UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Fiscal Year Ended December 31, 2004
___ Transition report pursuant to Section 13 of 15(d) of the Securities
Exchange Act of 1934 For the transition period from ___ to___
Commission File No. 0-19301
Communication Intelligence Corporation
(Exact name of registrant as specified in its charter)
Delaware 94-2790442
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
275 Shoreline Drive, Suite 500
Redwood Shores, California 94065
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(Address of principal executive (Zip Code)
offices)
Issuer's telephone number, including area code: 650-802-7888
Securities registered under Section 12(b) of the Securities Exchange Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference into Part III of this Form 10-K or any amendment to
this Form 10-K. X
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Securities Exchange Act of 1934). Yes ___ No X
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The aggregate market value of the voting stock (Common Stock) held by
non-affiliates of the registrant as of March 28, 2005 was approximately
$46,312,078 based on the closing sale price of $0.46 on such date, as reported
by the Nasdaq Over the Counter Market. The number of shares of Common Stock
outstanding as of the close of business on March 28, 2005 was 102,250,065.
COMMUNICATION INTELLIGENCE CORPORATION
TABLE OF CONTENTS
Page
PART I.................................................................... 3
Item 1. Business......................................................... 3
Item 2. Properties....................................................... 11
Item 3. Legal Proceedings................................................ 11
Item 4. Submission of Matters to a Vote of Security Holders.............. 12
PART II................................................................... 12
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters and Issuer Purchases of Equity Securities.... 12
Item 6. Selected Financial Data.......................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 29
Item 8. Consolidated Financial Statements and Supplementary Data......... 30
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures........................................ 30
Item 9A Controls and Procedures.......................................... 30
PART III.................................................................. 31
Item 10. Directors and Executive Officers of the Registrant............... 31
Item 11. Executive Compensation........................................... 33
Item 12. Security Ownership of Certain Beneficial Owners and Management... 34
Item 13. Certain Relationships and Related Transactions................... 35
Item 14. Principal Accounting Fees and Services........................... 35
PART IV................................................................... 37
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.............................................. 37
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CIC(R) and its logo, Handwriter(R), Jot(R), InkTools(R)??, Sign-it(R)??,
WordComplete(R)?, and? INKshrINK(R) and The Power To Sign Online(R) are
registered trademarks of the Company. HRS(TM), InkSnap(TM), PenX(TM),
QuickNotes(R), RecoEcho(TM),? Sign-On(TM)?? Speller(TM) and iSign(TM)?are
trademarks of the Company. Applications for registration of various trademarks
are pending in the United States, Europe and Asia. The Company intends to
register its trademarks generally in those jurisdictions where significant
marketing of its products will be undertaken in the foreseeable future.
-2-
PART I
Item 1. Business
Unless otherwise stated all amounts in Parts I through Part IV are stated in
thousands ("000s").
General
Communication Intelligence Corporation (the "Company" or "CIC") is the
leading supplier of biometric signature verification and a leading supplier of
natural input software and electronic signature solutions focused on emerging,
high potential applications including paperless workflow, handheld computers,
smartphones and eTransactions, enabling the world with "The Power to Sign
Online(R)". CIC's products are designed to increase the ease of use,
functionality, and security of electronic devices and eBusiness processes. CIC
sells directly to Enterprises, integration/channel partners and OEMs. Industry
leaders such as Charles Schwab, Fujitsu, IBM, Oracle, PalmSource, Prudential,
Siebel Systems, Siemens Medical Systems, Sony Ericsson, Symbol and TVA have
licensed the company's technology. CIC is headquartered in Redwood Shores,
California and has a joint venture, CICC, in Nanjing, China.
Revenues for the year ended December 31, 2004 of $7.3 million more than
doubled (243%) as compared to $3.0 million for the prior year. 2004 revenue was
derived from well over one hundred customers but was primarily attributable to
Charles Schwab & Co., Duncan Management Solutions Ltd., IA Systems Inc., Misys
Healthcare Systems, PalmSource Inc., Symbol Technologies Inc., State Farm
Insurance Companies, Wells Fargo Bank, N. A., and the Tennessee Valley Authority
..
2004 eSignature revenues of $6.1 million more than quadrupled (407%) over
2003 eSignature revenue of $1.5 million. In addition, the Company paid off a
$3.0 million debt, terminated it's equity line of credit agreement and
successfully completed a $4.0 million financing.
For the year ended December 31, 2004, the Company's operating income of
$2.3 million represented an improvement of $4.5 million over the $2.2 million
operating loss incurred in the prior year. Net income of $1.6 million for the
year ended December 31, 2004 represented an improvement of $3.9 million,
compared to a net loss of $2.3 million incurred in the prior year. 2004 year-end
financial results represent the first profitable year in the history of the
Company.
In March of 2004, CIC received the 2003 Frost & Sullivan award, for growth
strategy leadership in the signature verification market, which commends the
Company for sales results achieved under difficult market conditions. The award,
based on Frost & Sullivan's market study, further recognizes CIC as the leading
supplier well positioned to lead the signature verification market into a
high-growth stage.
Segments
The Company's financial information is presented in two
segments--handwriting recognition software and systems integration. The
handwriting recognition segment is comprised of three revenue categories:
eSignature, Natural Input and online sales. All handwriting recognition software
is developed around the Company's core technology. Systems integration
represents the sale and installation of third party computer equipment and
systems that use the Company's software products. All systems integration
revenue is generated through the Company's joint venture.
Core Technologies
The Company's core technologies are classified into two broad categories:
"natural input technologies" and "transaction and communication enabling
technologies." These technologies include multilingual handwriting recognition
systems (Jot and the Handwriter(R) Recognition System, referred to as HRS(TM)),
electronic signature, handwritten biometric signature verification,
cryptography, electronic ink recording tools (InkTools, Sign-it, iSign,
SignatureWallet(TM) and Sign-on), and operating system extensions that enable
pen input (PenX). Other consumer and original equipment manufacturer ("OEM")
products include electronic notetaking (QuickNotes, and InkSnap) and software
that can predict text input (WordComplete).
Natural Input Technologies. CIC's natural input technologies are designed
to allow users to interact with a computer or handheld device by using an
electronic pen or "stylus" as the primary input device or in conjunction with a
keyboard. CIC's natural input offerings include multilingual handwriting
recognition systems, software keyboards, predictive text entry, and electronic
ink capture technologies. Many small handheld devices, such as electronic
organizers, pagers and smart cellular phones do not have a keyboard. For such
devices, handwriting recognition and software keyboards offer the most viable
solutions for performing text entry and editing. CIC's predictive text entry
technology simplifies data entry even further by reducing the number of actual
-3-
letters required to be entered. The Company's ink capture technologies
facilitate the capture of electronic ink for notetaking, drawings or short
handwritten messages.
Transaction and Communication Enabling Technologies. The Company's
transaction and communication enabling technologies are designed to provide a
cost-effective means for securing electronic transactions, providing network and
device access control and enabling workflow automation of traditional paper form
processing. CIC believes that these technologies offer more efficient methods
for conducting electronic transactions while providing more functional user
authentication and heightened data security. The Company's transaction and
communication enabling technologies have been fundamental to its development of
software for electronic signatures, handwritten biometric signature
verification, data security, and data compression.
Handwriting recognition segment products
Key Handwriting recognition segment products include the following:
Handwriter, Chinese Multi-lingual handwriting recognition software
Handwriter and Jot
Inktools A suite of application development tools for
electronic signatures, biometric signature
verification and cryptography
SignatureOne SignatureOne is the server compliment to
CIC's Sign-it software which enables the
real time capture of electronic and digital
signatures in various application
environments. All user authentication and
transaction tracking in SignatureOne is
based on data from the Sign-it client
software
iSign Web based development tools for electronic
signature and biometric signature verification
PenX Operating systems extensions for the Windows
operating system that enables pen-based
functionality and handwriting
QuickNotes and InkSnap Electronic handwritten notetaking software
Sign-it and Sign-it Electronic signatures for the enterprise market
Server
Sign-On and Biometric Signature verification software for
SignatureWallet device access and data protection
WordComplete Predictive text entry software
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Products and upgrades for the Handwriting recognition products that were
introduced and first shipped in 2004 include the following:
WordComplete v3.1
iSign v3.0
iSign v3.1
Sign-it for Acrobat v4.0
Sign-it for Acrobat v4.1
Sign-it for Acrobat v4.2
Sign-it for Acrobat SDK v1.0
Sign-it for Word v4.11
SignatureOne v1.0 (Oracle Support)
Jot for Palm OS v2.05
Jot for Palm OS v2.1
Handwriting recognition software analyzes the individual strokes of
characters written with a pen/stylus and converts these stokes into
machine-readable text characters. This software is especially useful for
portable electronic devices that are too small to employ a keyboard, and for the
input of ideographic script characters such as those used in written Chinese and
Japanese. The Company currently has two recognition system offerings, Handwriter
and Jot. CIC's Handwriter Recognition System ("HRS(TM)") recognizes handwritten
input on Windows and Windows CE based pen computers and desktop PCs for either
English or simplified and traditional Chinese characters. HRS accurately
recognizes handwritten characters without recognizer training required, so the
user can write naturally. HRS is a full-context recognizer that offers some
unique features such as automatic spacing between words and automatic
capitalization of the first letter of new sentences. HRS is also an integral
component of the Company's PenX software and iSign Software Development Kit
("SDK") that is currently sold to consumers, OEMs and vertical market channel
partners.
Jot recognizes handwritten input and is specifically designed for small
devices. Unlike many recognizers that compete in the market for handheld data
input solutions, Jot offers a user interface that allows for the input of
natural upper and lowercase letters, standard punctuation and European languages
without requiring the user to memorize unique characters or symbols. This
recognizer offers rapid and accurate recognition without requiring the consumer
to spend time training the system. Jot has been licensed to such key OEMs as:
Microsoft, Sony Ericsson, Symbian, palmOne, PalmSource, National Semiconductor
and Vtech. Jot has been ported to many operating systems, including Palm OS,
Windows, Windows CE, VT-OS, EPOC, QNX, Linux and OS/9, and is currently under
development for others. The standard version of Jot, which is available through
OEM, Enterprise and Online product offerings, recognizes and supports input of
Roman-based Western European languages.
InkTools is an electronic signature and handwritten signature verification
software developers' kit that captures and analyzes the image, speed, stroke
sequence and acceleration of a person's handwritten electronic signature.
InkTools provides an effective and inexpensive handwriting security check for
immediate authentication. It also stores certain forensic elements of a
signature for use in determining whether a person actually electronically signed
a document. The InkTools kit also includes software libraries for industry
standard encryption and hashing to protect the sensitive nature of a user
signature. Commercial applications for this type of software include document
approval, verification of the identity of users participating in electronic
transactions and securing log-in access to computer systems or protected
networks. This software toolkit is used internally by CIC as the underlying
technology in its Sign-On, iSign, SignatureWallet and Sign-it products as well
as the integrated solutions provided by the Systems Integration operation of the
joint venture in China. It has been licensed to numerous key development
partners and end-users, including Chase Manhattan Bank, EDS, BNX, Siebel Systems
and Nationwide (UK).
Sign-On and SignatureWallet are product offerings that utilize the
Company's handwritten biometric signature verification technology to provide
access and data security on portable devices. This provides the additional level
of security needed for devices that are increasingly being used in business and
generally contain sensitive data. Currently available for the Palm 3.x or later,
Windows CE and Windows XP Tablet PC Edition operating systems; the product is
also being ported to other platforms.
-5-
Sign-it is a family of electronic signature products for recording
electronic signatures as they are being written as well as binding and verifying
electronic signatures within standard consumer applications. These products
combine the strengths of handwritten signatures and cryptography to process,
transact and create electronic documents that have the same legal standing as a
traditional wet signature on paper in accordance with the Electronic Signature
in National and Global Commerce Act. Organizations wishing to process electronic
forms, requiring varying levels of security, can reduce the need for paper forms
by adding electronic signature technologies to their workflow solution.
Currently, Sign-it is available for MS Word, AutoCAD and Adobe(R) Acrobat(R),
while support for additional application environments is in development.
iSign provides functionality similar to InkTools but is specifically
designed for web based architectures. The current product supports either a
Windows implementation with Internet Information Server and Internet Explorer or
Java implementations based on J2EE. The product is designed to meet the needs of
higher-end server products and a broad base of client systems, which range from
Windows devices to PDAs.
eSignature Revenues
2004 eSignature revenue of $6.1 million more than quadrupled (407%) over
2003 eSignature revenue of $1.5 million. The 2004 eSignature revenue was derived
from well over one hundred customers but was primarily attributable to Charles
Schwab, Duncan Management, IA Systems, Misys Healthcare, Symbol Technologies,
State Farm Insurance, Wells Fargo and TVA. The Company believes that the
increasing focus on corporate accountability, including a growing demand for
auditable business approval processes, is driving many enterprises to add
eTransactions to their priority deployments in 2005.
End users and resellers that have licensed the Company's technology include the
following:
Licensee Product(s) Application of Products
licensed
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Accelio Inktools Mobile forms
Agricultural Bank of China InkTools Document automation
Al-Faris Multiple Reseller and integrator
in the Middle East
focused on e-Signatures
American General Life & Sign-it Mobile forms
Assurance (AGLA)
Assurant Group Sign-It Sales force automation,
new account openings
Baptist Health Inktools Patient records
Boston Medical Center iSign Patient records
Cablevision Ink Tools Document automation
Cellular One iSign Document automation
Charles Schwab Sign-It New account openings
China Ministry of Railways InkTools Document automation
County of Marin Sign-It Document automation
County of Dade Document automation
Duncan Management Ink Tools Document automation
E-Com Asia Pacific Pty Ltd. Multiple Regional reseller,
multiple applications
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Licensee Product(s) Application of Products
licensed
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EDS InkTools Information assurance
for network and
application security
First American Bank Sign-It Various financial and
internal documents
First Command Financial Sign-It Document automation
Franklin Mint Sign-It Document automation
GE Power Systems Sign-It Document automation
IA Systems InkTools Loan organization
ILI Technologies, (Ltd.) InkTools & iSign Various e-Signature
applications for the
verticalmarkets in Israel
Industrial & Commercial InkTools Document automation
Bank of China
Integrate Online InkTools Mortgage closing
Interlink Electronics Sign-It OEM for multiple products
Missouri State Lottery Sign-It Document automation
Motion Computing Sign-On Tablet PC logon
Nanjing Agricultural Bureau InkTools Document automation
National Healthcare Sign-It Document automation
Nationwide Building Society InkTools Document automation
Naval Surface Warfare InkTools Material center receipts
Old Republic National Sign-It Title processing
applications
Orange County, CA Sign-It Automate building permit
process
Prudential Insurance Co. Sign-It EX Mobile forms
RecordsCenter.com InkTools Legal contracts and other
significant documents
Saytek Sign-It Document automation
State Farm Insurance Company Sign-It Mobile forms
St. Vincent's Hospital Multiple Document automation
Siebel Systems Multiple Sample delivery of
regulated drugs
Siemens Medical Solutions Multiple Healthcare
Symbol Technologies Multiple Reseller for multiple
products
Tennessee Valley Authority Multiple Approval of internal
documents
Topaz Systems, Inc. Multiple OEM for multiple products
Turner Construction/Oracle iSign Document automation
University of Virginia iSign Document automation
Varity InkTools Reseller of application
software
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Licensee Product(s) Application of Products
licensed
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Washington County Hospital Sign-It Patient records
Wells Fargo Bank Sign-It Document automation
Natural Input Revenue
Natural input revenue for 2004 of $845 more than tripled (388%), as
compared to $218 for the prior year and the increase was primarily attributable
to royalties from PalmSource .
In early 2003, PalmSource announced that it had licensed CIC's Jot(R)
handwriting recognition software to replace Graffiti(R) as the standard and only
handwriting software on all new Palm Powered(R) devices. Under this agreement,
"Graffiti 2 powered by Jot" is embedded by PalmSource in current versions of its
Palm OS(R) platform. The new Graffiti 2 handwriting software supports an
intuitive, more natural form of input, minimizing learning time for new users
and easing the transition for experienced users. Due to the continuing depressed
levels of handheld computer shipments throughout 2003 and existing OEM inventory
levels, the transition by OEMs to PalmSource's latest operating systems (with
Graffiti 2/Jot) has been much slower than anticipated. CIC first received
royalties in the second quarter of 2003, representing less than 10% of total
PalmSource OS reported shipments with fourth quarter royalties reflecting
approximately 70% of total PalmSource OS reported shipments. The transition to
Jot based PalmSource operating systems by OEM's was completed in the third
quarter of 2004.
Online/Retail Revenues
Revenues from the Company's software sold directly through it's website
(www.cic.com) and at the retail point of sale totaled $130 in 2004, 57% below
the $300 for the prior year, reflecting the continuing suppressed levels of
handheld computer shipments in 2004 as well as the overall decrease in consumer
spending both online and at retail stores on handheld computer (PDA) devices.
Retail sales are generated through an agreement with Elibrium Inc., that
positions CIC's Palm OS based software offerings directly at the point of sale
at retailers including Comp USA, Staples, and Office Max, and from , Handango
and PalmGear, leading online suppliers of software enhancements for Palm powered
devices.
China eSignature Revenue
CIC China ("CICC"), a joint venture 90% owned by CIC, was established over
nine years ago and is headquartered in Nanjing China. The Joint Venture is 10%
owned by the Jiangsu Hongtu Electronics Group.
Revenue from CICC's eSignature software of $120 in 2004, declined 62% from
$319 in the prior year. This decline represents both the impact of delays in
rolling out CICC's channel strategy as well as the passage of China's E-Sign Law
in August of 2004. Achieving accelerated and sustained sales growth in China by
leveraging resellers to provide China wide market coverage requires investment
of both time and resources. Training resellers' sales forces and committing the
upfront engineering resources required to embed our eSignature software into
partners' total solutions was anticipated and fundamental to achieving
China-wide sales coverage. The anticipation and final passage of China's E Sign
Law, however, significantly dampened sales results, especially in the last half
of 2004, as both resellers and end user customers awaited the implications of
the law on product functionality. However, passage of this Law is an overall
positive event in that it provides the framework for product functionality and
standards required to accelerate acceptance and growth for our technology in
China. It does, however, require new market validation studies and considerable
engineering effort to localize our newer technologies to meet the China market
requirements. This has led to our current strategy of identifying and focusing
on fewer strategic partners/resellers in China. Specifically, those capable of
both market validation and possessing a high level of engineering competence and
effective selling to target market applications.
-8-
China System Integration Revenue
CICC systems integration (SI) revenue of $36 in 2004 declined 95% from $667
in the prior year. The decline in system integration revenue reflects our
decision made in late 2003 not to continue in or expand this low margin, labor
intensive business, which would require significant increases in base costs to
provide turn-key capabilities. The SI business has become highly competitive,
with a low barrier to entry. It is increasingly comprised of small Chinese owned
businesses with virtually no differentiation in service offerings and primarily
competing on price and relationships. Our focus in China is on the emerging high
potential workflow/office automation market leveraging our eSignature technology
and strategic channel partners.
Copyrights, Patents and Trademarks
Handwriting Recognition Segment
The Company relies on a combination of patents, copyrights, trademarks,
trade secrecy and contractual provisions to protect its software offerings and
technologies. The Company has a policy of requiring its employees and
contractors to respect proprietary information through written agreements. The
Company also has a policy of requiring prospective business partners to enter
into non-disclosure agreements before disclosure of any of its proprietary
information.
Over the years, the Company has developed and patented major elements of
its software offerings and technologies. In addition, in October 2000 the
Company acquired, from PenOp, Inc. and its subsidiary, a significant patent
portfolio relevant to the markets in which the Company sells its products. The
Company's material patents and the years in which they each expire are as
follows:
Patent No. Expiration
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4718102 2005
5049862 2008
5544255 2013
5647017 2014
5818955 2015
5933514 2016
6064751 2017
6091835 2017
6212295 2018
6381344 2019
6487310 2019
The Company believes that these patents provide a competitive advantage in
the electronic signature and handwriting recognition markets. The Company
believes the technologies covered by the patents are unique and allow it to
produce superior products. The Company also believes these patents are very
broad in their coverage. The technologies go beyond the simple handwritten
signature and include measuring electronically the manner in which a person
signs to ensure tamper resistance and security of the resultant documents and
the use of other systems for identifying an individual and using that
information to close a transaction. The Company believes that the patents are
sufficiently broad in coverage that products with substantially similar
functionality will infringe its patents. Moreover, because the majority of these
patents do not expire for between 9 and 15 years from the date hereof, the
Company believes that it has sufficient time to develop new related
technologies, which may be patentable, and to establish CIC as market leader in
these product areas. Accordingly, the Company believes that for a significant
period of time the patents will deter competitors from introducing competing
products without creating substantially different technology or licensing or
infringing its technology.
The Company has an extensive list of registered and unregistered trademarks
and applications in the United States and other countries. The Company intends
to register its trademarks generally in those jurisdictions where significant
marketing of its products will be undertaken in the foreseeable future.
-9-
Systems Integration Segment
Systems integration does not rely to any material degree on the Company's
products and, therefore, its patents and their ultimate expiration do not
significantly impact the systems integration segment.
Material Customers
Handwriting Recognition Segment
Historically, the Company's handwriting recognition segment revenues have
been derived from a limited number of customers. One customer, a national
insurance company, accounted for 46 % and 19% of total segment revenues for the
years ended December 31, 2004 and 2003, respectively. One customer, Nationwide
Building Society, accounted for 11% of total segment revenues for the year ended
December 31, 2002.
