Zi posts loss, gets called on SEC target Lancer stake
Zi Corp ZIC
Shares issued 38,089,250
Aug 15 2003 close $ 3.44
Monday August 18 2003 Street Wire
Also Zi Corp (U-ZICA) Street Wire
DIAL "M" FOR MUDDLE
by Lee M. Webb
Zi Corp., a Calgary-based technology company entangled in a controversy involving U.S. Securities and Exchange Commission (SEC) target Michael Lauer and his allegedly fraudulent Lancer Group, reported a loss of $2.12-million on revenues of $2.4-million for the quarter ending June 30, 2003. The second-quarter loss bumped the company's accumulated deficit to more than $95-million.
Zi, which is listed on both the Toronto Stock Exchange (TSX) and Nasdaq, held a conference call on Aug. 15 to offer its perspective on yet another money-losing quarter, tout the company's future prospects and field questions from investors. Notwithstanding Zi's long history of losses, previous conference calls have been remarkably tame affairs. Several of those Zi love-ins featured boosterish comments from key Lancer figure Bruce Cowen, currently awaiting trial on stock manipulation and kickback conspiracy charges, and Mr. Lauer, now the subject of an SEC investigation.
In marked contrast to several other Zi conference calls, the company faced some pointed questions on Aug. 15, though not about its dismal financial results. Much of the company's latest conference call was taken up with a discussion of the muddle involving Mr. Lauer's undisclosed massive Zi stake.
On Aug. 6 Stockwatch broke the news that court documents filed by the SEC in its July 8 complaint against Mr. Lauer and his purported $1-billion (U.S.) Lancer funds indicated that Mr. Lauer controlled almost 50 per cent of Zi's stock. The SEC obtained a July 10 court order freezing Lancer's assets and appointing a receiver. Client position summaries from Banc of America Securities, Mr. Lauer's prime broker, put Lancer's Zi holdings at a previously undisclosed 18.7 million shares as of April 30.
On Aug. 11 Zi issued a statement regarding the Lancer holdings, essentially acknowledging that it did not have a clue about the number of shares controlled by Mr. Lauer. Among other things, Zi claimed that the vast majority of its shares were unregistered. As pointed out in a Stockwatch article published the same day, that claim was rather hard to square with a May 20 SEC filing in which Zi reported that 187 registered U.S. shareholders held more than 24.8 million shares or 64.7 per cent of its stock.
Against the backdrop of the Lancer muddle, a tumbling share price and another money-losing quarter, Zi executives held the Aug. 15 conference call.
THE CALL
Following the usual disclaimers, Zi's chief executive officer Michael Lobsinger introduced the latest addition to the company's management team, Michael Donnell. Mr. Donnell joined Zi on July 25 to take up the position of president and chief operating officer left vacant by the rather abrupt departure of Gary Kovacs.
"Mike joins us at a time of significant opportunity and challenge for the company and the board and I are convinced that his experience, vision and leadership will be key in our drive to substantially increase our market share, expand our suite of products and services and achieve sustainable revenue growth and profitability," Mr. Lobsinger said.
Zi, which has hardly lacked visionaries, has frequently touted significant opportunities, projected substantial revenue growth and imminent profitability. Among the many previous sugarplums that have danced through the heads of Zi visionaries are Miami International Gateway, Telecom Technology Centre and, most recently, Magic Lantern.
Miami International was acquired for $1.77-million as part of Zi's heavily promoted move into telecommunications in 1993. The company's unprofitable telecom portfolio resulted in massive losses and after a restructuring Zi announced that it was unloading money-gobbling Miami International, reporting that it had found a buyer willing to pony up at least $30-million (U.S.) for the company. Alas, that deal collapsed in 1997 and was replaced with a deal to unload Miami International to Zi director Ian Barrett for a meagre $1.5-million (U.S.) to be paid over four years and the assumption of liabilities. Even that turned sour when Miami International went bust and disappeared.
Zi acquired Hong Kong-based Telecom Technology in July of 2000 for $3.2-million (U.S.), renamed it Zi Services, and quickly set about touting its entry into the supposedly lucrative voice over Internet protocol (VoIP) market. By the following year, Zi was suggesting that VoIP revenues could dwarf the revenues from the company's predictive language technology, eZiText. That turned out to be more than a tad optimistic. Zi Services resulted in losses and writedowns of $9.1-million and in December of 2002 the company shuttered Zi Services, terminated all of its employees and liquidated the assets for a picayune $220,000.
