); (2)
the sale of the Los Angeles building which generated $3.4 million in cash; (3)
in April 1998, an escrow settlement was made in connection with the YAR
acquisition and the Company received $3 million in cash; (4) offset by the
retirement of $3.1 million in debt; and, (5) by $3.9 million of cash used in
operations. The decrease during the nine months ended October 31, 1997, was
primarily attributable to (1) a decrease in cash provided from operating
activities of $3.6 million; (2) an increase in cash used in investing activities
of $28.5 million which is attributable to the acquisition of YAR, the financing
of a strategic partner, Vivid Publishing, Inc., and expenditures for property,
equipment, and software development costs; and (3) offset by an increase in cash
provided by financing activities of $5.9 million used to fund the acquisition,
the opening of the Los Angeles office, the creation of a new subsidiary, Quantum
Leap Communications, Inc., the loan to a strategic partner, and other working
capital requirements.
On October 22, 1998, the Company received $5.3 million in cash from the sale of
various assets of the One World subsidiary and the transfer of the YAR AT&T
account. (See Note 3). Additional consideration for the sale of up to $1.5
million may be received in the fourth quarter after the resolution of a net
tangible assets audit.
In November 1997, one of the Company's wholly owned subsidiaries obtained an
additional line of credit from a bank to provide working capital financing and
funds for other general corporate purposes of the subsidiary. The line
12
<PAGE>
of credit was secured by substantially all the assets of the subsidiary, and
provided for borrowing up to a maximum principal amount of $5 million through
September 30, 1998. In September 1998, repayment on the line of credit was
extended to October 31, 1998. On October 22, 1998, the $1,895,000 outstanding
balance plus accrued interest to date was paid in full and this line of credit
was retired.
On July 17, 1998, the Company sold the building which houses the LA office of
The Leap Partnership, Inc. The building was sold for $3.48 million and
generated $2 million in cash after retiring $1.4 million of mortgage debt on the
building and after payment of all closing costs. These funds were also invested
in short-term certificates of deposit and will be used for working capital and
other general corporate purposes, including possible acquisitions.
Effective June 30, 1998, the Company refinanced $4,073,000 in outstanding debt
by securing a $5 million line of credit through June 30, 2000. A certificate of
deposit in the amount of $5,000,000, earning interest of 5.3% and maturing on
June 30, 1999, serves as collateral for this line of credit. The interest rate
on the line is 6.75%. At October 31, 1998, $4,073,000 was outstanding on this
line of credit.
On May 29, 1998, Vivid Publishing, Inc. repaid the Company $1.9 million in
repayment of amounts owed to the Company under a convertible debenture, accrued
interest, and for additional creative and other services. The funds were
invested in short-term certificates of deposit and will be used for working
capital and other general corporate purposes, including possible acquisition.
On April 30, 1998, in connection with the YAR acquisition, the Company received
$3 million in cash due to the release of escrowed funds. The funds reduced the
purchase price of the acquisition and the amount of recorded goodwill. The
funds were invested in short-term certificates of deposit and will be used for
working capital and other general corporate purposes, including possible
acquisitions.
On February 2, 1998, the Company received proceeds from a loan for $665,000 from
a bank. The three-year balloon note bears interest at the rate of 9%, payable in
monthly principal and interest installments of $5,992 through December 2, 2001,
with a balloon payment of approximately $184,000 in January 2002. The loan is
secured by a mortgage on the building in which the Company's current principal
offices are located and is personally guaranteed by an officer of the Company.
As of October 31, 1998, $656,186 was outstanding on this note.