Systems Integration Segment
One customer, Nanjing Minze, accounted for 40% of total system integration
revenue for the year ended December 31, 2004. One customer, Fujitsu Ltd.,
accounted for 21% and 30% of total system integration revenue for the year ended
December 31, 2003 and 2002, respectively.
Seasonality of Business
The Company believes that neither of its segments is subject to seasonal
fluctuations.
Backlog
Handwriting Recognition Segment
Backlog approximated $458 at December 31, 2004, representing advanced
payments on service maintenance agreements that are expected to be recognized
over the next twelve months. At December 31, 2003, backlog approximated $165,
representing advanced payments on service maintenance agreements and
non-recurring engineering projects.
Systems Integration Segment
There was no backlog at December 31, 2004 and 2003. At December 31, 2002,
backlog was approximately $34.
Competition
Handwriting Recognition Segment
The Company faces competition at different levels. Certain competitors,
e.g., PenPower Group, and Decuma AB, have developed or are developing software
offerings which may compete directly with the Company's offerings. Most of the
Company's direct competitors, e.g., Microsoft Corporation, Silanis Technology,
Inc., and Advanced Recognition Technology, Inc., have focused on only one
element of such offerings, such as handwriting recognition technology, signature
capture/verification or pen-based operating environments or other pen-based
applications. The Company believes that it has a competitive advantage in some
cases due to its range of product offerings. There can be no assurance, however,
that competitors, including some with greater financial or other resources, will
not succeed in developing products or technologies that are more effective,
easier to use or less expensive than the Company's products or technologies that
would render its products or technologies obsolete or non-competitive.
-10-
Systems Integration Segment
The Company's Joint Venture competes with other systems integrators of
similar size (less than 100 employees) in China for small to mid-size enterprise
opportunities. The Company primarily competes on price and quality and breadth
of services for these opportunities. The Company believes that it is competitive
in its pricing and has been consistently recognized by its customers for its
high quality of service. However, as previously discussed under System
Integration Revenue, the Company has shifted its focus in China away from the
system integration business to the emerging high potential work flow/office
automation market leveraging its eSignature technology and strategic channel
partners.
Employees
As of December 31, 2004, the Company employed an aggregate of 33 full-time
employees. The Company's handwriting recognition segment consisted of 33
employees, 19 of which are in the United States and 14 of which are in China.
The Company had no full-time employees in its systems integration segment in
China at December 31, 2004. From time to time, the Company also utilizes
additional personnel on an as needed basis. The Company believes it has good
relations with its employees. None of the Company's employees are a party to a
collective bargaining agreement.
Geographic Areas
For the years ended December 31, 2004, 2003, and 2002, the Company's sales
in China as a percentage of total sales were less than 1%, 34% and 38%,
respectively. For the years ended December 31, 2004, 2003, and 2002, the
Company's sales in the United States as a percentage of total sales were 99%,
66%, and 62%, respectively. For the years ended December 31, 2004, 2003, and
2002, the Company's export sales as a percentage of total revenues were
approximately 1%, 14%, and 14%, respectively.
Forward Looking Statements
Certain statements contained in this Annual Report on Form 10-K, including
without limitation, statements containing the words "believes", "anticipates",
"hopes", "intends", "expects", and other words of similar import, constitute
"forward looking" statements within the meaning of the Private Litigation Reform
Act of 1995. Such statements involve known and unknown risks, uncertainties and
other factors that may cause actual events to differ materially from
expectations. Such factors include the following: (1) technological,
engineering, quality control or other circumstances which could delay the sale
or shipment of products; (2) economic, business, market and competitive
conditions in the software industry and technological innovations which could
affect the Company's business; (3) the Company's ability to protect its trade
secrets or other proprietary rights, operate without infringing upon the
proprietary rights of others or prevent others from infringing on the
proprietary rights of the Company; and (4) general economic and business
conditions and the availability of sufficient financing.
Item 2. Properties
The Company currently leases its principal facilities, consisting of
approximately 9,600 square feet, in Redwood Shores, California, pursuant to a
sub-lease that expires in 2006. The Joint Venture leases approximately 1,500
square feet in Nanjing, China. The Company believes that its current facilities
will be suitable to continue operations in the foreseeable future.
Item 3. Legal Proceedings
In February of 2005, Valyd, Inc. filed a complaint against the Company
seeking a declaratory judgment that Valyd is not infringing certain of the
Company's patents, that such patents are invalid or unenforceable, and that the
Company tortiously interfered with a contract between Valyd, Inc. and Interlink
Electronics, Inc. by delivering an infringement notice to Interlink Electronics,
Inc. The complaint also alleged unfair competition under California law. No
specific monetary claim is set forth in the complaint. The Company believes that
the complaint is without merit and intends to vigorously defend against the
claims. On March 3, 2005, the Company responded to the complaint, denied all
allegations, and filed counterclaims against Valyd, Inc. The counterclaim
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asserted that Valyd, Inc. is infringing certain of the Company's patents and
asked for treble damages, alleging that the infringement is willful, deliberate
and in conscious disregard of CIC's rights. The ultimate outcome of this
litigation cannot presently be determined. However, in management's opinion, the
likelihood of a material adverse outcome is remote and any liability that might
be incurred would not have a material adverse effect on the Company's financial
position or its results of operations. Accordingly, adjustments, if any that
might result from the resolution of this matter have not been reflected in the
financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters
and issuer Purchases of Equity Securities
The Company's common stock is listed on the Over-the-Counter Bulletin Board
("OTC") under the trading symbol CICI.OB. Prior to March 14, 2003 it was listed
on the Nasdaq SmallCap Market under the symbol CICI. The following table sets
forth the high and low sale prices of the common stock for the periods noted.
Sale Price
Per Share
Year Period High Low
2003 First Quarter................................... $ 0.53 $ 0.13
Second Quarter.................................. $ 0.44 $ 0.15
Third Quarter................................... $ 0.65 $ 0.34
Fourth Quarter.................................. $ 0.45 $ 0.30
2004 First Quarter................................... $ 1.10 $ 0.35
Second Quarter.................................. $ 0.90 $ 0.42
Third Quarter................................... $ 0.80 $ 0.31
Fourth Quarter.................................. $ 0.71 $ 0.35
2005 First Quarter (through March 15, 2005)............. $ 0.63 $ 0.38
As of March 28, 2005, the closing sale price of the Common Stock on the
Nasdaq OTC was $0.46 per share and there were approximately 960 registered
holders of the Common Stock.
To date, the Company has not paid any dividends on its Common Stock and
does not anticipate paying dividends in the foreseeable future. The declaration
and payment of dividends on the Common Stock is at the discretion of the Board
of Directors and will depend on, among other things, the Company's operating
results, financial condition, capital requirements, contractual restrictions or
such other factors as the Board of Directors may deem relevant.
All securities sold during 2004 by the Company were either previously
reported on our Form 10Qs filed with the Securities and Exchange Commission or
sold pursuant to registration statements filed under the Securities Act of 1933,
as amended.
During the three months ended December 31, 2004, the Company granted
600,000 stock options to eight employees, with a weighted average exercise price
of $0.53 per share, under the Company's 1999 Stock option Plan. During the years
ended December 31, 2004, 2003, and 2002, respectively, the Company granted the
following options to purchase Common Stock to employees at the prices per share
indicated below.
-12-
Approximate Exercise
Year Number of Shares Price Per Share
--------------------- ----------------------- ------------------------
2004 1,334 $0.53
2003 858 $0.32
2002 1,108 $0.60
The information required by Item 201(d) of Regulation S-K is incorporated
by reference to Note 7 ("Stockholders Equity") of Notes to Consolidated
Financial Statements for the Year Ended December 31, 2004, page F-22.
Item 6. Selected Financial Data
The selected consolidated financial data presented below as of December 31,
2004, 2003, 2002, 2001, and 2000 and for each of the years in the five-year
period ended December 31, 2004 are derived from the audited consolidated
financial statements of the Company. The consolidated financial statements as of
December 31, 2004 and 2003, and for each of the years in the three-year period
ended December 31, 2004, are included in Item 8 of this Form 10-K. The selected
consolidated financial data should be read in conjunction with the Company's
audited financial statements and the notes thereto and other portions of this
Form 10-K including "Business" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Year Ended December 31,
-----------------------------------------------
2004 2003 2002 2001 2000
-----------------------------------------------
(In thousands, except per share amounts)
Statement of Operations Data:
Revenues.........................$7,284 $ 3,034 $ 3,272 $ 5,947 $ 7,312
Research and development
expenses(1)..................... 1,187 1,302 1,485 1,808 1,603
Sales and marketing expenses..... 1,306 905 1,543 2,054 2,239
General and administrative
expenses........................ 2,483 2,219 2,424 2,791 2,181
Income (loss) from operations.... 2,255 (2,157) (3,337) (2,946) (1,607)
Net income (loss) available
to common stockholders.......... 1,620 (2,345) (3,561) (3,215) (1,799)
Basic and diluted income (loss)
per share....................... 0.02 (0.02) (0.04) (0.04) (0.02)
As of December 31,
-----------------------------------------------
2004 2003 2002 2001 2000
-----------------------------------------------
(In thousands)
Balance Sheet Data:
Cash, cash equivalents and
restricted cash............... $4,736 $1,039 $ 711 $ 2,588 $ 2,349
Working capital(2)............. 4,068 (2,895) 443 3,017 3,109
Total assets................... 10,819 7,215 7,168 10,072 11,302
Deferred revenue............... 458 165 165 88 61
Long-term obligations.......... 1,790 13 3,000 3,000 1,427
Stockholders' equity (3)....... 7,531 2,187 2,934 6,060 8,307
- -----------
(1) Excludes software development costs capitalized in accordance with
Statement of Financial Accounting Standards No. 86 of $32 at December 31,
2004 and $20 for the years ended December 31, 2001, and 2000, respectively.
No software development costs were capitalized in the years ended December
31, 2003 and 2002.
(2) Current liabilities used to calculate working capital at December 31, 2004,
2003, 2002, 2001, and 2000 include deferred revenue of $458, $165, $165,
$88, and $61, respectively.
(3) The Company has never paid dividends to the holders of its common stock.
-13-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Unless otherwise stated herein, all figures in this MD& A section are
stated in thousands ("000s").
Overview
The Company was initially incorporated in Delaware in October 1986. Except
for the year ended December 31, 2004, in each year since its inception the
Company has incurred losses. For the five-year period ended December 31, 2004,
operating losses aggregated approximately $8,000 and at December 31, 2004, the
Company's accumulated deficit was approximately $81,000.
New Accounting Pronouncements
See note 1, Notes to Consolidated Financial Statements included under Part
IV. Item 15.
Critical Accounting Policies
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States of
America requires management to make judgments, assumptions and estimates that
affect the amounts reported in the Company's consolidated financial statements
and the accompanying notes. The amounts of assets and liabilities reported in
its balance sheets and the amounts of revenues and expenses reported for each
period presented are affected by these estimates and assumptions which are used
for, but not limited to, revenue recognition, allowance for doubtful accounts,
intangible asset impairments, inventory, fair value of financial instruments,
customer base, software development costs research and development costs,
foreign currency translation and net operating loss carryforwards. Actual
results may differ from these estimates. The following critical accounting
policies are significantly affected by judgments, assumptions and estimates used
by the Company's management in the preparation of the consolidated financial
statements.
Revenue is recognized when earned in accordance with applicable accounting
standards, including AICPA Statement of Position ("SOP") No. 97-2, Software
Revenue Recognition, as amended, Staff Accounting Bulletins 104 ("SAB 104") and
the interpretive guidance issued by the Securities and Exchange Commission and
EITF issue 00-21 of the FASB's Emerging Issues Task Force. The Company
recognizes revenues from sales of software products upon shipment, provided that
persuasive evidence of an arrangement exists, collection is determined to be
probable, all nonrecurring engineering work necessary to enable the Company
products to function within the customer's application has been completed and
the Company's product has been delivered according to specifications. Revenue
from service subscriptions is recognized as costs are incurred or over the
service period. Software license agreements may contain multiple elements,
including upgrades and enhancements, products deliverable on a when and if
available basis and post contract support.
Revenue from software license agreements is recognized upon delivery of the
software, provided that persuasive evidence of an arrangement exists, collection
is determined to be probable, all nonrecurring engineering work necessary to
enable the Company's products to function within the customer's application has
been completed and the Company has delivered its product according to contract
specifications. Deferred revenue is recorded for upgrades, enhancements and
post-contract support, which is paid for in addition to license fees, and is
recognized as costs are incurred or over the support period. Vendor specific
objective evidence of the fair value for multiple element software license
agreements is determined by the price charged for the same element when sold
separately or the price determined by management having the relevant authority
when the element is not yet sold separately. The price established by management
for the element not yet sold separately will not change prior to separate
introduction of that element into the marketplace.
Revenue from system integration activities, which represents the sale and
installation of third party computer equipment and limited related consulting
services, is recognized upon installation of the third party hardware and/or
software as projects are short term in nature, provided that a contract exists,
-14-
collectibility of the receivable is reasonably assured and the system is
functioning according to specifications. Service subscription revenues
associated with the system integration activities are recognized as costs are
incurred or over the service period which ever is longer.
The allowance for doubtful accounts is based on the Company's assessment of
the collectibility of specific customer accounts and an assessment of
international, political and economic risk as well as the aging of the accounts
receivable. If there is a change in actual defaults from the Company's
historical experience, the Company's estimates of recoverability of amounts due
it could be affected and, the Company would adjust the allowance accordingly.
The Company performs intangible asset impairment analyses on a quarterly
basis in accordance with the guidance in Statement of Financial Accounting
Standard No. 142, Goodwill and Other Intangible Assets ("SFAS No. 142") and
Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal
of Long Lived Assets ("SFAS No. 144"). The Company uses SFAS 144 in response to
changes in industry and market conditions that affects its patents, the Company
then determines if an impairment of its assets has occurred. The Company
reassesses the lives of its patents and tests for impairment quarterly in order
to determine whether the book value of each patent exceeds the fair value of
each patent. Fair value is determined by estimating future cash flows from the
products that are and will be protected by the patents and considering the
following additional factors:
o whether there are legal, regulatory or contractual provisions known to it
that limit the useful life of each patent to less than the assigned useful
life;
o whether the Company needs to incur material costs or make modifications in
order for it to continue to be able to realize the protection afforded by
the patents;
o whether any effects of obsolescence or significant competitive pressure on
the Company's current or future products are expected to reduce the
anticipated cash flow from the products covered by the patents;
o whether demand for products utilizing the patented technology will
diminish, remain stable or increase; and
o whether the current markets for the products based on the patented
technology will remain constant or will grow over the useful lives assigned
to the patents.
The Company believes that as of December 31, 2004 and 2003, no impairment
of the carrying values of the patents existed.
Customer Base. To date, the Company's revenues have been derived
principally from end-users, manufacturers, retailers and distributors of
computer products in North America, Europe and the Pacific Rim. The Company
performs periodic credit evaluations of its customers and does not require
collateral. The Company maintains reserves for potential credit losses.
Historically, such losses have been within management's expectations.
Software Development Costs. Software development costs are accounted for in
accordance with Statement of Financial Accounting Standards No. 86, "Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed"
("SFAS 86"). Under SFAS 86, capitalization of software development costs begins
upon the establishment of technological feasibility, subject to net realizable
value considerations. The costs capitalized include the coding and testing of
the product after the technological feasibility has been established and ends
upon the release of the product. The capitalized costs are amortized to cost of
sales on a straight-line basis over the estimated life of the product, generally
three years. As of December 31, 2004, 2003 and 2002, such costs were
insignificant.
Research and Development Costs. Research and development costs are charged
to expense as incurred.
Foreign Currency Translation. The Company considers the functional currency
of the Joint Venture to be the respective local currency and, accordingly, gains
and losses from the translation of the local foreign currency financial
statements are included as a component of "accumulated other comprehensive loss"
-15-
in the Company's consolidated balance sheets. Foreign currency assets and
liabilities are translated into U.S. dollars at exchange rates prevailing at the
end of the period, except for long-term assets and liabilities that are
translated at historical exchange rates. Revenues and expenses are translated at
the average exchange rates in effect during each period, except for those
expenses included in balance sheet accounts, which are translated at historical
exchange rates. Net foreign currency transaction gains and losses are included
as components of "interest income and other income (expense), net" in the
Company's consolidated statements of operations. Due to the stability of the
currency in China, net foreign currency transaction gains and losses were not
material for the year ended December 31, 2004, 2003 and 2002, respectively.
Net Operating Loss Carryforwards. Utilization of the Company's net
operating losses may be subject to an annual limitation due to the ownership
change limitations provided by the Internal Revenue Code of 1986 and similar
state provisions. As a result, a portion of the Company's net operating loss
carryforwards may not be available to offset future taxable income. The Company
has provided a full valuation allowance for deferred tax assets at December 31,
2004 of $28 million based upon the Company's history of losses.
Segments
The Company reports in two segments: handwriting recognition and systems
integration. Handwriting recognition includes online/retail revenues and
corporate sales, including enterprise and original equipment manufacturers
("OEM") revenues. All handwriting recognition software is developed around the
Company's core technology. Handwriting recognition product revenues are
generated through a direct sales force to individual or enterprise end users and
by web based application resellers. The Company also licenses a version of its
handwriting recognition software to OEM's. The handwriting recognition software
is included as part of the OEM's product offering. From time to time, the
Company is required to develop an interface (port) for its software to operate
on a new customer's hardware platform or within the customer's software
operating system. Development contract revenues are included in the handwriting
recognition segment.
System integration represents the sale and installation of third party
computer equipment and systems that utilize the Company's products. System
integration sales are derived through a direct sales force that then develops a
system to utilize the Company's software based on the customer's requirements.
Systems integration sales are accomplished solely through the Company's Joint
Venture. However, as previously discussed under System Integration Revenue, the
Company has shifted its focus in China away from the system integration business
to the emerging high potential work flow/office automation market leveraging its
eSignature technology and strategic channel partners.
Results of Operations
The following table provides unaudited financial information for each of
the Company's two segments.
Years Ended December 31,
2004 2003 2002
----------------- --------------- ---------------
Handwriting recognition
Online/retail $ 130 $ 300 $ 351
Corporate 6,997 1,703 1,667
China 120 319 239
----------------- --------------- ----------------
Total Handwriting recognition $ 7,247 $ 2,322 $ 2,257
Systems integration
China Total Systems integration $ 37 $ 712 $ 1,015
----------------- --------------- ----------------
Total revenues $ 7,284 $ 3,034 $ 3,272
----------------- --------------- ----------------
Cost of Sales
Handwriting recognition $ 22 $ 141 $ 423
Systems integration 31 624 734
----------------- --------------- ----------------
Total cost of sales $ 53 $ 765 $ 1,157
-16-
Years Ended December 31,
2004 2003 2002
----------------- --------------- ----------------
Operating cost and expenses
Research and development $ 1,187 $ 1,302 $ 1,485
Sales and Marketing 1,306 905 1,543
General and administrative 2,483 2,219 2,424
---------------- --------------- ----------------
Total operating costs and expenses $ 4,976 $ 4,426 $ 5,452
----------------- --------------- ----------------
Interest and other income
(expense) net, and Minority
interest $ (635) $ (188) $ (224)
----------------- --------------- ----------------
Net income (loss) $ 1,620 $ (2,345) $ (3,561)
================= =============== ================
Amortization of intangible assets
Cost of sales $ 12 $ 14 $ 14
General and administrative 379 379 378
----------------- --------------- ----------------
Total amortization of intangible
assets (See note 1) $ 391 $ 393 $ 392
================= =============== ================
Years Ended December 31, 2004 and December 31, 2003
Revenues
Handwriting Recognition
Handwriting recognition segment revenues include online/retail, corporate
and China software sales. Handwriting recognition segment revenues increased
212%, or $4,925, to $7,247 for the twelve months ended December 31, 2004,
compared to $2,322 in the prior year period as discussed below.
Online/retail revenues for the Company's natural input products decreased
57% or $170, to $130 for the twelve months ended December 31, 2004, compared to
$300 in the prior year period. In early 2003, PalmSource announced that it had
licensed CIC's Jot(R) handwriting recognition software to replace Graffiti(R) as
the standard and only handwriting software on all new Palm Powered(R) devices.
The embedding of Jot on Palm related devices had a negative impact on the
online/retail sales. The transition to Jot based PalmSource operating systems by
OEM's was completed in the third quarter of 2004 and the Company believes that
the online/retail revenues have stabilized for the near term.
Corporate revenues, which includes eSignature and natural input sales,
increased 311%, or $5,294, to $6,997 for the twelve months ended December 31,
2004, compared to $1,703 in the prior year period. Natural input OEM and channel
partner sales increased 53%, or $382, to $1,104 for the twelve months ended
December 31, 2004, compared to $722 in the prior year period. The increase in
natural input channel partner and OEM sales was due primarily to royalties from
the shipment by PalmSource of its operating system containing the Company' Jot
software. The Company expects natural input channel partner and OEM sales to
increase in the future as new customers are identified and new agreements are
signed. eSignature sales increased 501%, or $4,913, to $5,894 for the twelve
months ended December 31, 2004, compared to $981 in the prior year period. The
increase in eSignature sales was due primarily to sales to large national
customers in the insurance and banking industries. The Company believes that the
sales of smaller pilot deployments to large national eSignature customers will
lead to greater sales in future periods as the customers roll out their
applications on a wider scale. However the timing of customer product roll out
is difficult to project due to many factors beyond the Company's control. The
Company views eSignature as a high potential revenue market and intends to
continue to place increasing focus on this market.