Magic Lantern was acquired on March 18, 2002, for approximately $2-million in a same-day double shuffle in which the company was first purchased for $1.85-million from a subsidiary of Chell Group Corp. by an unidentified management group and immediately dealt off to Zi. Within a few months, Zi entered into a deal to sell the newly acquired Magic Lantern to a Lancer-controlled American Stock Exchange (AMEX) shell in exchange for 29.75 million shares and a $3-million (U.S.) promissory note. Magic Lantern, which is also mired in the Lancer imbroglio, was set to run out of cash by Aug. 15, leaving considerable doubt about the value of the promissory note and the shares.
Whether Mr. Donnell's vision will be complemented by an ability to execute remains to be seen. In any event, one of the significant and possibly pressing challenges facing the company and its new president may be to flush out some financing to meet Zi's capital requirements for the rest of the year. According to Mr. Lobsinger, that is now the focus of Zi's fundraising efforts.
With the introduction of Mr. Donnell and an update on the company's financing activities out of the way, Mr. Lobsinger turned to the Lancer controversy.
"There have been numerous media reports with respect to 'projecting' what the Lancer ownership in Zi Corporation 'may' be, but at this time the receiver-manager is 'unwilling' to file the appropriate Form 13D or respond to the percentage ownership that Lancer 'may' have in Zi Corporation," Mr. Lobsinger said, emphasizing words suggesting the speculative nature of the media reports and other considerations of Lancer's stake at this time.
"On Aug. 11, Zi Corporation distributed a press release disclosing all of the knowledge that it had at this time and indicating to the public that it would provide detailed factual information with respect to this issue as soon as it is received," he continued.
"The receiver-manager and the SEC have advised us that they are not relying on just the information that was filed in the SEC complaint and therefore cannot definitively respond to the question of the exact ownership by Lancer Group in Zi Corporation," Mr. Lobsinger said.
"The filing of a material change report by Zi Corporation and an amendment to our 20-F is being managed by our outside counsel in concert with the various securities commissions and exchanges, and that information will be made public as soon as it is available," Zi's chief executive officer advised.
Mr. Lobsinger then referred listeners to comments from court-appointed Lancer receiver Craig Rasile reported in the National Post on Aug. 12. "Craig states, and I quote, 'that his mandate is to marshall assets and protect the investors' interests,'" Mr. Lobsinger said, not getting the partial quote attribution quite right. "'I don't think it is in anybody's best interests at this point to liquidate positions in the short run,'" Mr. Lobsinger continued more accurately. "And that came from Craig Rasile," he added.
Mr. Rasile's mandate, of course, is to round up the frozen Lancer assets and protect the interests of the hapless Lancer investors. Whether that mandated protection will be of any benefit to other investors who independently just happened to sink money into companies included in the Lancer portfolios is another matter entirely and possibly not of much professional concern to Mr. Rasile.
"With respect to Magic Lantern, now known as GML (the AMEX stock symbol for Magic Lantern Group Inc.), as to whether or not this was an arms length transaction, here are the facts," Mr. Lobsinger said, turning to another sensitive issue that has surfaced in the wake of the Lancer scandal.
"Zi Corporation entered into a sale agreement with a publicly traded vehicle on the American Stock Exchange wherein Lancer was the major shareholder and funder," Mr. Lobsinger explained. "Magic Lantern, which was a wholly-owned subsidiary of Zi Corporation, was sold to the publicly traded company wherein Zi Corporation took back shares in GML in the amount of 29.75 million shares. This transaction was properly accounted for, given all of the information that Zi Corporation had at the time.
"Our auditors Deloitte & Touche have reviewed all of the information received at this time and advised that this transaction has been properly accounted for."
As far as Stockwatch has been able to determine, there have not been any media reports raising questions with respect to how Zi accounted for the Magic Lantern transaction with the Lancer-controlled AMEX shell.
"In summary, Zi Corporation is as surprised as anyone at the alleged percentage ownership of the Lancer Group in Zi Corporation and is working with all of the regulatory bodies to obtain the accurate factual information and report it to the public as quickly as possible," Mr. Lobsinger said in coming to the end of his statement. "In that regard I am not at liberty nor do I have any further information that would augment my comments herein."