The Company believes that the existing and future credit facilities, funds from
capital markets, funds from operations, and the cash received as discussed above
will be sufficient to meet the Company's cash requirements for at least the next
twelve months. The Company's capital requirements will depend on numerous
factors, including the rates at which the Company grows, expands its personnel
and infrastructure to accommodate growth and invests in new technologies. The
Company has various ongoing needs for capital, including working capital for
operations, project development costs and capital expenditures to maintain and
expand its operations. In addition, as part of its strategy, the Company
evaluates potential acquisitions of, or alliances with, businesses that extend
or complement the Company's business. The Company may in the future consummate
acquisitions or alliances which may require the Company to make additional
capital expenditures, and such expenditures may be significant. Future
acquisitions and alliances may be funded with available cash from seller
financing, institutional financing, issuance of common stock of the Company
and/or additional equity or debt offerings. There can be no assurance that the
Company will be able to raise any additional required capital on favorable
terms, or at all.
Seasonality
Depending upon its client mix at any time, the Company could experience
seasonality in its business. Such seasonality arises from the timing of product
introductions and business cycles of the Company's clients and could be material
to the Company's interim results. Such cycles vary from client to client, and
the overall impact on the Company's results of operations cannot be reasonably
predicted. In addition, the advertising industry as a whole exhibits
seasonality. Typically, advertising expenditures are highest in the fourth
calendar quarter and lowest in the first calendar quarter, particularly in
January. Although the Company has too limited an operating history to exhibit
any discernible seasonal trend, as the Company matures, Management believes that
the business and results of operations could be affected by the overall
seasonality of the industry.
13
<PAGE>
Dependence on Key Clients and Projects
An important part of the Company's strategy is to develop in-depth, long term
relationships with a select group of clients in a variety of industries.
Consistent with such a strategy, a large portion of the Company's revenues has
been, and is expected to continue to be, concentrated among a relatively limited
number of nationally recognized clients. For the quarter ended October 31, 1998,
one client (AT&T) accounted for 25% of consolidated revenues. For the quarter
ended October 31, 1997, one client (AT&T) accounted for 31.1% of consolidated
revenues.
Due to the nature of the advertising business, any of the Company's clients
could at any time in the future, and for any reason, reduce its marketing
budget, alter the timing of projects, engage another entity or take in-house all
or part of the business performed by the Company. Even though the Company has
taken steps to add new accounts, diversify its client base, negotiate a greater
percentage of retainer and fixed fee arrangements with clients and develop new
potential revenue streams from licensing of proprietary software and other
content, these steps may not fully mitigate the impact that the loss of any
significant account may have on the Company's operations.
AT&T Corporation, which has been a major client of both YAR and Kang & Lee, made
across the board reductions in its marketing programs in 1998 to reduce costs.
AT&T also indicated to the Company that it was looking to transfer its business
to another agency in order to further consolidate its agencies. As such, the
Company negotiated a definitive agreement to sell Kang & Lee and the AT&T
business of YAR Communications, Inc. to another AT&T agency, Young & Rubicam
(See Note 3). As a result of the sale, $5.3 million of the approximately $6.8
million in expected proceeds was received in October 1998, which mitigated the
impact of the loss of AT&T on the Company's financial condition. The account had
represented approximately 25% of the Company's consolidated revenues for the
quarter ended October 31, 1998.
Management believes that the loss of other key clients and varying effects of
seasonality, as described above, could also have an adverse impact on the
Company's business, results of operations and financial condition, particularly
in the short term.
Year 2000
The Company has assembled a Year 2000 task force which is in the process of
identifying and assessing potential operating and software problems related to
the "Year 2000" issue, both internally and externally. The Company's Year 2000
program will address both information technology and non-information technology
systems. The Company's Year 2000 task force has completed an inventory of the
hardware and software used in its operations and has assessed the Year 2000
readiness of most of the hardware and software inventoried. Based on this
effort, the Company has identified only non-material Year 2000 issues, which
will be resolved at little cost before September 30, 1999. Additionally, the
Company is in the process of communicating with its significant vendors and
other critical service providers to determine if such parties are year 2000
compliant or have effective plans in place to address the year 2000 issue and to
determine the extent of the Company's vulnerability to the failure of such
parties to remediate such issues. Based upon the responses that the Company
receives from these third parties, the Company will assess its risks and develop
appropriate contingency plans as needed.