China software sales declined 62%, or $199, to $120 for the twelve months
ended December 31, 2004, compared to $319 in the prior year period. This decline
represents both the impact of delays in rolling out CICC's channel strategy as
-17-
well as the passage of China's E-Sign Law in August of 2004. Achieving
accelerated and sustained sales growth in China by leveraging resellers to
provide China wide market coverage requires investment in both time and
resources. Training resellers' sales forces and committing the upfront
engineering resources required to embed our eSignature software into partners'
total solutions was anticipated and fundamental to achieving China-wide sales
coverage. The anticipation and final passage of China's E Sign Law, however,
significantly dampened sales results, especially in the last half of 2004, as
both resellers and end user customers awaited the implications of the law on
product functionality. However, passage of this Law is an overall positive event
in that it provides the framework for product functionality and standards
required to accelerate acceptance and growth for our technology in China. It
does, however, require new market validation studies and considerable
engineering effort to localize our newer technologies to meet the China market
requirements. This has led to our current strategy of identifying and focusing
on fewer strategic partners/resellers in China. Specifically, those capable of
both market validation and possessing a high level of engineering competence and
effective selling to target market applications.
Systems Integration.
System integration segment revenue declined 95%, or $675, to $37 for the
twelve months ended December 31, 2004, compared to $712 in the prior year
period. The decline in system integration revenue reflects the decision made in
late 2003 not to continue in or expand this low margin, labor intensive
business, which would require significant increases in base costs to provide
turn-key capabilities. The SI business has become highly competitive, with a low
barrier to entry. It is increasingly comprised of small Chinese owned businesses
with virtually no differentiation in service offerings and primarily competing
on price and relationships. Our focus in China is on the emerging high potential
workflow/office automation market leveraging our eSignature technology and
strategic channel partners.
Cost of Sales.
Handwriting recognition.
Handwriting recognition segment cost of sales includes online/retail,
corporate and China software sales costs. Such costs are comprised of royalty
and import tax payments, third party hardware costs, direct mail costs,
engineering direct costs and amortization of intangible assets excluding
patents. Cost of sales for the handwriting recognition segment decreased 84%, or
$119, to $22 for the twelve months ended December 31, 2004, compared to $141 in
the prior year period. The decline was primarily due to the sale of less third
party hardware along with the Company's software products. Cost of sales may
increase in the future depending on the customers decision to purchase from the
Company its software solution and third party hardware as a complete package
rather than buying individual components from separate vendors.
Online/retail cost of sales decreased 100%, or $16, to $0 for the twelve
months ended December 31, 2004, compared to $16 in the prior year period. The
decrease was due to the use of software reseller web sites to move its products
rather than maintaining an internal online store. The Company does not
anticipate a material increase in costs associated with the online/retail sales.
eSignature and natural input channel partner and OEM cost of sales
decreased 35%, or $11, to $20 for the twelve months ended December 31, 2004,
compared to $31 in the prior year period. The decrease was due to the lower
volume of third party hardware sales and engineering development costs compared
to the prior year. Increases in corporate cost of sales in the future will be
driven by the amount of third party hardware that is sold with the Company's
software solutions and increased amortization of software development costs
capitalized in future periods associated with product development.
China software cost of sales decreased 96%, or $90, to $4 for the twelve
months ended December 31, 2004, compared to $94 in the prior year period. The
decrease was due to the reduction in revenues over the twelve months ended
December 31, 2004, compared to the prior year periods. It is expected that cost
of sales will remain low for the foreseeable future as the current focus is the
sale of software solutions through channel partners with little third party
hardware costs.
-18-
Systems Integration.
China Systems integration segment cost of sales decreased 95%, or $593, to
$31 for the twelve months ended December 31, 2004, compared to $624 in the prior
year period. The decrease in costs was due primarily to the reduction in sales
during the twelve months ended December 31, 2004 as compared to the prior year.
The Company expects that system integration cost of sales will decrease over
time as the Company has decided not to pursue system integration revenues beyond
2004 but to continue to increase its focus on the emerging high potential
eSignature/office automation market in China.
Operating expenses
Research and Development Expenses. Research and Development expense
decreased 9%, or $115, to $1,187 for the twelve months ended December 31, 2004,
as compared to $1,302 in the prior year period. Engineering expenses consist
primarily of salaries and related costs, outside engineering, maintenance items,
and allocated facilities expenses. Salaries and related expense increased 6%, or
$53, to $881 for the year ended December 31, 2004, as compared to $828 in the
prior year period, due primarily to increases in salaries and related expenses.
Outside engineering cost and expenses declined 77%, or $24, to $7 for the year
ended December 31, 2004, compared to $31 in the prior year period. The decline
was due primarily to a reduction in the use of outside engineering services
compared to the prior year. The Company maintains a relationship with an outside
engineering group familiar with its products and may draw on their services, as
required, which could have a material effect on the amount of outside
engineering expense reported. Capitalized software development costs increased
100%, or $45, as compared to $0 in the prior year period. The increase in
capitalized software development was due to new product development and
significant upgrades and enhancements being made to the Company's natural input
and eSignature products. Capitalization of software development costs are
expected to remain at increased amounts for the foreseeable future. Other
engineering expenses decreased 22%, or $99, to $344 for the twelve months ended
December 31, 2004 as compared to $443 in the prior year period. The decrease was
primarily due to lower maintenance and depreciation expense compared to the
prior year periods. The Company believes that the reductions in engineering
expenses will not have an adverse effect on its product engineering and
development efforts due to its ability to call on outside engineering services
as required.
Sales and Marketing Expenses. Sales and marketing expenses increased 44%,
or $401, to $1,306 for the year ended December 31, 2004, compared to $905 in the
prior year period. Sales and marketing expenses consist of salaries, commissions
and related expenses, professional services, advertising and promotion, general
office and allocated facilities expenses. Salaries and related expenses
increased 51%, or $175, to $517 for the year ended December 31, 2004, compared
to $342 in the prior year period. The increase in salaries and related expense
was due primarily to the increase in headcount of one executive level employee
and, to a lesser extent, increases in employee salaries. Commission expense
increased 214%, or $214, to $314 for the year ended December 31, 2004, compared
to $100 in the prior year period. The increase in commission expense was due
primarily to an increase in revenues compared to the prior year. Travel and
entertainment increased 102%, or $43, to $85 for the year ended December 31,
2004, compared to $42 in the prior year period. This increase was due to the
increase in the sales employee headcount, and an increased amount of travel.
Recruiting expense increased 75%, or $15, to $35 for the year ended December 31,
2004, compared to $20 in the prior year period. The increase was due to the
hiring of an executive level employee through an executive level search firm.
Other expense, including general office and allocated facilities expenses
declined $46, or 11%, to $355 for the year ended December 31, 2004, compared to
$401 in the prior year period. The Company anticipates that sales and marketing
expenses will continue to increase in the near term as we strengthen our sales
efforts through increasing headcount to pursue new opportunities in the
eSignature market space. The Company continues to pursue a channel strategy for
its eSignature products. The Company believes the channel strategy, along with
its current and potential partners, will produce increasing revenues in the near
term.
General and Administrative Expenses. General and administrative expenses
increased 12%, or $264, to $2,483, for the year ended December 31, 2004,
compared to $2,219 in the prior year period. General and administrative expense
consists of salaries, professional fees, investor relations expenses, patent
amortization and office and allocated facilities costs. Salaries and wages
increased 5%, or $34, to $744 for the year ended December 31, 2004, compared to
$710 in the prior year period. The increase was due primarily to increases in
employee salaries. Professional service expense, which include consulting, legal
-19-
and outside accounting fees, increased 16%, or $74, to $542 for the year ended
December 31, 2004, compared to $468 in the prior year period. The increase was
due primarily to an increases in legal fees associated the infringement
litigation of Company's patent during the twelve months ended December 31, 2004,
compared to the prior year. The Company increased its expense for bad debts
300%, or $111, to $148, for the year ended December 31, 2004, compared to $37 in
the prior year period. The increase was to cover the slow payment cycle of
channel partner receivables of the Joint Venture. At this time, the Company
believes that its provision for bad debts is adequate. Other administrative
expenses decreased 3%, or $29, to $975 for the year ended December 31, 2004,
compared to $1,004 in the prior year period. The decrease was due primarily to
spending reductions. The Company believes that its General and Administrative
expenses will remain fairly stable for the near term.
Interest income and other income (expense), net
Interest income and other income (expense), net, increased 460%, or $46, to
$47 for the twelve months ended December 31, 2004, compared to $1 in the prior
year period. The increase was due to an increase in interest income due to
larger cash balances and to a refund of value added tax related to the tax year
2003 received by the Joint Venture in 2004.
Interest expense
Interest expense increased 242%, or $496, to $701 for the twelve months
ended December 31, 2004, compared to $205 in the prior year period. The increase
in interest expense was due to the amortization of fees to Cornell Capital
Partners, LP associated with the $750 in short-term debt, the $3,500 loan from
Cornell Capital Partners, LP, (See Note 4 of the condensed consolidated
financial statements) and interest on the long term debt. In addition the
Company is amortizing through interest expense the deferred financing costs and
debt discount associated with its long term debt (See Note 6 of the condensed
consolidated financial statements).
Years Ended December 31, 2003 and December 31, 2002
Revenues
Handwriting recognition segment. Handwriting recognition segment revenues
include online/retail, corporate and China software sales. Handwriting
recognition segment revenues increased 3%, or $65, to $2,322 for the twelve
months ended December 31, 2003 as compared to $2,257 in the comparable prior
year.
Online/retail revenues for the Company's natural input products declined
15%, or $51 to $300, for the twelve months ended December 31, 2003, compared to
$351 in the prior year period . In November of 2002, PalmSource replaced
Graffiti(R) with CIC's Jot as the standard and only handwriting software on all
new Palm PoweredTM devices. The Company believed that future online/retail
revenues would increase due to the "hallo effect" of the Palm license agreement,
as owners of older Palm operating systems were expected to upgrade the software
on their devices to the Company's Jot product. The Company did experience
increases in online/retail revenues in the first and second quarters of 2003
that it believed were the result of the Palm announcement. The increases were
short lived and the Company believes that the increase in online/retail revenues
were not sustained due to economic conditions and significantly reduced consumer
spending. The Company does not anticipate that it will experience significant
increases in its Online/Retail revenues in the near future.
Corporate revenues, which includes eSignature and natural input sales,
increased 2%, or $36, to 1,703 for the twelve months ended December 31, 2003,
compared to $1,667 in the prior year period. Natural input OEM revenues included
in corporate sales decreased 23%, or $84, to $722 for the twelve months ended
December 31, 2003, compared to $806 in the prior year period.. This decrease was
primarily due to decreases in the amount of royalty reported by two of the
Company's licensees. The Company believes natural Input OEM revenues will
increase in 2004 as Palm Source shipments of the older operating system are
replaced with their new operating system incorporating the Company's Jot
product. Despite Palm's prediction of declines in projected shipments of its
products, the Company believes new agreements signed with Symbol Technologies,
Inc. and VeriFone will offset any downturn in Palm unit shipments and lead to
increased eSignature and natural Input OEM revenues in 2004. eSignature sales
included in corporate sales increased 14%, or $120, to $981 for the twelve
-20-
months ended December 31, 2003, compared to $861 in the prior year period. The
increase in enterprise revenues was due to an increase in orders in 2003
compared to 2002.
Software sales in China increased 33%, or $80, to 319 for the twelve months
ended December 31, 2003, compared to $239 in the prior year period. The increase
is due to the continued sales efforts focused on establishing China-wide channel
partners to accelerate sales growth implemented in the second quarter of 2003.
Systems integration Segment. System integration segment revenue declined
30%, or $303, to $712 for the twelve months ended December 31, 2003, compared to
$1,015 in the prior year period. The Company believes that the SARS related
health crises in China in the first half of 2003 negatively impacted system
integration revenues and further hampered the implementation of its plans to
expand its system integration sales efforts into other provinces in China. The
decrease also reflects the need for the Joint Venture to expand sales coverage
from a traditional focus on the local Nanjing and Jiangsu Province markets to
other provinces within China.
Cost of Sales.
Handwriting recognition segment. Cost of sales includes royalty and import
tax payments, third party hardware costs, direct mail costs, engineering direct
costs and amortization of intangible assets excluding patents. Cost of sales for
the handwriting recognition segment decreased 67%, or $282, to $141 for the
twelve months ended December 31, 2003 compared to $423 in the prior year period.
Online/retail cost of sales decreased 93%, or $242, to $17 for the twelve
months ended December 31, 2003 compared to $259 in the prior year period. The
decrease was due primarily to the elimination of the direct mail campaign and
related costs as a result of reductions in the number of names available and a
poor sales close rate. The Company does not anticipate a material increase in
costs associated with online/retail sales and has no plans to reinstate the
direct mail program in the foreseeable future.
eSignature and natural Input OEM cost of sales decreased 69%, or $66, to
$30 for the twelve months ended December 31, 2003 compared to $96 in the prior
year period . The decrease was due primarily to the lower volume of third party
hardware sales and engineering development costs associated with sales compared
to the same period last year.
Cost of sales for eSignature software sold in China increased 38%, or $26,
to $94 for the twelve months ended December 31, 2003 compared to $68 in the
prior year period. The increase is due to a higher component of third party
hardware included with the sales during the first half of 2003 compared to the
first half of 2002. The Company anticipates that third party hardware sales
associated with the software sold in China will increase in the future due to
the method of selling software solutions in China.
Systems integration segment. Cost of sales decreased 15%, or $110, to $624,
for the twelve months ended December 31, 2003 compared to $734 in the prior year
period. The decrease in costs was due primarily to the lower sales volumes. The
cost of sales as a percentage of sales was 88% in 2003 compared to 64% in the
prior year period. The Company took a one time charge of $38 to cost of goods
sold for older inventory associated with the System Integration segment in the
fourth quarter of 2003. The Company believes that systems integration cost of
sales will remain at the higher percentage of sales as the Joint Venture expands
its sales territories into other provinces where competition will become a more
significant factor.
Operating expenses
Research and Development Expenses. Research and Development expense
decreased 12%, or $183, to $1,302 for the twelve months ended December 31, 2003,
as compared to $1,485 in the prior year period. Engineering expenses consist
primarily of salaries and related costs, outside engineering, maintenance items,
and allocated facilities expenses. Salaries and related expense declined 13%, or
$126, to $828 for the twelve months ended December 31, 2003, as compared to $954
in the prior year period, due primarily to the reduction in head count of two
engineers. Outside engineering cost and expenses declined 68%, or $67, to $31
-21-
for the twelve months ended December 31, 2003, compared to $98 in the prior year
period. The decline is due primarily to a reduction in the use of outside
engineering services compared to the prior year. Other engineering expenses
decreased 6%, or $28, to $442 for the twelve months ended December 31, 2003 as
compared to $470 in the prior year period. The decrease is primarily due to
lower maintenance and depreciation expense compared to the prior year periods.
Engineering costs transferred to cost of sales decreased $38 due to less
development contract work performed in 2003 as compared to 2002. The Company
believes that the reductions in engineering head count and expenses will not
have an adverse effect on its product engineering and development efforts. The
Company draws on the engineering capabilities of the Joint Venture as required
and, maintains a relationship with an outside engineering group familiar with
its products. These two resources can be engaged on an as needed basis to fill
future engineering requirements.
Sales and Marketing Expenses. Sales and marketing expenses declined 41% or
$638, to $905 for the twelve months ended December 31, 2003, compared to $1,543,
in the prior year period. Sales and marketing expenses consist of salaries,
commissions and related expenses, professional services, advertising and
promotion, general office and allocated facilities expenses. Salaries and
related expenses declined 46%, or $288 for the twelve months ended December 31,
2003, in the prior year period. The decline in salaries and related expense is
due primarily to the actions taken in the prior year, in the face of the
declining economic environment and reduced IT spending, which resulted in a
reduction of three sales persons during the first three quarters of 2003
compared to the prior year. The Company continues to roll out a channel strategy
for its handwriting recognition segment intended to increase the amount of
market coverage by utilizing the sales force of the channel partners. The
Company continues to sign new partner agreements in both the US and China. The
Company believes these channel partners will produce increasing revenues in the
near term. Professional services declined 89%, or $65, during the twelve months
ended December 31, 2003, compared to the prior year period. The decline is
primarily due to $37 in outside commission expense and $14 in salaries expense
paid to an outside sales consultant during the prior year. Advertising expense
decreased 100%, or $112, for the twelve months ended December 31, 2003, compared
to the prior year period. This decrease is due to the discontinuance of
in-the-box advertising for the Company's natural input products during 2003, as
compared to the prior year period. Commission expense decreased 24%, or $34, to
$100 for the twelve months ended December 31, 2003, compared to $134 in the
prior year period. The decrease in commission expense is due primarily to an
increase in OEM revenues which are considered house accounts and have no
commission due on the revenue compared to the prior year. Other expenses
including travel, general office and allocated facilities expenses declined $140
in 2003 as compared to 2002 due to reduced head count.
General and Administrative Expenses. General and administrative expenses
decreased 8%, or $205, to $2,219, for the twelve months ended December 31, 2003,
compared to $2,424 in the prior year period. General and administrative expense
consists of salaries, professional fees, investor relations expenses, patent
amortization and office and allocated facilities costs. Salaries and wages
increased 3%, or $24, for the twelve months ended December 31, 2003, compared to
the same period last year, due primarily to salary increases. Professional
service expenses which include consulting, legal and outside accounting fees,
decreased 21%, or $128, to $468 in the twelve months ended December 31, 2003,
compared to $596 in the prior year period. The decrease was due primarily to a
decrease in legal fees during the twelve months ended December 31, 2003 compared
to the prior year. Other administrative expenses decreased 2%, or $18, for the
twelve months ended December 31, 2003, compared to the prior year period. The
decrease was due primarily to reduced spending.
Interest Income and Other Income (Expense), Net. Interest income and other
income (expense), net increased $18 to $1 income for the year ended December 31,
2003, compared to the prior year period. The increase in income was due to the
refund of value added tax from 2002 received by the Joint Venture, a reduction
to Minority Interest and the elimination of credit card fees as a result of
outsourcing the Company's web store at the end of the first quarter of 2003.
Interest expense. Interest expense remained constant at $205 for the years
ended December 31, 2003 and 2002, respectively. Despite the decrease in the
interest rates during the current year, the increase of $750 in short term debt
and resultant interest expense offset the decline over the prior year.
-22-
Liquidity and Capital Resources
Cash and cash equivalents at December 31, 2004 totaled $4,736, compared to
cash and cash equivalents of $1,039 at December 31, 2003. This increase was
primarily attributable to $2,821 provided by operations and $958 provided by
financing activities. These cash inflows were offset by $82 of cash used in
investing activities. The effect of exchange rate changes on cash was
immaterial. The cash provided by operations was primarily due to income of
$1,620, depreciation and amortization of $425, amortization of the loan discount
of $142, a decrease in accounts receivable of $238, an increase in deferred
revenue of $293 and $55 from the disposal of fixed assets and provision for
inventory obsolescence. These inflows were offset by $100 from increases of
prepaid expenses and other current assets and decreases in accounts payable,
accrued compensation and other accrued liabilities. The cash used in investing
activities of $82 was due to the purchase of computer equipment and third party
software for internal use and to an increase the amount of capitalized software.
The $958 provided by financing activities consisted primarily of $3,885 in net
proceeds from the issuance of convertible debt, $36 in proceeds from the
issuance of short-term debt and $53 in proceeds from the issuance of common
stock due to the exercise of stock options. These cash inflows were offset by
$3,008 in payments on short term debt-related party and $8 in payments on
capital lease obligations.
Accounts receivable decreased 52%, or $386, to $356, net of $404 provided
for potentially uncollectable accounts, for the twelve months ended December 31,
2004 compared to $742 at December 31, 2003. The decrease is due to an $148
increase in the Company's bad debt provision and fewer sales late in the fourth
quarter compared to the prior year's fourth quarter. The Company expects that
the development of the eSignature market will result in more consistent revenue
on a quarter to quarter basis and, therefore, less fluctuation in accounts
receivable from quarter to quarter.
Deferred financing cost increased 1190%, or $714, to $774 at December 31,
2004, compared to $60 at December 31, 2003. Deferred financing costs includes
approximately $397 in non-cash expenses associated with the November financing
(See "Financing" below). The non-cash deferred financing costs along with the
cash expenses will be amortized to interest expense over 36 months or, the life
of the convertible notes, whichever is shorter.
Prepaid expenses and other current assets decreased 10%, or $12, to $105 at
December 31, 2004, compared to $117 at December 31, 2003. The decrease is
primarily due the timing of the billings of annual maintenance and other prepaid
contracts. Prepaid expenses generally fluctuate due to the timing of annual
insurance premiums and maintenance and support fees, which are prepaid in
December and June of each year.