Mr. Lobsinger then handed off to newly recruited Mr. Donnell, who offered an overview of the company's performance and future prospects. According to Mr. Donnell, Zi's momentum had been temporarily disrupted by two external factors: the SARS epidemic; and a general oversupply of mobile handsets in China and elsewhere in Asia. Nonetheless, Zi's new president claimed that the company is well positioned with local Chinese original equipment manufacturers that are expanding their market share in China.
Dale Kearns, the company's chief financial officer, took over to provide a more detailed analysis of the latest money-losing quarter, offering some year-over-year quarterly and six-month comparisons replete with exclusions and other hypothetical adjustments that cast a more favourable light on the dismal results. Zi's bean counter also spent some time reviewing the effects of the company's streamlining and cost-cutting measures. Nonetheless, there was a quarter-over-quarter decline in revenue and the bottom line remained a $2.12-million loss for the second quarter.
Following Mr. Kearns's contribution, Mr. Donnell briefly offered an upbeat sketch of his perspective on some of the exciting and significant opportunities available to the company going forward. He then opened the question and answer segment of the conference call with a couple of E-mail questions. "As you might imagine, we've had a lot of activity with E-mail recently," the new president remarked.
The first E-mail from an unidentified correspondent asked for a timeline for the release of additional information regarding the Lancer holdings.
"We cannot make that kind of prediction at this time," Mr. Lobsinger answered. "We are as concerned and anxious about this information as all of our shareholders are and we are working closely with the receiver to obtain this information as quickly as possible. We're obviously aware of all the speculation in the media based mostly on court filings, but we cannot comment until we have all the information deemed reliable by the bankruptcy attorney. Once we learn something, we'll communicate it immediately to our shareholders."
The second E-mail also concerned the Lancer issue. "You've worked with the Lancer Group and communicated with them and their principals on numerous occasions," the E-mail correspondent wrote. "How could you possibly not know that they were accumulating large quantities of your stock; and did Michael himself ever make a call to Lauer to find out?"
"Well, Lancer has been an investor for many, many years and participated in some of our private placements," Mr. Lobsinger began. "The company fields 15 to 20 calls per day from investors and they're all treated equally. We have absolutely no way of knowing if investors choose not to report their holdings. Investors are required to inform the public through specific filings of documents when they accumulate certain percentages of stock, which in this case Lancer may not have done."
While all Zi investors may be treated equally, Mr. Lauer may well have been comfortably ensconced as the first among equals, with Mr. Lobsinger his principal company contact. In any event, Mr. Kearns, who is listed as Zi's investor relations contact, claims that he has never spoken with Mr. Lauer.
"I've never spoken to him, but Mr. Lobsinger, I'm sure, has," Mr. Kearns said on Aug. 1 when Stockwatch asked when anyone from Zi had last spoken with Mr. Lauer. "I mean he's--he was a significant shareholder and certainly if a shareholder calls, you take their call. That's a question better put to Mr. Lobsinger."
Indeed, that is a question that Stockwatch wanted to put to Mr. Lobsinger, but Zi's chief executive officer has not responded to several interview requests. The question remains unanswered and Mr. Lobsinger completely skipped over the specific question from the E-mail correspondent with respect to whether he had ever made a call to Mr. Lauer to find out how many shares of the company Lancer controlled.
Given the extensive connections between Lancer and Zi, both with respect to Lancer's stake in Zi and the respective major interests in Magic Lantern, some investors clearly think that it would have been quite reasonable for Mr. Lobsinger to pick up the phone and ask Mr. Lauer directly about his Zi holdings.
Mr. Lobsinger and Mr. Lauer share some other common ground: both were significant shareholders in another Calgary-based, China-oriented company, China Broadband Corp. Mr. Lobsinger acted as a consultant to China Broadband while serving as Zi's chief executive officer and Mr. Lauer was a major financial backer of the Calgary-based company with extensive offshore connections. The OTC Bulletin Board promotion topped out at $10 (U.S.) per share in 2000 before collapsing. China Broadband now changes hands for less than 20 U.S. cents per share.
Notwithstanding all that common ground and the apparent expectation among some shareholders that the chief executive officer of Zi should have directly contacted Mr. Lauer in an effort to determine how many shares he controlled, whether Mr. Lobsinger made that contact remains publicly undisclosed.