The Company does not expect the impact of the Year 2000 to have a material
adverse impact on the Company's business or results of operations. However, no
assurances can be given that any failure to effectively complete the necessary
changes to the Company's financial and operating systems on a timely basis or
that unanticipated or undiscovered Year 2000 compliance problems arise that
could have a material adverse effect on the Company's business and results of
operations. In addition, there can be no assurance that Year 2000 non-
compliance by any of the Company's clients or significant suppliers or vendors
will not have a material adverse effect on the Company's business or results of
operations.
14
<PAGE>
Note Regarding Forward-Looking Statements
This report contains forward-looking statements (within the meaning of the
Private Securities Litigation Reform Act of 1995) that involve risks and
uncertainties. When used in this report, the words "anticipate," "believe,"
"estimate," "expect" and similar expressions as they relate to the Company or
its Management are intended to identify such forward-looking statements. A
number of important factors could cause the Company's actual results,
performance or achievements for fiscal 1999 and beyond to differ materially from
that expressed in such forward-looking statements. These factors are set forth
in the Company's Registration Statement on Form S-1 (File No. 333-05051) under
the heading "Risk Factors" and include, without limitation, material changes in
economic conditions in the markets served by the Company's clients; competition
in the Company's industry; uncertainties relating to the developing market for
new media; changing technologies; seasonality; costs and uncertainties relating
to establishing new offices and bringing them to profitability; uncertainties
related to certain litigation as described in Part II, Item 1; costs and
uncertainties relating to the Young & Rubicam transaction (see Note 3) and the
Company's dependence on key clients and projects (as discussed above under
"Dependence on Key Clients and Projects") and key personnel.
15
<PAGE>
Part II. Other Information
Item 1. Legal Proceedings
In February 1998, Venture Direct Worldwide, Inc. filed a lawsuit in
the Supreme Court of New York against an employee of Quantum Leap
Communications (QLC), the Company and QLC. The complaint alleges that
the employee's e-mail response to an e-mail communication from the
plaintiff caused damage to the plaintiff. The Company has received
from the plaintiff a settlement proposal that does not involve a
monetary payment. The Company intends to vigorously defend the suit
and believes that the employee's actions were outside the scope of
employment. The complaint alleges six causes of action, each seeking
ten million dollars plus punitive damages. Management does not believe
that the claims have any merit or that the ultimate outcome of this
matter will have a material adverse impact on the Company's financial
position or results of operations.
In November 1998, the Company filed a complaint in the Supreme Court
of the State of New York against Finkle, Ross & Rost, L.L.P., the
former accountants for Yurianna, Inc. (the company from which YAR
acquired various assets), alleging breach of contract and accountant
malpractice. The action seeks damages in excess of $13,500,000 and
such other relief as the court deems just and equitable. In December
1998, Finkle, Ross & Rost, L.L.P. filed a complaint in the Supreme
Court of the State of New York against the Company for $28,750 for
accounting services rendered. Although Finkle, Ross & Rost, L.L.P. has
performed services for the Company, the Company intends to vigorously
oppose this claim due to the quality of services provided.
On December 4, 1998, Yuri and Anna Radzievsky (the Radzievskys),
former employees of YAR Communications, Inc. (YAR), filed a multi-
count Demand for Arbitration with the American Arbitration Association
(AAA) against the Company and YAR. The Demand seeks: (1) a declaration
that the Radzievskys' termination from YAR was allegedly "without
cause", and that failure to continue to pay each of the Radzievskys'
Base Salary violates their respective employment agreements; and (2) a
declaration of various rights that flow from the foregoing
determinations, under the Radzievskys' Employment Agreements and Stock
Option Agreements. The Demand also asserts, inter alia, various other
breaches of the Radzievskys' Employment Agreements and of the Asset
Purchase between YAR, the Company, and the Radzievskys; unfair
competition; and tortious interference with business relations and
prospective business relations. The Demand seeks compensatory damages
in excess of $3.5 million and punitive damages in excess of $3.5
million. The Company and YAR deny that any of the claims have merit
and intend to vigorously defend against the Demand.