Current liabilities, which include deferred revenue, were $1,401 at
December 31, 2004, compared to $4,900 at December 31, 2003, a declined of
$3,499. Payment of the Company's $3,000 note in August 2004 and conversion of
the $750 note to Cornell Capital Partners LP is the primary reason for the
decline. Deferred revenue was $458 at December 31, 2004, compared to $165 at
December 31, 2003. The increase primarily reflects advance payments for products
and maintenance fees from the Company's licensees, which are generally
recognized as revenue by the Company when all obligations are met or over the
term of the maintenance agreement.
Financing.
In November 2004, the Company entered into a unsecured Note and Warrant
Purchase Agreement (the "Purchase Agreement") and a Registration Rights
Agreement (the "Registration Rights Agreement"), each dated as of October 28,
2004. The financing, a combination of debt and equity, closed November 2, 2004.
The proceeds to the Company were approximately $3,885, net of $310 in
commissions and legal expenses. H.C. Wainwright & Co., Inc. ("Wainwright"),
acted as placement agent. As placement agent for the Company, at closing
Wainwright received $731 in commissions, legal fees and warrants. The
commissions of approximately $285, and legal fees of $25, mentioned above, were
paid in cash. The Company issued warrants to Wainewright to acquire 1,218 shares
of the Company's common stock. Of the warrants issued, 870 are exercisable at
$0.46 and 348 are exercisable at $0.51. The Company has ascribed the value of
$421 to the Wainwright warrants which is recorded as deferred financing costs in
the balance sheet at December 31, 2004. The fair value ascribed to the
-23-
Wainwright warrants was estimated on the commitment date using the Black-Scholes
pricing model with the following assumptions: risk-free interest rate of 3.21%;
expected life of 3 years; expected volatility of 100%; and expected dividend
yield of 0%. The Company expects to use the proceeds of the financing for
additional working capital.
Under the terms of the financing, the Company issued to certain accredited
investors convertible promissory notes in the aggregate principal amount of
$4,195 and warrants to acquire 3,632 shares of the Company's common stock at an
exercise price of $0.508 per share. The notes accrue interest at the rate of 7%
per annum, payable semi-annually, and are convertible into shares of the
Company's common stock at the rate of $0.462 per share. The Company has ascribed
a value of $982 to the investor warrants, which is recorded as a discount to
notes payable in the balance sheet at December 31, 2004. The fair value ascribed
to the warrants was estimated on the commitment date using the Black-Scholes
pricing model with the following assumptions: risk-free interest rate of 3.21%;
expected life of 3 years; expected volatility of 100%; and expected dividend
yield of 0%. In addition to the fair value ascribed to the warrants, the Company
has ascribed $1,569 to the beneficial conversion feature in the convertible
notes, which is recorded as a discount to notes payable in the balance sheet at
December 31, 2004. The values ascribe to the warrants and beneficial conversion
feature follow the guidance of the EITF Issue No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios", and ETIF Issue No. 00-27, "Application of Issue
No. 98-5 to Certain Convertible Instruments" of the FASB's Emerging Issues Task
Force. The fair value of the warrants and beneficial conversion feature is
amortized to expense over the life of the convertible notes or upon earlier
conversion using the effective interest method. As of December 31, 2004, the
Company had amortized to interest expense approximately $187 of the loan
discount and deferred financing costs. The balance due under the convertible
notes is shown net of the remaining unamortized discount on the accompanying
consolidated balance sheet. If the aggregate principal amount owing under the
notes is converted, the Company will issue 9,080, shares of its common stock. If
the notes are not converted, all principal and accrued but unpaid interest will
be due October 28, 2007. The Company may pay accrued interest in cash or in
shares of Company common stock, issued at the market price for the common stock
calculated prior to the interest payment. The Company does not currently intend
to pay accrued interest with shares of its common stock.
The above warrants expire on October 28, 2009. The Company may call the
warrants if the Company's common stock trades at $1.00 or above for 20
consecutive trading days after the date that is 20 days following the
effectiveness of a registration statement providing for the resale of the shares
issued upon the conversion of the notes and exercise of the warrants. Wainwright
will be paid approximately $28 in the aggregate if all of the investor warrants
are exercised. The Company will receive proceeds of approximately $1,845 if all
of the warrants are exercised.
The Company also was required to file a registration statement providing
for the resale of the shares that are issuable upon the conversion of the notes
and the exercise of the warrants. The registration statement was filed on
December 22, 2004, and was declared effective on January 26, 2005.
On August 4, 2004, the Company, in connection with the equity line of
credit discussed below, borrowed $3,500 from Cornell Capital Partners, LP
("Cornell"), the proceeds of which were used to extinguish short-term debt with
a related party (See Note 5, to the Financial Statements "Short-term debt -
Related Party Transaction"). The Cornell short-term debt was secured by shares
of the Company's common stock held in escrow and accrued interest at the rate of
5% per annum on any unpaid balance remaining after the due date. The loan was
scheduled to be paid in ten equal installments, with the first installment due
December 6, 2004 and the last on February 7, 2005. The Company had the option to
repay the note in cash or by issuing shares of the Company's common stock. The
Cornell debt was repaid in full, in cash, on November 8, 2004, from proceeded
generated through operations. The Company expensed $298 of financing costs
associated with the $3,500 loan.
On April 20, 2004, the Joint Venture borrowed the aggregate equivalent of
$36, denominated in Chinese currency, from a Chinese bank. The proceeds of the
loan are to be used for working capital purposes until the channel sales
strategy is fully implemented and sales increase. The loan bears interest at
5.3% per annum and is due April 20, 2005. The borrowing did not require the
Joint Venture to deposit a compensating balance. The note can be repaid at any
time with out penalty. The Company expects to pay the loan in full on or before
April 20, 2005 using existing cash resources.
On December 19, 2003, the Company, in connection with the equity line of
credit discussed below, borrowed $750 from Cornell. The proceeds of the loan
were used for working capital purposes. The loan was secured by shares of the
-24-
Company's common stock held in escrow. The promissory note was due and payable
in seven installments commencing January 19, 2004 and ending on March 1, 2004,
and could be paid in cash or shares of the Company's common stock. The Company
had the option to delay the commencement of the installment payments for an
unlimited number of 30 day periods in exchange for payment of an amount equal to
2% of the principal amount owed on or before the beginning of the current option
period. The 2% fee could be made in cash or shares of common stock. Any delay in
the commencement date would result in an equal delay in the due date of the
note. The Company exercised its right to delay the commencement of the
installment payments by paying the 2% fee discussed above. Such fees aggregated
$38 and were paid in cash and expensed. The Company repaid the $750 loan through
the issuance of 1,133 shares of common stock in the quarter ending June 2004.
The Company wrote off approximately $60 in unamortized deferred financing costs
associated with the $750 loan against equity.
In June 2003, the Company's Joint Venture borrowed from one of its
directors, Tong Ming Sheng, approximately $24 denominated in U. S. dollars to
purchase a replacement van used in the Company's operations. The note bears
interest at the rate of 5% per annum and is due in June 2006.
In July 2002, the Company negotiated a Line of Credit Agreement expiring
two years from the date of an effective registration statement with Cornell
("Line of Credit") (see Note 1, to the Financial Statements "Line of Credit
Agreement"). Under the terms of the Line of Credit and the registration
statements, the Company could periodically issue and sell shares of its common
stock for a total purchase price of $15,000, subject to the number of shares
available for issuance and the purchase price of such shares. The maximum amount
of each advance was stated as $1,000 in any 30-day period. The Company paid to
Cornell an advance fee equal to 6.5% of the amount of each advance. The Company
filed a Registration Statement on Form S-1 covering approximately 24 million
shares for use under the equity line of credit. On February 13, 2003, the Form
S-1 was declared effective. The Company was required to keep the registration
statement effective until the earlier of when the investor had sold all of the
shares acquired under the Line of Credit or the investor was able to resell the
shares under Rule 144 without regard to the volume limitations set forth in that
rule. The Company used the proceeds from the equity line to repay short-term
debt and for working capital purposes. Pursuant to the terms of the Note and
Warrant Purchase Agreement signed on October 28, 2004 discussed above, the
Equity line of Credit agreement was terminated in December 2004.
Since the inception of the Line of Credit the Company has borrowed $6,250,
less a 6.5% financing fee from Cornell. As of December 31, 2004, $2,750 was
repaid through the sale of the Company's common stock pursuant to the terms of
the equity line of credit.
On June 19, 2001, the Company consummated a three-year $3,000 financing
(the "Loan") with a charitable remainder annuity trust of which a former
director and officer of the Company is a trustee (the "Trust"). The proceeds of
the Loan were used to refinance $1,500 of indebtedness outstanding to the Trust
pursuant to a loan made by the Trust to the Company in October 1999, and for
working capital purposes. The Loan bore interest at the rate of 2% over the
prime rate publicly announced by Citibank N.A. from time to time, and was due
June 18, 2004. The Company received a sixty day extension to pay the $3,000 Loan
to the Trust in exchange for thirty days worth of interest ($15) calculated
according to the terms of the note. The extended due date was August 18, 2004.
All other provisions of the Loan remained unchanged. On August 5, 2004, the
Company paid the $3,000 note due August 18, 2004, to the Trust. The funds to
retire the debt were obtained from Cornell on August 4, 2004, (See Note 4 -
"Short-term debt - other").
Contractual Obligations.
The Company had the following material commitments as of December 31, 2004:
Payments due by periods
------------------------------- --------------------------------------------
Less One to Four to After
than Three five five
Contractual obligations Total One year years years years
------------------------------- -------- -------- -------- -------- -------
Long-term debt (1) $ 1,790 - 1,790 - -
Short-term debt 8 8 - - -
Operating lease commitments (2) 738 380 358 - -
------- -------- -------- -------- -------
Total contractual cash
obligations $ 2,536 $ 388 $ 2,148 $ - $ -
======= ======= ======== ====== =======
-25-
1. Long-term debt is net of approximately $2,410 in discounts representing the
fair value of warrants issued to the investors and the beneficial
conversion feature associated with the convertible notes.
2. The operating lease commenced on November 1, 2002. The cost of the lease
will increase approximately 3% per annum over the term of the lease, which
expires on October 31, 2006.
As of December 31, 2004, the Company leased facilities in the United States
and China totaling approximately 11,100 square feet. The Company's rental
expense for the years ended December 31, 2004, 2003 and 2002 was approximately
$443, $450, and $418, respectively. In addition to the base rent in the United
States, the Company pays a percentage of the increase, if any, in operating cost
incurred by the landlord in such year over the operating expenses incurred by
the landlord in the base year. The Company believes the leased offices in the
United States will be adequate for the Company's needs over the term of the
lease. The Company will be reducing the amount of space leased in China as a
result of the elimination of employees associated with System Integration
operations.
As of December 31, 2004, the Company's principal source of liquidity was
its cash and cash equivalents of $4,736. With the exception of 2004, in each
year since the Company's inception the Company has incurred losses. The Company
believes that its current cash and resources, together with the expected revenue
levels, will provide sufficient funds for planned operations for at least the
next twelve months. However, if the Company is unable to generate adequate cash
flow from sales or if expenditures required to achieve the Company's plans are
greater than expected the Company may need to obtain additional funds or reduce
discretionary spending. There can be no assurance that additional funds will be
available when needed or, if available, will be on favorable terms or in the
amounts the Company may require. If adequate funds are not available when
needed, the Company may be required to delay, scale back or eliminate some or
all of its marketing and development efforts or other operations, which could
have a material adverse effect on the Company's business, results of operations
and prospects.
Risks related to our business
Operating losses may continue, which could adversely affect financial results
from operations and stockholder value.
In each year since our inception, except for the year ended December 31,
2004, we have incurred operating losses, which were significant in certain
periods. For the five-year period ended December 31, 2004, those losses
aggregated approximately $7,792. At December 31, 2004, our accumulated deficit
was approximately $ $80,544. While we recorded a profit for the year ended
December 31, 2004 there is no guarantee that we will continue to be profitable
and we may incur substantial losses in the future, which could adversely affect
financial results from operations and stockholder value.
We have experienced significant declines in revenues in recent periods which, if
continued, could adversely affect stockholder value.
Revenues increased 140% for the twelve months ended December 30, 2004,
compared to twelve months ended December 31, 2003. However, there is no
assurance that the trend in revenues and profits in 2004 will continue. If
revenues decline, we will be unable to sustain profitability. We believe the
declines in prior years reflected primarily the weak economy and significant
slow down of information technology spending, both of which had a negative
impact on our revenues. We believe that recent increases in revenues and profits
similarly reflect a strengthening economy and increases in information
technology spending as well as improvements in our sales and marketing efforts
and cost-cutting measures that have reduced our expenses. However, we cannot
predict with any degree of certainty whether the economy will continue to
strengthen or whether information technology spending will continue to show
signs of strengthening.
-26-
We may need additional financing and, if we are unable to get additional
financing when needed, we may be required to materially change our operations,
which could adversely affect our results from operations and shareholder value.
As of December 31, 2004,our working capital was approximately $4,068. We
have suffered recurring losses from operations that, in prior years, raised a
substantial doubt about our ability to continue as a going concern. We cannot
assure you that, even with the proceeds from the Notes, we will have adequate
capital resources to fund planned operations or that any additional funds will
be available to us when needed, or if available, will be available on favorable
terms or in amounts we require. If we are unable to obtain adequate capital
resources to fund operations, we may be required to delay, scale back or
eliminate some or all of our operations, which may have a material adverse
effect on our business, results of operations and ability to operate as a going
concern.
Our inability to raise additional funds may affect our ability to continue
operations as a going concern.
We need the funds generated from the issuance of the Notes and from
operations in order to continue operations as a going concern. We believe that
the funds raised from the issuance of the Notes, when combined with funds
generated from operations, should be sufficient to allow us to fund our
operations for the next twelve months. If all of the Warrants are exercised, we
will receive approximately $2,500 in additional gross proceeds. Even with these
funds, if we are unable to generate substantially greater funds from operations
than we generated in 2004, we may not be able to continue operating as a going
concern without significant changes to our operations. Such changes, which we
cannot identify at this time, could adversely affect stockholder value.
Our competitors could develop products or technologies that could make our
products or technologies non-competitive, which would adversely affect sales,
financial results from operations and stockholder value.
Although we believe that our patent portfolio provides a barrier to entry
to the electronic signature verification market, there can be no assurance that
we will not face significant competition in this and other aspects of our
business.
Some of our competitors, such as PenPower Group, and Palm Inc., have
developed or are developing complete pen-based hardware and software systems.
Others, such as Microsoft Corporation, Silanis Technology, Inc., and Advanced
Recognition Technology, Inc., have focused on different elements of those
systems, such as character recognition technology, pen-based operating systems
and environments, and pen-based applications. Some of our competitors, including
more established companies or those with greater financial or other resources,
could develop products or technologies that are more effective, easier to use or
less expensive than ours. This could make our products and technologies obsolete
or non-competitive, which would adversely affect sales, financial results from
operations and stockholder value.
If we are unable to adequately protect our intellectual property, third parties
may be able to use our technology, which could adversely affect our ability to
compete in the market, our financial results from operations and stockholder
value.
We rely on a combination of patents, copyrights, trademarks, trade secrets
and contractual provisions to protect our proprietary rights in our products and
technologies. These protections may not adequately protect us for a number of
reasons. First, our competitors may independently develop technologies that are
substantially equivalent or superior to ours. Second, the laws of some of the
countries in which our products are licensed do not protect those products and
our intellectual property rights to the same extent as do the laws of the United
States. Third, because of the rapid evolution of technology and uncertainties in
intellectual property law in the United States and internationally, our current
and future products and technologies could be subject to infringement claims by
-27-
others. Fourth, a substantial portion of our technology and know-how are trade
secrets and are not protected by patent, trademark or copyright laws. We require
our employees and contractors to execute written agreements that seek to protect
our proprietary information. We also have a policy of requiring prospective
business partners to enter into non-disclosure agreements before any of our
proprietary information is revealed to them. However, the measures taken by us
to protect our technology, products and other proprietary rights might not
adequately protect us against improper use.
We may be required to take legal action to protect or defend our
proprietary rights. Litigation or third-party claims of intellectual property
infringement could require us to spend substantial time and money and adversely
affect our ability to develop and commercialize products. If we are required to
defend against lawsuits brought by third parties, or if we sue to protect our
proprietary rights, we may be required to pay substantial litigation costs, and
our management and technical personnel's attention may be diverted from
operating our business. If the results of any litigation is adverse to us, we
may be required to expend significant resources to develop non-infringing
technology or obtain licenses from third parties. If we are not successful in
those efforts or if we are required to pay any substantial litigation costs, our
business would be materially and adversely affected.
Fluctuations in the value of currencies could adversely affect our joint venture
in the People's Republic of China and adversely affect our results from
operations and shareholder value.
We own 90% of Communication Intelligence Computer Corporation, Ltd., which
is a joint venture between us and the Information Industries Bureau of Jiangsu
Province, a provincial agency of the People's Republic of China. Revenues
provided by the joint venture as a percentage of total sales amounted to 2%, 34%
and 38% for the years ended December31, 2004, 2003 and 2002, respectively. Our
investment in the joint venture is subject to fluctuations in currency values
between the U.S. dollar and the Chinese currency. Our results from operations
and shareholder value could be adversely affected if the Chinese currency
increases in value relative to the U.S. dollar.
Longer payment cycles with respect to our joint venture could adversely affect
our results from operations and shareholder value.
Longer payment cycles with respect to our joint venture could result in
lower earnings in any particular period and in lower cash flows, which could
result in having to incur additional debt in order to fund operations. Either of
these results could adversely affect our results from operations and shareholder
value.
Increased difficulty in collecting accounts receivable of our joint venture
could adversely affect our results from operations and shareholder value.
It may become more difficult to collect accounts receivable of the joint
venture in the future. Such increased difficulty could result in lower earnings
to the extent accounts are deemed to be uncollectible and we have to increase
our reserves. This increased difficulty also could result in lower cash flows,
which could result in having to incur additional debt in order to fund
operations. Additional debt may lead to increased interest expenses and lower
profits, which could adversely affect shareholder value.
Complying with the laws of the People's Republic of China may become more
difficult and expensive in the future, which could adversely affect our results
from operations and shareholder value.
The joint venture is subject to the laws of the People's Republic of China.
Compliance with these laws may become more difficult and costly in the future.
In addition, these laws may change and such change may require us to change the
joint venture's operations. Any of these results could adversely affect our
results from operations and shareholder value by increasing expenses and
reducing revenues, thereby reducing profits.
Political and economic instability in the People's Republic of China may make
doing business through the joint venture more difficult and costly, which could
adversely affect our results from operations and shareholder value.
Economic and political instability may increase in the future in the
People's Republic of China. Such instability may make it more difficult to do
business through the joint venture and may make it more expensive to do so. In
addition, in extreme cases, the joint venture may be nationalized by the
government, which could cause us to write off the value of the joint venture and
eliminate revenues generated by the joint venture. Any of these results could
result in onetime charges or increased expenses as well as lower revenues, which
could adversely affect our results of operations and harm shareholder value.
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A significant portion of our sales are derived from a limited number of
customers, and results from operations could be adversely affected and
shareholder value harmed if we lost any of these customers.
Our revenues historically have been derived from a limited number of
customers. Therefore, the success of our business depends on our ability to
obtain customers and maintain satisfactory relationships with them in the
future. We may not be able to continue to maintain satisfactory relationships
with our customers in the future. Our top customer accounted for 46% and 19% of
revenues in the twelve months ended December 31, 2004 and December 31, 2003,
respectively. The loss of any significant customer or other revenue source would
have a material adverse effect on our revenues and profitability.
Risks Related to our Capital Structure
The market price of our stock can be volatile, which could result in losses for
investors.
Our common stock is listed on the OTC. Stock prices of technology companies
in recent years have experienced significant volatility, including price
fluctuations that are unrelated or not proportional to the operating performance
of these companies. Volatility on the OTC is typically higher than the
volatility of stocks traded on Nasdaq or the exchanges. The market price of our
common stock has been and could be subject to significant fluctuations as a
result of variations in our operating results, announcements of technological
innovations or new products by us or our competitors, announcements of new
strategic relationships by us or our competitors, general conditions in the
technology industry or market conditions unrelated to our business and operating
results.
Statutory provisions and provisions in our charter may delay or frustrate
transactions that may be beneficial to our stockholders.
Certain provisions of the Delaware General Corporation Act and our charter
may delay or prevent a merger, tender offer or proxy contest that is not
approved by our Board of Directors, even if such events may be beneficial to the
interests of stockholders. For example, our Board, without shareholder approval,
has the authority and power to issue all authorized and unissued shares of
common stock and preferred stock which have not otherwise been reserved for
issuance. In addition, the Delaware General Corporation Law contains provisions
that may have the effect of making it more difficult or delaying attempts by
others to obtain control of us. See "Description and Price Range of Common
Stock--Anti-Takeover Provisions."
Resale by the holder of the Notes and Warrants could adversely affect the market
price of our stock.
The holders of the Notes and Warrants may immediately sell the shares
issued upon conversion and exercise of the Notes and Warrants. In light of our
historically low trading volume, such sales may adversely affect the price of
the shares of our stock.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. The Company has an investment portfolio of fixed income
securities that are classified as cash equivalents. These securities, like all
fixed income instruments, are subject to interest rate risk and will fall in
value if the market interest rates increase. The Company attempts to limit this
exposure by investing primarily in short-term securities. The Company did not
enter into any short-term security investments during the twelve months ended
December 31, 2004.