With the two E-mail queries posed and at least partially answered, Mr. Donnell turned the conference call over to the operator for telephone questions. The first question came from Kelly Wenzel (phonetic), identified as a representative of Berthel Fisher & Co., which is an Iowa-based broker/dealer.
"This question has to do with Magic Lantern and the question is I was wondering if you could explain your relationship with Cameron Chell and Mark Valentine, who was the former chairman of Thomson Kernaghan and they're facing fraud charges in what is called the Bermuda Short investigation; and then also, aren't they former owners of Magic Lantern?" Mr. Wenzel asked, with an obviously shaky grasp of the facts.
Among other things, neither Mr. Chell nor Thomson Kernaghan are facing fraud charges in connection with Operation Bermuda Short, the joint FBI-RCMP undercover sting that resulted in the arrests of 60 penny stock players including Mr. Valentine last August. Notwithstanding the shaky underpinning, Mr. Lobsinger welcomed the question.
"Thanks Kelly, and yes I'd like to address that," Mr. Lobsinger said. "I don't know these men and have never met them. Any insinuation that we have had dealings with them is absolutely, completely erroneous.
"We purchased the Magic Lantern company from Doug Connolly and his partners. Doug Connolly had been the former owner, co-founder and manager of Magic Lantern for 15 years. Before we bought the company from Doug Connolly, he had sold the company to a publicly traded company called the Chell Group, which was a Nasdaq publicly traded company. But in January of 2002 Doug Connolly and his partners had negotiated a management buyout from the Chell Group and in turn sold the company to Zi Corporation.
"We had no dealings with Cameron Chell; no dealings with Mark Valentine; nor has Zi Corporation ever dealt with Thomson Kernaghan as previously has been reported in the media."
Mr. Lobsinger's response glossed over the same-day double shuffle facilitated by Zi that saw Magic Lantern pass from a Chell Group subsidiary to Mr. Connolly's management group and then to Zi on March 18, 2002.
"Our intent from the day of acquiring Magic Lantern was to combine some of its technology with that of the technology in Oztime and take Magic Lantern public," Mr. Lobsinger continued, expanding his answer beyond the question that was posed by Mr. Wenzel. "We started that process immediately on the acquisition of Magic Lantern. The transaction with JKC was to sell Magic Lantern to a publicly traded company and in this case Lancer had funded JKC with over $2-million. That is why we chose JKC, which has now become GML.
"This event occurred over 17 months ago before any of the current events had taken place. Lancer, as far as disclosed at that time, owned 9.6 per cent of Zi Corporation and was to be a financial partner in Magic Lantern.
"So, I appreciate the question Kelly and hopefully the media can report this correctly."
The next telephone question came from Credit Suisse First Boston representative Tony O'Callahan, a veteran participant in Zi conference calls, including several that featured bullish comments and upbeat leading questions from Mr. Lauer and his Lancer cohort Mr. Cowen. As in the past, Mr. O'Callahan's question included a request for an indication of whether the company would move to profitability in the next quarter. Indeed, Mr. O'Callahan's query was remarkably similar to one he posed in a Nov. 15, 2001, conference call when Zi's momentum had been disrupted by the tragic events of Sept. 11, 2001.
"I just want to ask do you believe that the SARS epidemic, you know, having run its course that your business will go back to, you know, be more normalized and, if it has run its course and you are seeing your business pick up again, what about the move to profitability in the third quarter?" Mr. O'Callahan asked in his most recent outing.
Mr. Donnell fielded that question. "The SARS epidemic has definitely run its course as far as we can tell in Asia in terms of the activities for the handset purchasing," Zi's president of three weeks said. "There could be some extended channel loading issues that are related to the SARS epidemic, but we're definitely seeing some signs of progress and activity picking up, so we believe that absolutely the worst is behind us.
"As far as profitability, you know we've really got several paths to profitability, but if you look at our current results, you know, excluding the Oztime costs and some of our financing costs, we'd be operating at profit levels right now; and, of course, with the announced plans of divestiture of Oztime, we feel really good about hitting that this year still."
While Mr. Donnell's response regarding the move to profitability may have struck some listeners as being little more than a claim that the company would have been profitable in the second quarter, if not for the fact that it actually lost money, the answer apparently satisfied the patient Mr. O'Callahan. The Credit Suisse First Boston representative thanked Mr. Donnell and gave way to the next caller.