On December 10, 1998, the Company and YAR filed a Complaint in the
Supreme Court of the State of New York against the Radzievskys and
Greg Fomin, also a former employee of YAR, alleging (1) multiple
breaches of fiduciary duty by the Radzievskys and by Fomin, and
seeking compensatory damages as the result; and (2) tortious
interference by the Radzievskys with the Company's business relations
regarding its transaction with Young & Rubicam, and claiming
compensatory damages in excess of $4.2 million and punitive damages of
$9 million.
There are no other significant claims or lawsuits against the Company.
16
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
11. Statement Regarding Computation of Per-Share Earnings
27. Financial Data Schedule
b. Reports on Form 8-K
Form 8-K, dated October 22, 1998, and filed with the Commission on
November 6, 1998, which includes unaudited pro forma financial
information with respect to the Asset Sale of One World
Communications, Inc. and the AT&T account of YAR Communications,
Inc. to Young & Rubicam, Inc.
Items 2, 3, 4 And 5 Are Not Applicable And Have Been Omitted.
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 thereunto duly authorized.
THE LEAP GROUP, INC.
--------------------
(Registrant)
Date: December 14, 1998 By: /s/ FREDERICK A. SMITH
------------------------------------------------
Frederick A. Smith, Chairman and Chief Executive
Officer (principal executive, financial and
accounting officer)
EXHIBIT INDEX
Exhibit
Number Exhibits
------- --------
11. Statement Regarding Computation of Per-Share
Earnings
27. Financial Data Schedules
17
<PAGE>
EXHIBIT 11
The Leap Group, Inc.
STATEMENT REGARDING COMPUTATION OF PER-SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Ended October 31, Nine Months Ended October 31,
------------------------------ -----------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss ($16,594,611) ($3,038,595) ($16,505,731) ($5,744,815)
Weighted average number of common
shares outstanding during period 13,648,866 13,614,667 13,646,199 13,613,037
Net shares issuable upon exercise of
dilutive outstanding stock options - - - -
------------ ----------- ------------ -----------
Shares used in Diluted per share
calculation 13,648,866 13,614,667 13,646,199 13,613,037
Basic earnings per common share ($1.22) ($.22) ($1.21) ($0.42)
Diluted earnings per common share ($1.22) ($.22) ($1.21) ($0.42)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheets as of October 31, 1998 and January 31, 1998, the
Consolidated Statements of Operations for the Nine Months ended October 31, 1998
and 1997, and the Consolidated Statements of Cash Flows for the Nine Months
ended October 31, 1998 and 1997 and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 12,346
<SECURITIES> 0
<RECEIVABLES> 7,198
<ALLOWANCES> (731)
<INVENTORY> 0
<CURRENT-ASSETS> 20,352
<PP&E> 3,685
<DEPRECIATION> (806)
<TOTAL-ASSETS> 23,337
<CURRENT-LIABILITIES> 8,779
<BONDS> 0
<COMMON> 136
0
0
<OTHER-SE> 14,278
<TOTAL-LIABILITY-AND-EQUITY> 23,337
<SALES> 0
<TOTAL-REVENUES> 27,776
<CGS> 0
<TOTAL-COSTS> 11,004
<OTHER-EXPENSES> 29,099
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 443
<INCOME-PRETAX> 13,121
<INCOME-TAX> (3,385)
<INCOME-CONTINUING> (16,506)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (16,506)
<EPS-PRIMARY> (1.21)
<EPS-DILUTED> (1.21)
</TABLE>