Foreign Currency Risk. The Company operates a subsidiary in China and from
time to time makes certain capital equipment or other purchases denominated in
foreign currencies. As a result, the Company's cash flows and earnings are
exposed to fluctuations in interest rates and foreign currency exchange rates.
The Company attempts to limit these exposures through operational strategies and
generally has not hedged currency exposures.
Future Results and Stock Price Risk. The Company's stock price may be
subject to significant volatility. The public stock markets have experienced
significant volatility in stock prices in recent years. The stock prices of
technology companies have experienced particularly high volatility, including,
at times, severe price changes that are unrelated or disproportionate to the
operating performance of such companies. The trading price of the Company's
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common stock could be subject to wide fluctuations in response to, among other
factors, quarter-to-quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
announcements of new strategic relationships by the Company or its competitors,
general conditions in the computer industry or the global economy generally, or
market volatility unrelated to the Company's business and operating results.
Item 8. Consolidated Financial Statements and Supplementary Data
The Company's audited consolidated financial statements for the years ended
December 31, 2004, 2003, and 2002 begin on page F-1 of this Annual Report on
Form 10-K, and is incorporated into this item by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
None
Item 9A. Controls and Procedures
Disclosure Controls
Under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, the Company has evaluated the effectiveness of the design and operation
of its disclosure controls and procedures pursuant to applicable rules under the
Securities Exchange Act of 1934, as amended, as of December 31, 2004. Based on
that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that these disclosure controls and procedures are
effective.
The Company does not expect that its disclosure controls and procedures
will prevent all error and all fraud. A control procedure, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control procedure are met. Because of the inherent
limitations in all control procedures, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The Company considered these
limitations during the development of its disclosure controls and procedures,
and will continually reevaluate them to ensure they provide reasonable assurance
that such controls and procedures are effective.
Internal Controls and Procedures
There have not been any changes in the Company's internal control over
financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the Company's fourth fiscal quarter that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
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PART III
Item 10. Directors and Executive Officers of the Registrant
Directors
The following table sets forth certain information concerning the
Directors:
Year First Elected
Name Age or Appointed
Guido D. DiGregorio......... 66 1997
Michael Farese (1), (2), (3), (4) 57 2002
Louis P. Panetta (1), (2), (3), (4) 55 2000
C. B. Sung (1), (2), (3), (4) 79 1986
David E. Welch (1), (4)..... 57 2004
1. Member of the Audit Committee
2. Member of the Finance Committee
3. Member of the Compensation Committee
4. Member of the Nominating Committee
The business experience of each of the directors for at least the past five
years includes the following:
Guido D. DiGregorio was elected Chairman of the Board in February 2002,
Chief Executive Officer in June 1999 and President in November 1997. From
November 1997 to June 1999, he was also the Company's Chief Operating Officer.
He was a partner in DH Partners, Inc. (a management consultant firm) from 1996
to 1997. Prior to that Mr. DiGregorio was recruited by a number of companies to
reverse trends of financial losses, serving as President and CEO of each of the
following companies: Display Technologies, Inc. (a manufacturer of video data
monitors) from 1994 to 1996, Superior Engineering Corp. (a producer of
factory-built gas fireplaces) from 1991 to 1993, Proxim, Inc. (wireless data
communications) from 1989 to 1991, Maxitron Corp. (a manufacturer of computer
products) from 1986 to 1989 and Exide Electronics (producer of computer power
conditioning products) from 1983 to 1986. From 1966 to 1983, Mr. DiGregorio was
employed by General Electric in various management positions, rising to the
position of General Manager of an industrial automation business.
Mike Farese was elected a director of the Company in February 2002. Mr.
Farese has over thirty years of broad based telecommunications industry
experience including an extensive background in cellular and wireless subscriber
equipment. He has been the President & CEO of WJ Communications, a Silicon
Valley-based manufacturer of innovative broadband communications products for
current and next generation wireless communications networks from March 2002 to
present. Prior to joining WJ Communications, Mr. Farese was President & CEO,
Tropian Inc. from 1999 to 2002. Prior to that he held numerous senior management
positions including Vice President & General Manager-Global Personal Networks,
Motorola, Vice President & General Manager-American Business Group, Ericsson,
Vice President, Product Planning & Strategy, Nokia, Executive Director-Business
Systems, ITT and Division Manger-Networks Business Systems, AT&T.
Louis P. Panetta was elected a director of the Company in October 2000.
From November 2001 to September 2003 Mr. Panetta was a member of the Board of
Directors of Active Link. Mr. Panetta was Vice President of Marketing and
Investor Relations with Mobility Concepts, Inc. (a wireless Systems Integrator),
a subsidiary of Active Link Communications from February 2001 to April 2003. Mr.
Panetta was President and Chief Operating Officer of PortableLife.com
(e-commerce products provider) from September 1999 to October 2000 and President
and Chief Executive Officer of Fujitsu Personal Systems (a manufacturer of
computer hardware) from December 1992 to September 1999. From 1995 to 1999, Mr.
Panetta served on the Board of Directors of Fujitsu Personal Systems.
C.B. Sung was elected a director of the Company in 1986. Mr. Sung has been
the Chairman and Chief Executive Officer of Unison Group, Inc. (a multi-national
corporation involved in manufacturing, computer systems, international
investment and trade) since 1986 and Unison Pacific Corporation since 1979. He
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also serves on the Board of Directors of several private companies and
non-profit organizations.
David E. Welch was elected a director in March 2004 and serves as the
financial expert on the Audit Committee. Mr. Welch is the principal of David E.
Welch Consulting, a financial consulting firm, from July 2002 to present. Mr.
Welch has also been Vice President and Chief Financial Officer of American
Millennium Corporation, Inc., a provider of satellite based asset tracking and
reporting equipment, from April 2004 to present. Mr. Welch was Vice President
and Chief Financial Officer of Active Link Communications, a manufacturer of
telecommunications equipment, from 1999 to 2002. Mr. Welch has held positions as
Director of Management Information Systems and Chief information Officer with
Micromedex, Inc and Language Management International from 1995 through 1998.
Mr. Welch is a member of the Board of Directors of Advanced Neutraceuticals,
Inc., and AspenBio, Inc. Mr. Welch is a licensed Certified Public Accountant in
the state of Colorado.
EXECUTIVE OFFICERS
The following table sets forth the name and age of each executive officer
of the Company, and all positions and offices of the Company presently held by
each of them.
Name Age Positions Currently Held
Guido D. DiGregorio 66 Chairman of the Board,
Chief Executive Officer and President,
Francis V. Dane 53 Chief Legal Officer,
Secretary and Chief Financial Officer
The business experience of each of the executive officers for at least the
past five years includes the following:
Guido D. DiGregorio - see above.
Francis V. Dane was appointed the Company's Secretary in February of 2002,
its Chief Financial Officer in October 2001, its Human Resources Executive in
September 1998 and he assumed the position of Chief Legal Officer in December of
1997. From 1991 to 1997 he served as a Vice President and Secretary of the
Company, and from 1988 to 1992 as its Chief Financial Officer and Treasurer.
Since July of 2000, Mr. Dane has also been the Secretary and Treasurer of
Genyous, Inc. a biotechnology venture capital and incubation company. From
October 2000 to April 2004, Mr. Dane served as a director of Perceptronix
Medical, Inc. and SpetraVu Medial Inc., two companies focused on developing
improved methods for the early detection of cancer. From October 2000 to June
2003. Mr. Dane was a director of CPC Cancer Prevention Centers Inc., a company
that is developing a comprehensive cancer prevention program based upon the
detection of early stage, non-invasive cancer. Prior to this Mr. Dane spent over
a decade with PricewaterhouseCoopers, his last position was that of Senior
Manager, Entrepreneurial Services Division. Mr. Dane is a member of the State
Bar of California and has earned a CPA certificate from the states of
Connecticut and California.
CODE OF BUSINESS CONDUCT AND ETHICS
We have adopted a written code of business conduct and ethics, known as our
Code of Business Conduct and Ethics, which applies to all of our directors,
officers, and employees, including our principal executive officer and our
principal financial and accounting officer. A copy of the Code of Business
Conduct and Ethics is posted on the Company's web site, at www.cic.com.
-32-
Item 11. Executive Compensation
The following table sets forth compensation awarded to, earned by or paid
to the Company's President, regardless of the amount of compensation, and each
executive officer of the Company serving as of December 31, 2004 whose total
annual salary and bonus for 2004 exceeded $100,000 (collectively, the "Named
Executive Officers").
Summary Compensation Table
Long-Term
Annual Compensation Compensation
Securities
Other Annual Underlying
Name and Principal Position Year Salary Compensation Options
- --------------------------- ---- ------ ------------ -------
Guido DiGregorio............... 2004 $ 259,371(1) - -
Chairman, President 2003 $ 206,250(1) - -
and Chief Executive Officer 2002 $ 213,500(1) - 250,000
Francis V. Dane................ 2004 $ 138,125 - 100,000
Chief Legal Officer, 2003 128,500 - 100,000
Secretary and 2002 $ 110,083 - 100,000
Chief Financial Officer
- -----------
(1) Mr. DiGregorio's salary was increased in February 2002 to $250,000. Mr.
DiGregorio has deferred approximately $70,000 in salary payments to ease
cash flow requirements. Mr. DiGregorio may resume payment of his full
salary at any time, and payment of deferred amounts may be demanded by Mr.
DiGregorio at any time after December 31, 2002 and 2003, respectively. Mr.
DiGregorio was paid his deferred salary from 2002 and 2003 of approximately
$64, and $70 in January 2003 and 2004, respectively.
Option Grants in 2004
On November 11, 2004, Mr. Dane was granted options to purchase 100,000
shares of the Company's common stock, at an exercise price of $0.55 per share.
The options granted vest pro rata quarterly over three years.
Aggregate Option Exercises in 2003 and Year-End Option Values
The following table sets forth certain information concerning the Named
Executive Officers with respect to the exercise of options in 2004, the number
of shares covered by exercisable and unexercisable stock options at December 31,
2004 and the aggregate value of exercisable and unexercisable "in-the-money"
options at December 31, 2004.
Value of
Number of Securities Unexercised
Underlying In-The-Money
Unexercised Options
Options at Fiscal at Fiscal
Shares Year-End Year-End(1)
Acquired Exercisable(E)/ Exercisable(E)/
On Value Unexercisable(U) Unexercisable(U)
Name Exercise Realized
Guido DiGregorio.. - $ - 1,950,000(E) $ - (E)(1)
Francis V. Dane... - $ - 309,852(E) $ 19,114 (E)(1)
134,091(U) 9,886 (U)(1)
- -----------
(1) The value of unexercised in-the-money options was determined by using the
difference between the closing sale price of the common stock on the Nasdaq
Over the Counter Market as of December 31, 2004 ($0.62) and the exercise
price of such options.
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Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information with respect to the beneficial
ownership of (i) any person known to be the beneficial owner of more than 5% of
any class of voting securities of the Company, (ii) each director and director
nominee of the Company, (iii) each of the current executive officers of the
Company named in the Summary Compensation Table under the heading "Executive
Compensation" and (iv) all directors and executive officers of the Company as a
group.
Common Stock
----------------------------
Name of Beneficial Owner Number Percent
of Shares of Class
Guido DiGregorio (1)...................... 1,950,000 1.91%
C. B. Sung (2)............................ 1,762,610 1.72%
Louis P. Panetta (3)...................... 178,125 *
Michael Farese (4)........................ 125,000 *
Welch, Davie E. (5)....................... 50,000 *
Francis V. Dane (6)....................... 325,040 *
All directors and executive officers
as a group (6 persons)................... 4,390,775 4.29%
- -----------
* Less than 1%.
(1) Represents 1,950,000 shares, issuable upon the exercise of stock options
exercisable within 60 days of December 31, 2004. The business address of
Mr. DiGregorio is 275 Shoreline Drive, Suite 500, Redwood Shores,
California 94065. See "Executive Compensation; Option Grants in 2002."
(2) Includes (a) 1,568,051 shares held by the Sung Family Trust, of which Mr.
Sung is a trustee, (b) 3,369 shares held by the Sung-Kwok Foundation, of
which Mr. Sung is the Chairman, and (c) 191,190 shares of common stock
issuable upon the exercise of stock options , exercisable within 60 days of
December 31, 2004. Mr. Sung may be deemed to beneficially own the shares
held by the Sung Family Trust and the Sung-Kwok Foundation. The business
address of Mr. Sung is, UNISON Group, 1001 Bayhill Dr., 2nd Floor, San
Bruno, California 94066. See "Certain Relationships and Related
Transactions."
(3) Represents 178,125 shares issuable upon the exercise of options exercisable
within 60 days of December 31, 2004. Mr. Panetta's business address is 827
Via Mirada, Monterey, California 93940. See "Certain Relationships and
Related Transactions."
(4) Represents 125,000 shares issuable upon the exercise of stock options
exercisable within 60 days of December 31, 2004. The business address of
Mr. Farese is 401 River Oaks Parkway, San Jose, CA 95134. See "Certain
Relationships and Related Transactions."
(5) Represents 50,000 shares issuable upon the exercise of stock options
exercisable with in 60 days of December 31, 2004. The business address of
Mr. Welch is 1729 East Otero Avenue, Littleton, CO 80122. See "Certain
Relationships and Related Transactions."
(6) Represents (a) 212 shares held by Mr. Dane and (b) 325,040 shares issuable
upon the exercise of stock options exercisable within 60 days of December
31, 2004. The business address of Mr. Dane is 275 Shoreline Drive, Suite
500, Redwood Shores, California 94065. See "Executive Compensation; Option
Grants in 2002."
-34-
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's officers, directors and persons who own
more than ten percent of a registered class of the Company's equity securities
to file certain reports with the Securities and Exchange Commission (the "SEC")
regarding ownership of, and transactions in, the Company's securities. These
officers, directors and stockholders are also required by SEC rules to furnish
the Company with copies of all Section 16(a) reports that are filed with the
SEC. Based solely on a review of copies of such forms received by the Company
and written representations received by the Company from certain reporting
persons, the Company believes that for the year ended December 31, 2004 all
Section 16(a) reports required to be filed by the Company's executive officers,
directors and 10% stockholders were filed on a timely basis.
Item 13. Certain Relationships and Related Transactions
Director Compensation
For their services as directors of the Company, all non-employee directors
receive a fee of $1 for each Board of Directors meeting attended and all
directors are reimbursed for all reasonable out-of-pocket expenses incurred in
connection with attending such meetings. Directors are also eligible to receive
stock options. In March 2004, Mr. Welch was granted immediately exercisable
non-qualified options to purchase 50,000 share upon his appointment to the board
at an exercise price of $0.76, which options expire on March 11, 2011. In June
2004, Michael Farese, Louis Panetta and C. B. Sung were each granted immediately
exercisable non-qualified options to purchase 25,000 shares of common stock at
an exercise price of $0.54, which options expire on June 21, 2011. The Company
retains a declining balance repurchase option on the shares underlying these
options for one year from the date of grant.
In June 2003, the Company's Joint Venture borrowed from one of its
directors approximately $24 denominated in U. S. dollars to purchase a
replacement van used in the Company's operations. The note bears interest at the
rate of 5% per annum and is due in June 2006.
Item 14. Principal Accounting Fees and Services
In December, 1999, the Company retained Stonefield Josephson, Inc. as its
independent auditors. Prior to the retention of Stonefield Josephson, Inc.,
neither the Company nor any person on its behalf consulted with Stonefield
Josephson, Inc. regarding the application of accounting principles to any
transaction or the types of audit opinion that might be rendered on the
Company's financial statements.
The aggregate fees billed for professional services by Stonefield
Josephson, Inc. in 2004 were $294, and in 2003 were $321, for the following
services:
Audit Fees: Stonefield Josephson, Inc.'s fees in connection with its
quarterly reviews and year end audits for 2004 were $245, and were approximately
$214, in 2003, which represented approximately 83% and 66% of the aggregate fees
billed by Stonefield Josephson, Inc. in 2004 and 2003, respectively.
Audit-Related Fees. Stonefield Josephson, Inc. did not bill the Company for
any assurance and related work in fiscal year 2004 or 2003.
Tax Fees. Stonefield Josephson, Inc fees in connection with the 2003
federal and state tax returns, which were billed in 2004, were approximately
$5,900, or 2% of the aggregate fees billed for professional services by
Stonefield Josephson, Inc. in 2004. Stonefield Josephson, Inc. fees in
connection with the 2002 federal and state tax returns, which were billed in
2003, were approximately $3, or 1% of the aggregate fees billed for professional
services by Stonefield Josephson, Inc. in 2003.
-35-
Financial Information Systems Design and Implementation Fees: There were no
fees incurred in fiscal year 2004 or 2003 for financial information systems
design and implementation services.
All other Fees: Stonefield Josephson, Inc's fees for all other services
provided in 2004 totaled approximately $43, or 15% of the aggregate fees billed
by Stonefield Josephson, Inc. in 2004 and related primarily to preparation of
the company's 2004 proxy and a Registration statement on Form S-1. Stonefield
Josephson, Inc's fees for all other services provided in 2003 totaled
approximately $105, or 33% of the aggregate fees billed by Stonefield Josephson,
Inc. in 2003 and related primarily to a Registration statement on Form S-1.
Pre-Approval Policies. It is the policy of the Company not to enter into
any agreement for Stonefield Josephson, Inc. to provide any non-audit services
unless (a) the agreement is approved in advance by the Audit Committee or (b)
(i) the aggregate amount of all such non-audit services constitutes no more than
5% of the total amount we pay to Stonefield Josephson, Inc. during the fiscal
year in which such services are rendered, (ii) such services were not recognized
by the Company as constituting non-audit services at the time of the engagement
of the non-audit services and (iii) such services are promptly brought to the
attention of the Audit Committee and prior to the completion of the audit were
approved by the Audit Committee or by one or more members of the Audit Committee
who are members of the Board of Directors to whom authority to grant such
approvals has been delegated by the Audit Committee. The Audit Committee will
not approve any agreement in advance for non-audit services unless (x) the
procedures and policies are detailed in advance as to such services, (y) the
Audit Committee is informed of such services prior to commencement and (z) such
policies and procedures do not constitute delegation of the Audit Committee's
responsibilities to management under the Securities Exchange Act of 1934, as
amended.
The Audit Committee has considered whether the provision of non-audit
services has impaired the independence of Stonefield Josephson, Inc. and has
concluded that Stonefield Josephson, Inc. is independent under applicable SEC
and Nasdaq rules and regulations.
-36-
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Index to Financial Statements
Page
(a)(1) Financial Statements
Report of Stonefield Josephson, Inc., Independent Registered
Public Accounting Firm....................................... F-1
Consolidated Balance Sheets at December 31, 2004 and 2003.... F-2
Consolidated Statements of Operations for the years
ended December 31, 2004, 2003, and 2002...................... F-3
Consolidated Statements of Changes in Stockholders'
Equity for the years ended December 31, 2004, 2003 and 2002.. F-4
Consolidated Statements of Cash Flows for the years
ended December 31, 2004, 2003 and 2002....................... F-5
Notes to Consolidated Financial Statements................... F-6
(a)(2) Financial Statement Schedule
Schedule II Valuation and Qualifying Accounts and Reserves... S-1
(b) Reports on Form 8-K
1. Current Report on Form 8-K, Items 7, 9 and 12, dated October 27, 2004, with
respect to the Company's Third quarter 2004 financial results.
2. Current Report on Form 8-K, Items 1, 2 and 3, dated November 3, 2004, with
respect to the Company's announcement of entering into a note and warrant
purchase agreement with Wainewright, Inc.
3. Current Report on Form 8-K, Items 7, and 9, dated November 9, 2004, with
respect to the Company's payment of its $3.5 million note to Cornell
Capital Partners LC.
4. Current Report on Form 8-K, Items 7, 8 and 9, dated November 24, 2004, with
respect to the Company's Settlement Agreement with Topaz Systems, Inc.
(c) Exhibits
Exhibit Document
Number
2.0 Second Amended Plan of Reorganization of the Company, incorporated
herein by reference to the Company's Form 8-K filed October 24,
1994.
2.1 Orderly Liquidation Valuation, Exhibit F to the Second Amended
Plan of Reorganization, incorporated herein by reference to the
Company's Form 8-K filed October 19, 1994.
2.2 Order Confirming Plan of Reorganization, incorporated herein by
reference to the Company's Form 8-K filed November 14, 1994.
3.1 Certificate of Incorporation of the Company, as amended,
incorporated herein by reference to Exhibits 3.1, 3.2, 3.3 and 3.4
to the Company's Registration Statement on Form 10 (File No.
0-19301).
3.2 Certificate of Amendment to the Company's Certificate of
Incorporation (authorizing the reclassification of the Class A
Common Stock and Class B Common Stock into one class of Common
Stock) as filed with the Delaware Secretary of State's office on
November 1, 1991, incorporated herein by reference to Exhibit 3 to
Amendment 1 on Form 8 to the Company's Form 8-A (File No.
0-19301).
-37-
3.3 By-laws of the Company adopted on October 6, 1986, incorporated
herein by reference to Exhibit 3.5 to the Company's Registration
Statement on Form 10 (File No. 0-19301).
4.1 1984 Stock Option Plan of the Company, as amended and restated as
of October 15, 1987 and as amended by resolutions of the
stockholders of the Company passed on August 15, 1989 and October
8, 1990 to increase the aggregate shares covered thereby to
1,000,000, incorporated herein by reference to Exhibit 4.4 to the
Company's Registration Statement on Form 10 (File No. 0-19301).