The next telephone question came from a caller identified as Joey Feste of Feste Capital. "Michael, I know you mentioned that you really couldn't expound too much more on the financing, but I've got to ask, I mean that is a concern on the street," Mr. Feste began. "What are your future financing needs or the direction you're going to take?"
Mr. Donnell also took that question. "We're actively pursuing financing and, of course you know, we wouldn't have wished this Lancer press, but frankly there's still a very high level of interest and we feel very good about our prospects on achieving our goals on financing," Mr. Donnell said. "Really the only issue is the volatility in the stock and this will pass and that will settle down and, you know, we'll get this done."
Mr. Feste then asked whether any of the OEMs wanted to see a financing. Mr. Donnell acknowledged that being relatively new to the job he had not spoken with all of the OEMs, but he had not heard any concerns regarding Zi's balance sheet. He asked whether Mr. Lobsinger or Mr. Kearns had heard any such concerns. "Nothing specifically," came an equivocal response from one of them.
The fourth and final caller, and the one with the most pointed questions, was identified as Peter Raymond from Cedar Fund.
"I just want to ask a little bit about the recent press releases, specifically the Aug. 11 where you stated that the vast majority of the shares are held in investment dealer book entry form, i.e., street form, and therefore you couldn't comment on," Mr. Raymond began. "But your statement in the 20-F states that based on the report from the transfer agent, CIBC Mellon, as at December 31, 2002, there were 187 registered shareholders in the United States that held 24,858,028 shares or 64.7 percent of the common shares outstanding. Those two seem to be mutually exclusive statements, and I've got a follow-up question about your July 25 press release."
Mr. Kearns stepped in to offer a halting and rather shaky response to Mr. Raymond's query. "That reference in the 20-F to 187 registered shareholders is in fact reference to 187 investment dealers who have a number of clients behind them that would be a sheer guess on my part," Mr. Kearns said.
"Now, Dale, that's not what it says," Mr. Raymond pointed out, apparently finding Mr. Kearns's answer less than convincing. "It says registered shareholders."
"And I'm telling you the reference is to the number of holders being banks because that's what we meant when we wrote it," Mr. Kearns insisted.
"So; but then one would have showed up, one very large holding with Banc of America would have showed up then," Mr. Raymond pressed. "Is that correct?"
"I think we commented that we noticed a concentration, yes," Mr. Kearns replied.
"Okay; so you did see the list, the actual names," Mr. Raymond said.
"That's correct," Mr. Kearns answered.
"Okay," Mr. Raymond said, sounding less than satisfied with the answers. "Turning to your July 25 press release in which you named Mr. Donnell as the new president, you made a statement in there that Gary Kovacs had successfully completed his contract with Zi. Now this doesn't jive with statements that you've made in your proxy material and in your 20-F in which it states that the employment contract in respect of the president, Gary Kovacs, expires on Oct. 15, 2003. And what was the exact date that he resigned?"
That question brought a response from Mr. Lobsinger. "The contract expired on Oct. 15 and there was a notice clause involved and Mr. Kovacs is consulting with the company until Oct. 15, so it does jive," Mr. Lobsinger said.
Oddly, the July 25 news release announcing Mr. Donnell's immediate appointment as president and Mr. Kovacs's departure after reportedly having successfully completed his contract with Zi made no mention of any consulting by Mr. Kovacs until the actual expiry of his contract on Oct. 15. Nonetheless, Mr. Lobsinger's explanation with its peculiar past tense reference to a future event may have satisfied some listeners; though it is not at all clear that Mr. Raymond found it satisfactory.
"Okay; so your view on it is that the consulting takes you through to Oct. 15," Mr. Raymond said.
"Yes," replied Mr. Lobsinger.
"Okay," Mr. Raymond said, adding that he had no further questions.
That brought the question and answer segment and the conference call to a close.
While Zi traded down on both the TSX and Nasdaq for much of the session on the day of the conference call, the stock staged a late rally on both sides of the border. With 96,900 shares changing hands in Nasdaq trading, Zi gained 19 U.S. cents to close at $2.53 (U.S.). On the TSX, a more modest 39,600 shares traded and Zi gained 16 cents to close at $3.44 on Aug. 15.
Comments regarding this article may be sent to lwebb@stockwatch.com.
(More information regarding Zi is available in Stockwatch articles published on Aug. 6, 11, 12 and 13, 2003.)
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