4.2 Form of Stock Option Grant under 1984 Stock Option Plan,
incorporated herein by reference to Exhibit 4.5 to the Company's
Registration Statement on Form 10 (File No. 0-19301).
4.3 1991 Stock Option Plan of the Company, incorporated herein by
reference to Exhibit 4.5 of the Company's Form S-1 dated December
23, 1991 (Registration No. 33-43879).
4.4 1991 Non-Discretionary Stock Option Plan, incorporated herein by
reference to Exhibit 4.6 of the Company's Form S-1 dated December
23, 1991 (Registration No. 33-43879).
4.5 Form of Incentive Stock Option Grant under 1991 Stock Option Plan,
incorporated herein by reference to Exhibit 4.7 of the Company's
Form S-1 dated December 23, 1991 (Registration No. 33-43879).
4.6 Form of Non-Qualified Stock Option Grant under 1991 Stock Option
Plan, incorporated herein by reference to Exhibit 4.8 of the
Company's Form S-1 dated December 23, 1991 (Registration No.
33-43879).
4.7 Form of Stock Option Grant under 1991 Non-Discretionary Stock
Option Plan, incorporated herein by reference to Exhibit 4.9 of
the Company's Form S-1 dated December 23, 1991 (Registration No.
33-43879).
4.8 1994 Stock Option Plan, incorporated herein by reference to
Exhibit G of the Company's Second Amended Disclosure Statement
filed on Form 8-K dated October 19, 1994 and approved by
shareholders on November 14, 1994.
4.9 Form of Warrant of the Company dated March 28, 1997 issued in
connection with the Waiver by and among the Company and the
signatories thereto, incorporated herein by reference to Exhibit
4.9 of the Company's 1996 Form 10-K (File No. 0-19301).
4.10 1999 Stock Option Plan, incorporated herein by reference to
Exhibit A of the Company's Definitive Proxy Statement filed on May
4, 1999 and approved by shareholders on June 7, 1999.
.
4.11 Form of Convertible Promissory Note issued by Communication
Intelligence Corporation, incorporated herein by reference to
Exhibit 10.3 to the Company's Form 8-K dated November 3, 2004.
4.12 Form of Warrant issued by Communication intelligence Corporation,
incorporated herein by reference to Exhibit 10.4 to the Company's
Form 8-K dated November 3, 2004.
+10.1 Licensing and Development Agreement for Use and Marketing of
Program Materials dated September 25, 1992 between the Company and
International Business Machines Corporation, incorporated herein
by reference to Exhibit 10.13 of the Company's 1992 Form 10-K
(File No. 0-19301)
10.2 Standby Stock Purchase Agreement between the Company and Philip
Sassower dated October 3, 1994, incorporated herein by reference
to Exhibit 10.13 of the Company's 1994 Form 10-K (File No.
0-19301)
10.3 Form of Subscription Agreement between the Company and the
Purchasers, dated November 28, 1995, incorporated herein by
reference to Exhibit 1 of the Company's Form 8-K dated November
28, 1995.
10.4 Form of Registration Rights Agreement between the Company and the
Purchasers, dated November 28, 1995, incorporated herein by
reference to Exhibit 1 of the Company's Form 8-K dated November
28, 1995.
10.5 Form of Warrant of the Company issued to Libra Investments, Inc.
on November 28, 1995, incorporated herein by reference to Exhibit
1 of the Company's Form 8-K dated November 28, 1995.
10.6 Form of Registration Rights Agreement between the Company and
Libra Investments, Inc., dated November 28, 1995, incorporated
herein by reference to Exhibit 1 of the Company's Form 8-K dated
November 28, 1995.
-38-
10.7 Form of Subscription Agreement between the Company and various
investors, dated June 13, 1996, incorporated herein by reference
to Exhibit 1 of the Company's Form 8-K dated June 27, 1996.
10.8 Form of Registration Rights Agreement between the Company and
various investors, dated June 13, 1996, incorporated herein by
reference to Exhibit 2 of the Company's Form 8-K dated June 27,
1996.
10.9 Form of Preferred Stock Investment Agreement, dated as of December
31, 1996, between the Company and the investors listed on Schedule
1 thereto, incorporated herein by reference to Exhibit 1 of the
Company's Form 8-K dated December 31, 1996.
10.10 Form of Registration Rights Agreement between the Company and the
Investors Listed on Schedule 1 thereto, incorporated herein by
reference to Exhibit 2 of the Company's Form 8-K dated December
31, 1996.
10.11 Form of Certificate of Designation of the Company with respect to
the 5% Cumulative Convertible Preferred Stock, incorporated herein
by reference to Exhibit 3 of the Company's Form 8-K dated December
31, 1996.
10.12 Waiver, dated March 26, 1997, effective December 31, 1996, by and
among the Company and the signatories thereto, incorporated herein
by reference to Exhibit 10.19 of the Company's 1996 Form 10-K
(File No. 0-19301).
10.13 Form of Subscription Agreement between the Company and each
subscriber, dated as of November 25, 1997, incorporated herein by
reference to Exhibit 10.1 of the Company's Form 8-K dated December
3, 1997.
10.14 Certificate of Designations of the Company with respect to the
Series B 5% Cumulative Convertible Preferred Stock, incorporated
herein by reference to Exhibit 10.2 of the Company's Form 8-K
dated November 13, 1997.
10.15 Form of Registration Rights Agreement, by and among the Company
and the signatories thereto, dated as of November 25, 1997,
incorporated herein by reference to Exhibit 10.3 to the Company's
Form 8-K dated November 13, 1997.
10.16 Amendment to the Company's Certificate of Designation with respect
to the 5% Cumulative Convertible Preferred Stock dated June 12,
1998, incorporated herein by reference to Exhibit 10.23 of the
Company's 1998 Form 10-K (File No. 0-19301).
10.17 Amendment to the Company's Amended and Restated Certificate of
Incorporation dated June 12, 1998 incorporated herein by reference
to Exhibit 10.24 of the Company's 1998 Form 10-K (File No.
0-19301).
10.18 Employment Agreement dated August 14, 1998 between James Dao and
the Company incorporated herein by reference to Exhibit 10.25 of
the Company's 1998 Form 10-K (File No. 0-19301).
++10.19 Software Development and License Agreement dated December 4, 1998
between Ericsson Mobile Communications AB and the Company
incorporated herein by reference to Exhibit 10.26 of the Company's
1998 Form 10-K (File No. 0-19301).
10.20 Loan and Warrant Agreement dated October 20, 1999 between the
Company and the Philip S. Sassower 1996 Charitable Remainder
Annuity Trust.
10.21 Asset Purchase Agreement between the Company and PenOp Ltd and
PenOp Inc. incorporated herein by reference to the Company's Form
8-K dated October 6, 2000.
10.22 Loan Agreement dated June 19, 2001 between the Company and the
Philip S.Sassower 1996 Charitable Remainder Annuity Trust.
10.23 Equity Line of Credit Agreement between the Company and Cornell
Capital Partners, LP, incorporated by reference to the Company's
Registration Statement on Form S1 dated February 13, 2003 (File
No. 333-103157)
10.24 Form of Note and Warrant Purchase Agreement dated October 28,
2004, among Communication Intelligence Corporation and the
Purchasers identified there in, incorporated herein by reference
to Exhibit 10.1 to the Company's Form 8-K dated November 3, 2004.
10.25 Form of Registration Rights Agreement dated October 28, 2004,
among Communication Intelligence Corporation and the parties
identified there in, incorporated herein by reference to Exhibit
10.2 to the Company's Form 8-K dated November 3, 2004.
-39-
14.00 Code of Ethics -Incorporated by reference to the registrant's
Annual Report on Form 10-K (fileno. 0-19301) filed with the
Commission on March 30, 2004.
21.1 Schedule of Subsidiaries.
23.1 Consent of Stonefield Josephson, Inc, Independent Registered
Public Accounting Firm.
31.1 Certification of Company's Chief Executive Officer pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certificate of Company's Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley
Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 USC
Section 1750, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 USC
Section 1750, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
+ Confidential treatment of certain portions of this exhibit have
been previously granted pursuant to a request for confidentiality
dated March 29, 1993, filed pursuant to the Securities Exchange
Act of 1934.
* Filed herewith.
++ Confidential treatment of certain portions of this exhibit have
been requested from the SEC pursuant to a request for
confidentiality dated March 30, 1999, filed pursuant to the
Securities and Exchange Act of 1934.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned; thereunto duly authorized, in the City of Redwood
Shores, State of California, on March 28, 2005.
COMMUNICATION INTELLIGENCE CORP.
By:
/s/ Francis V. Dane
Francis V. Dane
(Principal Financial Officer and Officer Duly Authorized
to Sign on Behalf of the Registrant)
-40-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Registrant
and in the capacities indicated on March 28, 2005.
Signature Title
/s/ Guido DiGregorio Chairman, President and Chief Executive Officer
------------------------ (Principal Executive Officer)
Guido DiGregorio
/s/ Francis V. Dane Chief Legal Officer and Chief Financial Officer
------------------------ (Principal Financial and Accounting Officer)
Francis V. Dane
/s/ Michael Farese Director
------------------------
Michael Farese
/s/ Louis P. Panetta Director
------------------------
Louis P. Panetta
/s/ Chien Bor Sung Director
------------------------
Chien Bor Sung
/s/ David Welch Director
------------------------
David Welch
-41-
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders of
Communication Intelligence Corporation
Redwood Shores, California
We have audited the accompanying consolidated balance sheets of Communication
Intelligence Corporation and its subsidiary ("the Company") as of December 31,
2004 and 2003 and the related consolidated statements of operations, changes in
stockholders' equity, cash flows and financial statement schedule for each of
the three years in the period ended December 31, 2004, as listed in the index
appearing under Item 15(a)(1) and (2) of this Annual Report on Form 10-K. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and the disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Communication Intelligence Corporation and its subsidiary as of December 31,
2004, and 2003 and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2004, in conformity with
accounting principles generally accepted in the United States of America. Also
in our opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company's significant recurring operating
losses and accumulated deficit raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
STONEFIELD JOSEPHSON, INC.
San Francisco, California
February 11, 2005, except for Note 14, as to which the date is March 3, 2005
F-1
Communication Intelligence Corporation
Consolidated Balance Sheets
(In thousands, except par value amounts)
December 31,
------------------------------
2004 2003
Assets
Current assets:
Cash and cash equivalents....................... $ 4,736 $ 1,039
Accounts receivable, net of allowances
of $404 and $256 at December 31, 2004
and 2003, respectively.......................... 356 742
Inventories..................................... - 47
Deferred financing costs - current portion...... 272 60
Prepaid expenses and other current assets....... 105 117
------------- -------------
Total current assets...................... 5,469 2,005
Property and equipment, net....................... 123 138
Patents........................................... 4,663 5,042
Capitalized software development costs............ 32 -
Deferred financing costs - long-term.............. 502 -
Other assets...................................... 30 30
------------- -------------
Total assets.............................. $ 10,819 $ 7,215
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Short-term debt - related party................. $ 8 $ 3,008
Short-term debt - other......................... 36 750
Accounts payable................................ 241 243
Accrued compensation............................ 258 259
Other accrued liabilities....................... 400 475
Deferred revenue................................ 458 165
------------- -------------
Total current liabilities................. 1,401 4,900
Long-term debt - related party.................... 5 13
Convertible notes, net of unamortized fair
value assigned to beneficial
conversion feature and warrants of $2,410........ 1,785 -
Minority interest................................. 97 115
Commitments and contingencies - -
Stockholders' equity:
Common stock, $.01 par value; 125,000 shares
authorized; 101,412 and 100,102
shares issued and outstanding at December
31, 2004 and 2003, respectively................. 1,014 1,001
Additional paid-in capital....................... 87,231 83,528
Accumulated deficit.............................. (80,544) (82,164)
Accumulated other comprehensive loss............. (170) (178)
------------ -------------
Total stockholders' equity......................... 7,531 2,187
------------ -------------
Total liabilities and stockholders' equity......$ 10,819 $ 7,215
============ =============
The accompanying notes form an integral part of
these Consolidated Financial Statements
F-2
Communication Intelligence Corporation
Consolidated Statements of Operations
(In thousands, except per share amounts)
Years ended December 31,
----------------------------------------
2004 2003 2002
----------------------------------------
Revenues:
Online.............................. $ 130 $ 300 $ 351
Corporate........................... 6,997 1,703 1667
China............................... 157 1,031 1254
----------- ----------- -----------
7,284 3,034 3,272
----------- ----------- -----------
Operating costs and expenses:
Cost of sales:
Online........................... - 17 259
Corporate........................ 20 30 96
China............................ 33 718 802
Research and development........... 1,187 1,302 1,485
Sales and marketing................ 1,306 905 1,543
General and administrative......... 2,483 2,219 2,424
----------- ----------- -----------
5,029 5,191 6,609
----------- ----------- -----------
Income (loss) from operations......... 2,255 (2,157) (3,337)
Interest income and other income
(expense), net....................... 47 1 (17)
Interest expense...................... (701) (205) (205)
Minority interest..................... 19 16 (2)
------------ ----------- -----------
Net income (loss)..................... $ 1,620 $ (2,345) $ (3,561)
============ =========== ===========
Basic and diluted income
(loss) per share..................... $ 0.02 $ (0.02) $ (0.04)
============ =========== ===========
Basic weighted average shares......... 100,909 97,436 91,298
============ =========== ===========
Diluted weighted average shares....... 107,572 97,436 91,298
============ =========== ===========
The accompanying notes form an integral part of
these Consolidated Financial Statements
F-3
Communication Intelligence Corporation
Consolidated Statements of Changes in Stockholders' Equity
(In thousands)
Accumulated
Additional Other
Common Common Paid-In Accumulated Comprehensive
Shares Stock Capital Deficit Loss Total
---------------------------------------------------------------------------------
Balances as of December 31, 2001..
90,911 $ 909 $ 81,605 $(76,258) $ (196) $ 6,060
---------------------------------------------------------------------------------
Exercise of options for 570 shares
of Common Stock................. 570 $ 6 $ 420 $ $ $ 426
Comprehensive income (loss):
Net (loss)................... (3,561) (3,561)
Foreign currency translation
adjustment................... 9 9
-------------
Total comprehensive income (loss).
(3,552)
--------------------------------------------------------------------=============
Balances as of December 31, 2002..
91,481 $ 915 $ 82,025 $(79,819) $ (187) $ 2,934
---------------------------------------------------------------------------------
Sale of Common 8,621 shares through Cornell Capital net of expenses.
8,621 $ 86 $ 1,503 $ $ $ 1,589
Comprehensive income (loss):
Net (loss)................... (2,345) (2,345)
Foreign currency translation
adjustment................... 9 9
-------------
Total comprehensive income (loss).
(2,336)
--------------------------------------------------------------------=============
Balances as of December 31, 2003..
100,102 $ 1,001 $ 83,528 $(82,164) $ (178) $ 2,187
---------------------------------------------------------------------------------
Sale of shares of Common stock
through Cornell Capital net of
expenses........................ 1,133 $ 11 $ 680 $ $ $ 691
Exercise of options for shares of
common stock.................... 177 2 51 53
Fair value of warrants issued to
the agent in connection with
convertible notes................ 421 421
Fair value of warrants issued to
the investors in connection with
convertible notes................ 982 982
Fair value of beneficial conversion
feature associated with the
convertible notes................ 1,569 1,569
Comprehensive income (loss):
Net income................... 1,620 1,620
Foreign currency translation
adjustment................... 8 8
-------------
Total comprehensive income........ 1,628
--------------------------------------------------------------------=============
Balances as of December 31, 2004..
101,412 $ 1,014 $ 87,231 $(80,544) $ (170) $ 7,531
=================================================================================
The accompanying notes form an integral part of
these Consolidated Financial Statements
F-4
Communication Intelligence Corporation
Consolidated Statements of Cash Flows
(In thousands)
Years ended December 31,
----------------------------------
2004 2003 2002
----------------------------------
Cash flows from operating activities
Net income (loss)..............................$ 1,620 $ (2,345) $ (3,561)
Adjustments to reconcile net income (loss)
to net cash provided by(used in) operating
activities:
Depreciation and amortization................ 425 456 467
Discount on long term debt................... 142 - -
Loss on disposal of property and equipment... 8 8 6
Provision for inventory obsolescence......... - 38 -
Provision for doubtful accounts.............. 148 13 129
Changes in operating assets and liabilities
Accounts receivable,....................... 238 (278) 437
Inventories................................ 47 28 16
Prepaid expenses and other current assets... (12) 67 (105)
Other assets................................ - 13 156
Accounts payable............................ (2) 83 (46)
Accrued compensation........................ (1) 9 42
Other accrued liabilities................... (85) (87) 295
Deferred revenue............................ 293 - 77
---------- -------- ---------
Net cash provided by (used in)
operating activities.......................... 2,821 (1,995) (2,087)
---------- -------- ---------
Cash flows from investing activities
Acquisition of property and equipment.......... (37) (30) (30)
Capitalization of software development costs... (45) - -
---------- -------- ---------
Net cash used in investing activities.......... (82) (30) (30)
---------- -------- ---------
Cash flows from financing activities
Proceeds from issuance of short-term debt...... 36 750 -
Proceeds from issuance of long-term debt
- related party............................... - 24 -
Proceeds from issuance of convertible
notes, net.................................... 3,885 - -
Principal payments on short-term debt.......... (3,008) - (181)
Principal payments on long-term debt -
related party................................. - (3) -
Principal payments on capital lease
obligations................................... (8) (7) (5)
Proceeds from issuance of common stock......... - 2,000 -
Offering costs................................. - (411) -
Proceeds from exercise of stock options........ 53 - 426
--------- --------- ---------
Net cash provided by financing activities...... 958 2,353 240
--------- --------- ---------
Net increase (decrease) in cash
and cash equivalents.......................... 3,697 328 (1,877)
Cash and cash equivalents at beginning
of year....................................... 1,039 711 2,588
--------- --------- ---------
Cash and cash equivalents at end of year.......$ 4,736 $ 1,039 $ 711
========= ========= =========
The accompanying notes form an integral part of
these Consolidated Financial Statements
F-5
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies
The Company
Communication Intelligence Corporation and its joint venture (the "Company"
or "CIC") develops and markets natural input and biometric electronic signature
solutions aimed at the emerging markets such as, e-commerce, wireless
Internet/information devices, and corporate security. These markets include all
areas of personal computing, as well as electronic commerce and communications.
The Company's research and development activities have given rise to
numerous technologies and products. The Company's core technologies are
classified into two broad categories: "natural input technologies" and
"transaction and communication enabling technologies". CIC's natural input
technologies are designed to allow users to interact with a computer or handheld
device through the use of an electronic pen or "stylus". Such products include
the Company's multi-lingual Handwriter(R) Recognition System, and its
Handwriter(R) for Windows(R) family of desktop computing products. CIC's
transaction and communication enabling technologies provide a means for
protecting electronic transactions and discretionary communications. CIC has
developed products for dynamic signature verification, electronic ink data
compression and encryption and a suite of development tools and applications
which the Company believes could increase the functionality of its core products
and facilitate their integration into original equipment manufacturers' ("OEM")
hardware products and computer systems and networks.
Through its 90% owned joint venture, Communication Intelligence Computer
Corporation, in China (the "Joint Venture"), the Company provides system
integration services and markets its pen-based business computer systems to
Chinese businesses, government users and other joint ventures.
Going Concern
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. Except for 2004, the Company has
incurred significant losses since its inception and, at December 31, 2004, the
Company's accumulated deficit was approximately $80,544. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
The Company has primarily funded these losses through the sale of debt and
equity securities.
In November 2004, the Company consummated a financing in the form of
convertible notes aggregating $3,885, net of expenses (See Note 6). However,
there can be no assurance that the Company will have adequate capital resources
to fund planned operations or that any additional funds will be available to the
Company when needed, or if available, will be available on favorable terms or in
amounts required by the Company. If the Company is unable to obtain adequate
capital resources to fund operations, it may be required to delay, scale back or
eliminate some or all of its operations, which may have a material adverse
effect on the Company's business, results of operations and ability to operate
as a going concern. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Basis of Consolidation
The accompanying consolidated financial statements are prepared in
accordance with generally accepted accounting principles in the United States of
America, and include the accounts of CIC and its 90% owned Joint Venture in the
People's Republic of China. All inter-company accounts and transactions have
been eliminated. All amounts shown in the accompanying consolidated financial
statements are in thousands of dollars except per share amounts.
F-6
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, revenue
recognition, allowance for doubtful accounts, long lived assets impairment,
inventory, fair value of financial instruments, and disclosure of contingent
assets and liabilities, at the date of the financial statements, as well as the
reported amounts of revenues and expenses during the reporting periods. Actual
results could differ from these estimates.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable, short-term debt and
long-term debt approximate fair value due to their relatively short maturities.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities at the
date of purchase of three months or less to be cash equivalents.
The Company's cash and cash equivalents, at December 31, consisted of
the following:
2004 2003
----------- ------------
Cash in bank.................................. $ 1,734 $ 110
Money market funds............................ 3,002 929
----------- ------------
Cash and cash equivalents................... $ 4,736 $ 1,039
=========== ============
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of cash, cash equivalents, and
accounts receivable. The Company maintains its cash and cash equivalents with
various financial institutions. This diversification of risk is consistent with
Company policy to maintain liquidity, and mitigate against risk of loss as to
principal. Although such amounts may exceed the F. D. I. C. limits, the Company
limits the amount of credit exposure with any one financial institution and
believes that no significant concentration of credit risk exists with respect to
cash and cash equivalents.
At December 31, 2004, the Joint Venture had approximately $132 in cash
accounts held by a financial institution in the People's Republic of China. The
Joint Venture deposits are not covered by any federal deposit insurance program
that is comparable to the programs applicable to U.S. deposits.
To date, accounts receivable have been derived principally from revenues
earned from end users, manufacturers, retailers and distributors of computer
products in North America, Europe and the Pacific Rim. The Company performs
periodic credit evaluations of its customers, and does not require collateral.
The Company maintains reserves for potential credit losses; historically, such
losses have been within management's expectations.
The allowance for doubtful accounts is based on the Company's assessment of
the collectibility of specific customer accounts and an assessment of
international, political and economic risk as well as the aging of the accounts
receivable. If there is a change in actual defaults from the Company's
historical experience, the Company's estimates of recoverability of amounts due
it could be affected and the Company will adjust the allowance accordingly (See
Schedule II).
F-7
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Inventories
Inventories are stated at the lower of cost or market, cost being
determined using the first-in first-out ("FIFO") method. Cost principally
includes direct materials. At December 31, 2004 and 2003, the Company recorded a
provision of $8 and $38, respectively, to System Integration Cost of Sales for
obsolete inventory. At December 31, 2004 and 2003, inventories consisted
primarily of finished goods.
Deferred Financing Costs
Deferred financing costs are stated at fair value and include costs paid in
cash, such as professional fees and commissions, and warrant costs . The fair
value ascribed to the warrants was estimated on the commitment date using the
Black-Scholes pricing model with the following assumptions: risk-free interest
rate of 3.21%; expected life of 3 years; expected volatility of 100%; and
expected dividend yield of 0% (See Note 6). The costs are amortized to interest
expense over the life of the convertible notes or upon earlier conversion using
the effective interest method. The costs amortized to interest expense amounted
to $46, $0, and $0 for the years ended December 31, 2004, 2003, and 2002,
respectively. Accumulated amortization amounted to $46 and $0 at December 31,
2004 and 2003, respectively Amortization expense expected for the years ending
December 31, 2005, 2006, and 2007 is $272, $273 and $229, respectively.
Property and Equipment, Net
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the related assets,
ranging from three to five years. Leasehold improvements are amortized over
their estimated useful lives, not to exceed the term of the related lease. The
cost of additions and improvements is capitalized, while maintenance and repairs
are charged to expense as incurred. Depreciation and amortization expense was
$31, $63, and $75 for the years ended December 31, 2004, 2003 and 2002,
respectively. The Chinese Joint Venture disposed of certain assets at cost of
$34, $76 and $36 in 2004, 2003 and 2002, respectively.
Property and equipment, net at December 31, consists of the following:
2004 2003
------------ ------------
Machinery and equipment......................... $1,283 $1,247
Office furniture and fixtures................... 432 432
Leasehold improvements.......................... 84 84
Purchased software.............................. 218 218
------------ ------------
2,017 1,981
Less accumulated depreciation and amortization.. (1,894) (1,843)
------------ ------------
$ 123 $ 138
============ ============
Included in property and equipment, as of December 31, 2004 and 2003, are
$82 and $82, respectively, of assets acquired under capital leases. Accumulated
depreciation on such assets totaled $61 and $52 at December 31, 2004 and 2003,
respectively.
Patents
On October 6, 2000, the Company acquired certain assets of PenOp Limited
("PenOp") and its subsidiary PenOp Inc. pursuant to an asset purchase agreement
dated as of September 29, 2000. Patents are stated at cost less accumulated
amortization which in Management's opinion represents fair value. Amortization
is computed using the straight-line method over the estimated lives of the
related assets, ranging from five to seventeen years. Amortization expense was
$379, $379 and $378 for the years ended December 31, 2004, 2003 and 2002,
respectively.
F-8
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Patents (continued)
The nature of the underlying technology of each material patent is as follows:
o Patent numbers 5544255, 5647017, 5818955 and 6064751 involve (a) the
electronic capture of a handwritten signature utilizing an electronic
tablet device on a standard computer system within an electronic document,
(b) the verification of the identity of the person providing the electronic
signature through comparison of stored signature measurements, and (c) a
system to determine whether an electronic document has been modified after
signature.
o Patent number 6091835 involves all of the foregoing and the recording of
the electronic execution of a document regardless of whether execution
occurs through a handwritten signature, voice pattern, fingerprint or other
identifiable means.
o Patent numbers 5933514, 6212295, 6381344, and 6487310 involve methods and
processes related to handwriting recognition developed by the Company over
the years. Legal fees associated with these patents was immaterial and
expensed as the fees were incurred.
Patents, net at December 31, consists of the following:
Expiration Life 2004 2003
-------- ---- ------------ ------------
Patent (Various).......... Various 5 $ 9 $ 9
Patent (Various).......... Various 7 476 476
5544255................... 2013 13 93 93
5647017................... 2014 14 187 187
5818955................... 2015 15 373 373
6064751................... 2017 17 1,213 1,213
6091835................... 2017 17 4,394 4,394
------------ ------------
6,745 6,745
Less accumulated amortization.. (2,082) (1,703)
------------ ------------
$ 4,663 $ 5,042
============ ============
Amortization expense for the years ending December 31, 2005, 2006, 2007,
2008, and 2009 are estimated to be $379, $379, $379, $379 and $379,
respectively. The patents identified, as "various" are technically narrow or
dated patents that the Company believes the expiration of which will not be
material to its operations.
The useful lives assigned to the patents are based upon the following
assumptions and conclusions:
o The estimated cash flow from products based upon each patent are expected
to exceed the value assigned to each patent;
o There are no legal, regulatory or contractual provisions known to the
Company that limit the useful life of each patent to less than the assigned
useful life;
o No additional material costs need to be incurred or modifications made in
order for the Company to continue to be able to realize the protection
afforded by the patents; and
F-9
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Patents (continued)
o The Company does not foresee any effects of obsolescence or significant
competitive pressure on its current or future products, anticipates
increasing demand for products utilizing the patented technology, and
believes that the current markets for its products based on the patented
technology will remain constant or will grow over the useful lives assigned
to the patents because of a legal, regulatory and business environment
encouraging the use of electronic signatures.
The Company performs intangible asset impairment analyses on a quarterly
basis in accordance with the guidance in Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") and
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long Lived Assets" ("SFAS 144"). The Company uses SFAS
144 in response to changes in industry and market conditions that affects its
patents; the Company then determines if an impairment of its assets has
occurred. The Company reassesses the lives of its patents and tests for
impairment quarterly in order to determine whether the book value of each patent
exceeds the fair value of each patent. Fair value is determined by estimating
future cash flows from the products that are and will be protected by the
patents and considering the additional factors listed in Critical Accounting
Policies in Item 7 of this Form 10-K. The Company believes that as of December
31, 2004 and 2003, no impairment of the carrying values of the patents existed.
Long-Lived Assets
The Company evaluates the recoverability of its long-lived assets whenever
circumstances or events indicate such assets might be impaired. The Company
would recognize an impairment charge in the event the net book value of such
assets exceeded the future undiscounted cash flows attributable to such assets.
No such impairment charges have been recorded in the three years ended December
31, 2004.
Software Development Costs
Software development costs are accounted for in accordance with Statement
of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed" ("SFAS 86"). Under SFAS 86,
capitalization of software development costs begins upon the establishment of
technological feasibility, subject to net realizable value considerations. The
costs capitalized include the coding and testing of the product after the
technological feasibility has been established and ends upon the release of the
product. The capitalized costs are amortized to cost of sales on a straight-line
basis over the estimated life of the product, generally three years. At December
31, 2004 the Company had capitalized approximately $45 of software development
costs. As of December 31, 2003, and 2002, such costs were insignificant.
Amortization of capitalized software development costs for the years ended
December 31, 2004, 2003 and 2002 was $13, $14 and $14, respectively.
Other Current Liabilities
The Company records liabilities based on reasonable estimates for expenses,
or payables that are known but actual amounts must be estimated such as
deposits, taxes, rents and services. The estimates are for current liabilities
that should extinguished within one year.
F-10
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Other Current Liabilities (continued)
The Company had the following accrued liabilities at December 31:
2004 2003
-------------- ----------------
Accrued professional services $ 154 $ 164
Refundable deposits 115 115
Other 131 196
-------------- ----------------
Total $ 400 $ 475
============== ================
Stock-Based Compensation
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"). The Company has elected to continue to use the intrinsic value based
method of Accounting Principles Board Opinion No. 25,"Accounting for Stock
Issued to Employees", as allowed under SFAS 123, to account for its employee
stock-based compensation plans. The Company complies with the disclosure
provisions of SFAS 123.
Revenue Recognition
Revenue is recognized when earned in accordance with applicable accounting
standards, including AICPA Statement of Position ("SOP") No. 97-2, "Software
Revenue Recognition", as amended, Staff Accounting Bulletin 104, "Revenue
Recognition" ("SAB 104"), and the interpretive guidance issued by the Securities
and Exchange Commission and EITF issue number 00-21, "Accounting for Revenue
Arrangements with Multiple Elements", of the FASB's Emerging Issues Task Force.
The Company recognizes revenues from sales of software products upon shipment,
provided that persuasive evidence of an arrangement exists, collection is
determined to be probable, all non-recurring engineering work necessary to
enable the Company's product to function within the customer's application has
been completed and the Company's product has been delivered according to
specifications. Revenue from service subscriptions is recognized as costs are
incurred or over the service period which-ever is longer.
Software license agreements may contain multiple elements, including
upgrades and enhancements, products deliverable on a when and if available basis
and post contract support. Revenue from software license agreements is
recognized upon delivery of the software, provided that persuasive evidence of
an arrangement exists, collection is determined to be probable, all nonrecurring
engineering work necessary to enable the Company's products to function within
the customer's application has been completed, and the Company has delivered its
product according to specifications. Deferred revenue is recorded for upgrades,
enhancements and post contract support, which is paid for in addition to license
fees, and is recognized as costs are incurred or over the support period
which-ever is longer. Vendor specific objective evidence of the fair value for
multiple element software license agreements is determined by the price charged
for the same element when sold separately or the price determined by management
having the relevant authority when an element is not yet sold separately. The
price established by management for the element not yet sold separately will not
change prior to separate introduction of that element into the marketplace.
Revenue from system integration activities, which represents the sale and
installation of third party computer equipment and limited related consulting
services which requires little modification or customization to the software, is
recognized upon installation as projects are short term in nature, provided
persuasive evidence of an arrangement exists, collection of the resulting
receivable is probable and the system is functioning according to
specifications. Service subscription revenues associated with the system
integration activities are recognized as costs are incurred or over the service
period which-ever is longer.
F-11
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Revenue Recognition
The online/retail sales category includes sales of software made directly
from the Company's website, which are downloaded either directly by a reseller
or to a customer of such reseller. In both cases, the reseller reports the
number of units sold each month by submitting payment and a royalty report. The
reseller receives a percentage of each sale. The Company allows the on-line
resellers a right of return or right of offset. The number of units reported is
net of any product returns from prior months. The Company recognizes revenues on
the net amount reported by the resellers each month. The Company has a limited
number of resellers for its software available through the Company's website.
The online/retail sales category also includes sales made through retail
establishments under the Elibrium agreement. Revenue from software product sales
through retail are recognized upon notification from Elibrium of the number of
units sold through Elibrium's retail customers provided collection of the
resulting receivable is reasonably assured.
Major Customers
Handwriting Recognition Segment. Historically, the Company's handwriting
recognition segment revenues have been derived from a limited number of
customers. One customer, a major insurance company, accounted for 46% and 19% of
total segment revenue for the years ended December 31, 2004 and 2003,
respectively. One customer, Nationwide Building Society, accounted for 11% of
total segment revenues for the year ended December 31, 2002.
Systems Integration Segment. One customer, Nanjing Nimze accounted for 40%
of total system integration revenue for the year ended December 31, 2004. One
customer, Fujitsu Ltd., accounted for 21% of total system integration revenue
for the year ended December 31, 2003. Fujitsu Ltd. accounted for 30% of total
segment revenues for the year ended December 31, 2002.
Two customers accounted for 76% of total revenues for the year ended
December 31, 2004. One customer accounted for 14% of total revenues for the year
ended December 31, 2003. One customer accounted for 10% of total revenues for
the year ended December 31, 2002.
Research and Development
Research and development costs are charged to expense as incurred.
Advertising
The Company expenses advertising costs as incurred. Advertising expense for
the years ended December 31, 2004, 2003, and 2002 was $0, $0, and $112,
respectively.
F-12
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Net Income (Loss) Per Share
The Company calculates net income (loss) per share under the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS
128"). SFAS 128 requires the disclosure of both basic net income (loss) per
share, which is based on the weighted average number of shares outstanding, and
diluted income (loss) per share, which is based on the weighted average number
of shares and dilutive potential shares outstanding. For the year ended December
31, 2004, 3,902 potential equivalent shares were excluded from the calculation
of dilutive earnings per share due to the exercise price of such options was
greater than the average market price of the Company's common stock. For the
years ended December 31, 2003 and 2002, potential equivalent shares excluded
from the calculation of diluted earnings per share, as their effect is not
dilutive, include stock options of 5,911 and 6,452 of equivalent shares,
respectively. At December 31, 2004, there were 4,850 in the money warrants
outstanding and included in the calculation of diluted income (loss) per share.
There were no warrants outstanding at December 31, 2003 or 2002.
For the Year Ended December 31,
2004 2003 2002
------------- ------------- ------------
Weighted Weighted Weighted
Average Average Average
Net Shares Per-Share Net Shares Per-Share Net Shares Per-Share
Income Outstanding Amount Loss Outstanding Amount Loss Outstanding Amount
Basic income
(loss):
Income
(loss)available
to stockholders $1,620 100,909 $0.02 $(2,345) 97,436 $ (0.02) $(3,561) 91,298 $(0.04)
Effect of
dilutive
securities:
Stock options
1,813 - - -
Warrants
4,850 - - -
-------- --------- -------- -------- ------- ------- -------- ------- -------
Diluted income
(loss) $1,620 107,572 $0.02 $(2,345) 97,436 $(0.02) $(3,561) 91,298 $(0.04)
======== ========= ======== ======== ======= ======= ======== ======= =======
Foreign Currency Translation
The Company considers the functional currency of the Joint Venture to be
the local currency and, accordingly, gains and losses from the translation of
the local foreign currency financial statements are included as a component of
"accumulated other comprehensive loss" in the accompanying consolidated balance
sheets. Foreign currency assets and liabilities are translated into U.S. dollars
at the end-of-period exchange rates except for long-term assets and liabilities,
which are translated at historical exchange rates. Revenues and expenses are
translated at the average exchange rates in effect during each period except for
those expenses related to balance sheet amounts which are translated at
historical exchange rates.
Net foreign currency transaction gains and losses are included in "Interest
income and other income (expense), net" in the accompanying consolidated
statements of operations. Foreign currency transaction gains in 2004, 2003 and
2002 were insignificant.
F-13
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Income Taxes
Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax bases of assets and
liabilities and their financial statement reported amounts and for tax loss and
credit carryforwards. A valuation allowance is provided against deferred tax
assets when it is determined to be more likely than not that the deferred tax
asset will not be realized.
Line of Credit Agreement
In July 2002, the Company negotiated a Line of Credit ("Line") agreement
with Cornell Capital Partners, LP, expiring two years from the effective date of
the related registration statement (i.e. February 14, 2005). Under the terms of
the Line and the registration statement the Company could periodically issue and
sell shares of its common stock and/or borrow funds up to an aggregate amount of
$15,000, subject to the number of shares available for issuance and the purchase
price of such shares. As of December 31, 2004, the Company had received $2,750
gross ($2,280 net of related costs) for approximately 9,754 shares.
When the Company requests an advance under the Line of Credit, Cornell
Capital Partners, L.P. will purchase shares of common stock of the Company for
100% of the "Market Price" of its stock (less a 6.5% advance fee). Market Price
is defined as the volume weighted average price of the Company's common stock as
reported by Bloomberg, LP, calculated based upon the trading price of the
Company's common stock over the five trading days after the Company requests an
advance. The maximum amount of each advance was limited to $1,000 in any 30-day
period. In addition, in no event would the number of shares issuable to Cornell
Capital Partners, LP cause Cornell to own in excess of 9.9% of the then
outstanding shares of the Company's common stock. On each advance date, the
Company paid to Cornell Capital Partners, L.P. an advance fee equal to 6.5% of
the amount of each advance. Closing was held six (6) trading days after such
written notice, at which time the Company delivered shares of common stock and
paid Cornell Capital Partners, L.P. the advance amount. Cornell Capital
Partners, L.P. cannot transfer its interest in the Line of Credit to any other
person and cannot engage in short sales of shares of common stock acquired under
the Line of Credit.
Pursuant to the terms of the Note and Warrant Purchase Agreement (the
"Purchase Agreement" see Note 6) the Line of Credit agreement was terminated in
December 2004.
Recent Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). FIN 46 changes the criteria by which one
company includes another entity in its consolidated financial statements.
Previously, the criteria were based on control through voting interest. FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. A company that consolidates a variable interest entity is
called the primary beneficiary of that entity. The consolidation requirements of
FIN 46 apply immediately to variable interest entities created after January 31,
2003. The consolidation requirements apply to older entities in the first fiscal
year or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established.
During October 2003, the FASB deferred the effective date for applying the
provisions of FIN 46 until the end of the first interim or annual period ending
after December 31, 2003 if the variable interest was created prior to February
1, 2003 and the public entity has not issued financial statements reporting that
variable interest entity in accordance with FIN 46.
F-14
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Recent Pronouncements
In December 2003 the FASB concluded to revise certain elements of FIN 46,
primarily to clarify the required accounting for interests in variable interest
entities. FIN-46R replaces FIN-46, that was issued in January 2003. FIN-46R
exempts certain entities from its requirements and provides for special
effective dates for entities that have fully or partially applied FIN-46 as of
December 24, 2003. In certain situations, entities have the option of applying
or continuing to apply FIN-46 for a short period of time before applying
FIN-46R. In general, for all entities that were previously considered special
purpose entities, FIN 46R should be applied in periods ending after December 15,
2003. Otherwise, FIN 46R is to be applied for registrants who file under
Regulation SX in periods ending after March 15, 2004, and for registrants who
file under Regulation SB, in periods ending after December 15, 2004. The Company
has adopted FIN 46R and the effect of the adoption will not have a significant
impact on the Company's financial position or results of operations.
In December 2003, the Staff of the Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," which
supersedes SAB No. 101, "Revenue Recognition in Financial Statements." The
primary purpose of SAB No. 104 is to rescind accounting guidance contained in
SAB No. 101 and the SEC's "Revenue Recognition in Financial Statements
Frequently Asked Questions and Answers" related to multiple element revenue
arrangements. The adoption of SAB No. 104 did not significantly impact the
Company's revenue recognition policies.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4". The amendments made by Statement 151
clarify that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current period charges
and require the allocation of fixed production overheads to inventory based on
the normal capacity of the production facilities. The guidance is effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Earlier application is permitted for inventory costs incurred during fiscal
years beginning after November 23, 2004. The Company has evaluated the impact of
the adoption of SFAS 151, and does not believe the impact will be significant to
the Company's overall results of operations or financial position.
In December 2004, the FASB issued SFAS No.153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions." The amendments made by Statement 153 are based on the principle
that exchanges of nonmonetary assets should be measured based on the fair value
of the assets exchanged. Further, the amendments eliminate the narrow exception
for nonmonetary exchanges of similar productive assets and replace it with a
broader exception for exchanges of nonmonetary assets that do not have
commercial substance. Previously, Opinion 29 required that the accounting for an
exchange of a productive asset for a similar productive asset or an equivalent
interest in the same or similar productive asset should be based on the recorded
amount of the asset relinquished. Opinion 29 provided an exception to its basic
measurement principle (fair value) for exchanges of similar productive assets.
The Board believes that exception required that some nonmonetary exchanges,
although commercially substantive, be recorded on a carryover basis. By focusing
the exception on exchanges that lack commercial substance, the Board believes
this Statement produces financial reporting that more faithfully represents the
economics of the transactions. The Statement is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier
application is permitted for nonmonetary asset exchanges occurring in fiscal
periods beginning after the date of issuance. The provisions of this Statement
shall be applied prospectively. The Company has evaluated the impact of the
adoption of SFAS 153, and does not believe the impact will be significant to the
Company's overall results of operations or financial position.
In December 2004, the FASB issued SFAS No.123 (revised 2004), "Share-Based
Payment". Statement 123(R) will provide investors and other users of financial
statements with more complete and neutral financial information by requiring
that the compensation cost relating to share-based payment transactions be
recognized in financial statements.
F-15
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
1. Nature of Business, Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Recent Pronouncements
That cost will be measured based on the fair value of the equity or
liability instruments issued. Statement 123(R) covers a wide range of
share-based compensation arrangements including share options, restricted share
plans, performance- based awards, share appreciation rights, and employee share
purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for
Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. Statement 123, as originally issued in 1995,
established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in Opinion 25,
as long as the footnotes to financial statements disclosed what net income would
have been had the preferable fair-value-based method been used. Public entities
(other than those filing as small business issuers) will be required to apply
Statement 123(R) as of the first interim or annual reporting period that begins
after June 15, 2005. The Company is still evaluating the transition provisions
allowed by SFAS 123(R) and the impact of the adoption of the Statement.
In December 2004 the Financial Accounting Standards Board issued two FASB
Staff Positions - FSP FAS 109-1, Application of FASB Statement No. 109
"Accounting for Income Taxes" to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004, and FSP FAS
109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004. Neither of these
affected the Company as it does not participate in the related activities.
2. Chinese Joint Venture
The Company currently owns 90% of a joint venture (the "Joint Venture")
with the Jiangsu Hongtu Electronics Group, a provincial agency of the People's
Republic of China (the "Agency"). In June 1998, the registered capital of the
Joint Venture was reduced from $10,000 to $2,550. As of December 31, 2004, the
Company had contributed an aggregate of $1,800 in cash to the Joint Venture and
provided it with non-exclusive licenses to technologies and certain distribution
rights and the Agency had contributed certain land use rights. Following the
reduction in registered capital of the Joint Venture, neither the Company nor
the Agency is required to make further contributions to the Joint Venture. Prior
to the reduction in the amount of registered capital, the Joint Venture was
subject to the annual licensing requirements of the Chinese government.
Concurrent with the reduction in registered capital, the Joint Venture's
business license has been renewed through October 18, 2043.
3. Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). The Company adopted SFAS 130 effective January 1, 1998. SFAS 130 requires
that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual statement that is displayed with
the same prominence as other annual financial statements. SFAS 130 also requires
that an entity classify items as other comprehensive earnings by their nature in
an annual financial statement. For example, other comprehensive earnings may
include foreign currency translation adjustments, minimum pension liability
adjustments, and unrealized gains and losses on marketable securities classified
as available-for-sale.
4. Short-term Debt - Other
On April 20, 2004, the Company's 90% owned Joint Venture borrowed the
aggregate equivalent of $36, denominated in Chinese currency, from a Chinese
bank. The unsecured loan bears interest at 5.3% per annum and is due April 20,
2005. The borrowing did not require the Joint Venture to deposit a compensating
balance. The note can be repaid at any time without penalty.
F-16
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
4. Short-term Debt - Other (continued)
On December 19, 2003, the Company borrowed $750 from Cornell Capital
Partners, LP. The proceeds of the loan were used for working capital purposes.
The loan was secured by 4,621 shares of the Company's common stock held in
escrow. The promissory note was due and payable in seven installments,
commencing January 19, 2004 and ending on March 1, 2004, and could have been
paid in cash or shares of the Company's common stock. The Company exercised its
option, provided in the note, to delay the commencement of the installment
payments by paying the 2% fee, which was $38 in the aggregate. The Company
repaid the $750 loan through the issuance of 1,133 shares of common stock in the
quarter ended June 2004. The Company wrote off approximately $60 in unamortized
deferred financing costs associated with the $750 loan against equity.
On August 4, 2004 the Company borrowed an additional $3,500 from Cornell,
the proceeds of which were used to extinguish short-term debt with a related
party. See Note 5, "Short-term debt - related party". The Cornell short-term
debt was subject to lock-up fees of 1% and would accrue interest at the rate of
5% per annum on any unpaid balance remaining after the due date. The short-term
debt was scheduled to be paid, in ten equal installments with the first
installment due December 6, 2004 and the last on February 7, 2005. The Company
had the option to repay the note in cash or by issuing shares of the Company's
common stock. The Cornell debt was repaid in full, in cash, on November 8, 2004.
5. Short-term and Long-term Debt - Related Party
Short-term debt - related party
On June 19, 2001, the Company consummated a three-year $3,000 financing
(the "Loan") with a charitable remainder annuity trust of which a former
director and officer of the Company is a trustee (the "Trust"). The proceeds of
the Loan were used to refinance $1,500 of indebtedness outstanding to the Trust
pursuant to a loan made by the Trust to the Company in October 1999, and for
working capital purposes. The Loan bore interest at the rate of 2% over the
prime rate publicly announced by Citibank N.A. from time to time, and was due
June 18, 2004. The Company received a sixty day extension to pay the $3,000 Loan
to the Trust in exchange for thirty days worth of interest ($15) calculated
according to the terms of the note. The extended due date was August 18, 2004.
All other provisions of the Loan remained unchanged.
On August 5, 2004, CIC paid the $3,000 note due August 18, 2004, to the
Trust. The funds to retire the debt were obtained from Cornell on August 4,
2004, (See Note 4 - "Short-term Debt - Other").
Long-term debt - related party
In June 2003 the Company's Joint Venture borrowed from one of its
directors, Tong Ming Sheng, approximately $24 denominated in U. S. dollars to
purchase a replacement van used in the Company's operations. The note bears
interest at the rate of 5% per annum, and is due in June 2006. Principal
payments on long term debt are $8, and $5 for the years ending December 31,
2005, and 2006, respectively.
In 2002, $16 in consulting fees, including office expenses, were paid to a
party who, at that time, was the Chairman of the Board.
The weighted average interest rate was 6.0%, 6.8%, and 6.8% for the years
ended December 31, 2004, 2003, and 2002, respectively.
Interest expense for the years ended December 31, 2004, 2003, and 2002 was
$701, $205 and $205, respectively. Interest expense associated with related
party debt was $123, $183, and $200 for the years ended December 31, 2004, 2003
and 2002, respectively.
F-17
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
6. Convertible Notes
In November 2004, the Company entered into a unsecured Note and Warrant
Purchase Agreement (the "Purchase Agreement") and a Registration Rights
Agreement (the "Registration Rights Agreement, each dated as of October 28,
2004). The financing, a combination of debt and equity, closed November 2, 2004.
The proceeds to the Company were approximately $3,885, net of $310 in
commissions and legal expenses. H.C. Wainwright & Co., Inc. ("Wainwright") acted
as placement agent. As placement agent for the Company, at closing Wainwright
received $731 in commissions, legal fees and warrants. The commissions of
approximately $285 and legal fees of $25, mentioned above, were paid in cash.
The Company issued warrants to Wainwright to acquire 1,218 shares of the
Company's common stock. Of the warrants issued, 870 are exercisable at $0.462
and 348 are exercisable at $0.508. The Company has ascribed the value of $421 to
the Wainwright warrants, which is recorded as deferred financing costs in the
balance sheet at December 31, 2004. The fair value ascribed to the Wainwright
warrants was estimated on the commitment date using the Black-Scholes pricing
model with the following assumptions: risk-free interest rate of 3.21%; expected
life of 3 years; expected volatility of 100%; and expected dividend yield of 0%.
The Company expects to use the proceeds of the financing for additional working
capital.
Under the terms of the financing, the Company issued to certain accredited
investors convertible promissory notes in the aggregate principal amount of
$4,195 and warrants to acquire 3,632 shares of the Company's common stock at an
exercise price of $0.508 per share. The notes accrue interest at the rate of 7%
per annum, payable semi-annually, and are convertible into shares of the
Company's common stock at the rate of $0.462 per share. The Company has ascribed
a value of $982 to the investor warrants, which is recorded as a discount to
notes payable in the balance sheet at December 31, 2004. The fair value ascribed
to the warrants was estimated on the commitment date using the Black-Scholes
pricing model with the following assumptions: risk-free interest rate of 3.21%;
expected life of 3 years; expected volatility of 100%; and expected dividend
yield of 0%. In addition to the fair value ascribed to the warrants, the Company
has ascribed $1,569 to the beneficial conversion feature in the convertible
notes, which is recorded as a discount to notes payable in the balance sheet at
December 31, 2004. The values ascribe to the warrants and beneficial conversion
feature follow the guidance of the EITF Issue No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios", and ETIF Issue No. 00-27, "Application of Issue
No. 98-5 to Certain Convertible Instruments" of the FASB's Emerging Issues Task
Force. The fair value of the warrants and beneficial conversion feature is
amortized to expense over the life of the convertible notes or upon earlier
conversion using the effective interest method. As of December 31, 2004, the
Company had amortized to interest expense approximately $187 of the loan
discount and deferred financing costs. The balance due under the convertible
notes is shown net of the remaining unamortized discount on the accompanying
consolidated balance sheet. If the aggregate principal amount owing under the
notes is converted, the Company will issue 9,080, shares of its common stock. If
the notes are not converted, all principal and accrued but unpaid interest will
be due October 28, 2007. The Company may pay accrued interest in cash or in
shares of Company common stock, issued at the market price for the common stock
calculated prior to the interest payment. The Company does not currently intend
to pay accrued interest with shares of its common stock.
The above warrants expire on October 28, 2009. The Company may call the
warrants if the Company's common stock trades at $1.00 or above for 20
consecutive trading days after the date that is 20 days following the
effectiveness of a registration statement providing for the resale of the shares
issued upon the conversion of the notes and exercise of the warrants. Wainwright
will be paid approximately $28 in the aggregate if all of the investor warrants
are exercised. The Company will receive proceeds of approximately $1,845 if all
of the warrants are exercised.
The Company also was required to file a registration statement providing
for the resale of the shares that are issuable upon the conversion of the notes
and the exercise of the warrants. The registration statement was filed on
December 22, 2004 and was declared effective on January 26, 2005.
F-18
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
7. Stockholders' Equity
Common Stock Options
In 1994, the Company adopted the 1994 Stock Option Plan (the "1994 Plan").
Under the 1994 Plan, directors, officers and employees are eligible for grants
of incentive and non-qualified stock options. In May 1997, the stockholders
approved an increase of 1,000 shares to the number of shares authorized for
issuance under the 1994 Plan. Accordingly, a total of 6,000 shares of Common
Stock are authorized for issuance under the 1994 Plan. The exercise prices of
options under the 1994 Plan are determined by a committee of the Board of
Directors, but, in the case of an incentive stock option, the exercise price may
not be less than 100% of the fair market value of the underlying Common Stock on
the date of grant. Non-qualified options may not have an exercise price of less
than 85% of the fair market value of the underlying Common Stock on the date of
grant. Options under the 1994 Plan are generally exercisable over a period not
to exceed seven years and vest quarterly over three years. At December 31, 2004,
there were no options available for grant under the 1994 Plan. As of December
31, 2004, 809 plan options were outstanding and exercisable with a weighted
average exercise price of $0.83 per share.
The Company has issued non-plan options to its employees and directors. The
non-plan options vest over four years or prorata quarterly over three years. For
those non-plan options which vest over four years, 20% of the total non-plan
options granted vest on the first anniversary of the date of grant and an
additional 20%, 20%, and 40% of the total non-plan options granted vest on the
second, third, and fourth anniversaries of the date of grant, respectively.
Non-plan options are generally exercisable over a period not to exceed seven
years. As of December 31, 2004, 2,488 non-plan options were outstanding and
exercisable with a weighted average exercise price of $0.75 per share.
In June 1999, the Company adopted and the shareholders approved a stock
option plan (the "1999 Plan"). Incentive and non-qualified options under the
1999 Plan may be granted to employees, officers, and consultants of the Company.
There are 4,000 shares of Common Stock authorized for issuance under the 1999
Plan. The options generally have a seven year life and generally vest quarterly
over three years. At December 31, 2004, there were 1,444 shares available for
future grants. As of December 31, 2004, 2,418 plan options were outstanding and
1,318 plan options were exercisable with a weighted average exercise price of
$0.71 per share.
Information with respect to the Company's 1994 Plan and the 1999 Plan is
summarized below:
Year Ended December 31,
--------------------------------------------
2004 2003
--------------------- ---------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
--------------------------------------------
Outstanding at beginning
of period........................... 2,796 $0.70 3,337 $1.26
Granted.............................. 1,334 $0.53 858 $0.32
Exercised............................ (70) $0.33 - $0.00
Forfeited............................ (833) $0.36 (1,399) $1.83
------- --------
Outstanding at period end............ 3,227 $0.67 2,796 $0.71
======= ========
Options exercisable at
period end.......................... 2,127 $0.75 2,083 $0.81
======= ========
Weighted average grant-date
fair value ofoptions granted
during the period..... $0.29 $0.27
======= ========
F-19
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
7. Stockholders' Equity (continued)
Common Stock Options
The following table summarizes information about stock options outstanding under
the 1994 Plan and the 1999 Plan at December 31, 2004:
Weighted Average
--------------------------
Remaining
Options Contractual
Range of Exercise Prices Outstanding Life (Years) Exercise Price
- -------------------------------------------------------------------------------
$0.00 - $0.50................ 1,016 5.4 $0.39
$0.51 - $2.00................ 2,191 3.6 $0.77
$2.01 - $2.99................ - - $ -
$3.00 - $7.50................ 20 4.6 $3.50
--------------
3,227
==============
The following table summarizes information about stock options exercisable
under the 1994 Plan and the 1999 Plan at December 31, 2004:
Weighted
Options Average
Range of Exercise Prices Exercisable Exercise Price
- --------------------------------------------------------------- ----------------
$0.00 - $0.50............................. 388 $0.34
$0.51 - $2.00............................. 1,718 $0.81
$2.01 - $2.99............................. - $ -
$3.00 - $7.50............................. 21 $3.50
---------------
2,127
===============
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") as amended by Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosures-an Amendment
of FASB Statement No. 123". The Company has elected to continue to use the
intrinsic value based method of Accounting Principles Board Opinion.
F-20
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
7. Stockholders' Equity (continued)
Common Stock Options
No. 25, as allowed under SFAS 123, to account for its employee stock-based
compensation plans. The Company complies with the disclosure provisions of SFAS
123.
Had compensation cost for the Company's option plans been determined based
on the fair value of the options at the date of grant, as prescribed by SFAS
123, the Company's net income (loss) available to common stockholders and basic
and diluted net income (loss) per share available to stockholders would have
been as follows for the year ended December 31:
2004 2003 2002
-------------------------------------
Net income (loss) as reported............ $ 1,620 $(2,345) $(3,561)
Add: Stock-based employee compensation
expense included in reported results of
operations, net of related tax effects.... - - -
Deduct: Total stock-based employee
compensation expense determined under
fair value-based method for all
awards, net of related tax effects........ (248) (380) (795)
-------------------------------------
Pro forma net income (loss).............. $ 1,372 $ (2,725) $ (4,356)
=====================================
Basic and diluted net income (loss) per
share available to stockholders:
As reported.............................. $ 0.02 $ (0.02) $ (0.04)
Pro forma................................ $ 0.01 $ (0.03) $ (0.05)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants during the applicable periods: risk-free interest
rate of 3.65% for 2004, 2.37% for 2003, and 2.26% for 2002, an expected life of
5.61 years for 2004, 6.65 years for 2003, and 8.66 years for 2002; expected
volatility of 51.6% for 2004 and 100% for 2003 and 2002, and a dividend yield of
0% for all periods.
The Company expects to make additional option grants. The Company believes
the above pro forma disclosures may not be representative of the pro forma
effects on reported results of operations to be expected in future periods due
to changes in interest rates, expected lives of current and future option grants
and changes in the volatility of the price of the Company's common stock in the
market.
As of December 31, 2004, 5,716 shares of Common Stock were reserved for
issuance upon exercise of outstanding options.
Warrants
At December 31, 2004, 4,850 shares of Common stock were reserved for
issuance upon exercise of outstanding warrants.
8. Commitments
Lease Commitments
The Company currently leases 9,634 square feet, its principal facilities,
(the "Principal Offices) in Redwood Shores, California, pursuant to a sublease
that expires in 2006. In addition, the Company subleased to third parties
certain space adjacent to the Principal Offices through August 2001. The Joint
Venture leases approximately 1,500 square feet in Nanjing, China. In addition to
monthly rent, the U.S. facilities are subject to additional rental payments for
utilities and other costs above the base amount. Facilities rent expense was
approximately $443, $450, and $418, in 2004, 2003, and 2002, respectively.
F-21
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
8. Commitments (continued)
Lease Commitments
Future minimum lease payments under noncancelable operating leases are
approximately $380, and $358 for the years ending December 31, 2005, and 2006,
respectively.
Future minimum payments required under capital leases, which expire in
2007, were insignificant at December 31, 2004.
9. Income Taxes
As of December 31, 2004, the Company had federal net operating loss
carryforwards available to reduce taxable income through 2014 of approximately
$67,133. The Company also had federal research and investment tax credit
carryforwards of approximately $315 that expire at various dates through 2012.
Deferred tax assets and liabilities at December 31, consist of the
following:
2004 2003
----------------------------
Deferred tax assets:
Net operating loss carryforwards.................. $ 26,853 $ 27,785
Credit carryforwards.............................. 356 315
Deferred income................................... 183 67
Other, net........................................ 875 933
----------------------------
Total deferred tax assets......................... 28,267 29,100
Valuation allowance............................... (28,267) (29,100)
----------------------------
Net deferred tax assets........................... $ - $ -
============================
Income tax (benefit) differs from the expected statutory rate as follows:
2004 2003 2002
---------- ---------- ---------
Expected income tax cost (benefit) $ 668 $ (799) $ (1,211)
State income tax net of Federal (89) (144) (214)
benefit
Loss write off of foreign investment - - (4,357)
Expired net operating loss 254
---------- --------- ---------
Change in valuation allowance (833) 943 5,782
---------- --------- ---------
Income tax expense (benefit) $ - $ - $ -
========== ========= =========
A full valuation allowance has been established for the Company's net
deferred tax assets since the realization of such assets through the generation
of future taxable income is uncertain.
Under the Tax Reform Act of 1986, the amounts of, and the benefit from, net
operating losses and tax credit carryforwards may be impaired or limited in
certain circumstances. These circumstances include, but are not limited to, a
cumulative stock ownership change of greater than 50%, as defined, over a
three-year period. During 1997, the Company experienced stock ownership changes
which could limit the utilization of its net operating loss and research and
investment tax credit carryforwards in future periods.
F-22
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
10. Segment Information
Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information" ("SFAS 131") establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company's information has been stratified into two
segments - Handwriting Recognition Software and Systems Integration.
The accounting policies followed by the segments are the same as those
described in the "Summary of Significant Accounting Policies." Segment data
includes revenues, as well as allocated corporate-headquarter costs charged to
each of the operating segments.
The Company identifies reportable segments by classifying revenues into two
categories: Handwriting Recognition and System Integration. Handwriting
recognition software is an aggregate of three revenue categories, OEM,
Enterprise and Online sales. All handwriting recognition software is developed
around the Company's core technology. System integration represents the sale and
installation of third party computer equipment and systems that utilize the
Company's products. All sales below represent sales to external customers.
The table below presents information about reporting segments for the years
ended December 31:
Handwriting Systems
Recognition Integration Total
----------------- ---------------- ---------------
2004 Revenues $ 7,247 $ 37 $ 7,284
Income (loss) from
operations $ 2,600 $ (345) $ 2,255
Total assets $ 9,899 $ 920 $ 10,819
Depreciation and
amortization $ 424 $ 18 $ 442
2003 Revenues $ 2,322 $ 712 $ 3,034
Loss from operations $ (2,106) $ (51) $ (2,157)
Total assets $ 6,294 $ 921 $ 7,215
Depreciation and
amortization $ 438 $ 18 $ 456
2002 Revenues $ 2,214 $ 1,015 $ 3,272
Loss from operations $ (3,307) $ (30) $ (3,337)
Total assets $ 6,181 $ 1,005 $ 7,186
Depreciation and
amortization $ 450 $ 17 $ 467
The following table represents revenues and long-lived asset information by
geographic location for the period ended December 31:
Revenues Long Lived Assets
----------------------------- ------------------------------
2004 2003 2002 2004 2003 2002
--------- -------- ---------- ---------- ---------- ---------
U.S. $ 7,127 $ 2,003 $ 2,018 $ 4,773 $ 5109 $ 5,549
China 157 1,031 1,254 45 71 31
--------- --------- --------- ---------- ---------- ---------
Total $ 7,284 $ 3,034 $ 3,272 $ 4,818 $ 5,180 $ 5,580
========= ========= ========= ========== ========== =========
F-23
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
10. Segment Information (continued)
Interest expense is related solely to Handwriting recognition segment and
was $701, $205, and $205, for the years ended December 31, 2004, 2003, and 2002,
respectively. Included in interest expense for the year ended December 31, 2004
is approximately $187 in warrant and beneficial conversion feature expense and
amortization of deferred financing costs associated with the convertible notes.
The Company's export sales from U.S. operations were less than one percent
in 2004. The Company's export sales from U.S. operations were 14%, and 12%, of
revenues in 2003, and 2002, respectively.
11. Statement of Cash Flows Data
December 31,
-------------------------------------
2004 2003 2002
Schedule of non-cash transactions:
Inventory reserve provision................ $ - $ 38 $ -
Non-cash compensation...................... $ 70 $ 70 $ -
Common stock issued upon the conversion
of short term debt net ................... $ 691 $ - $ -
Deferred financing costs associated
with convertible notes.................... $ 714 $ - $ -
Loan discount associated with convertible
notes net of amortization................. $ 2,409 $ - $ -
Supplemental disclosure of cash flow information:
Interest paid in 2004, 2003, and 2002 was $509, $209, and $212,
respectively.
12. Employee Benefit Plans
The Company sponsors a 401(k) defined contribution plan covering all
employees meeting certain eligibility requirements. Contributions made by the
Company are determined annually by the Board of Directors. To date, the Company
has made no contributions to this plan.
13. Quarterly information (Unaudited)
The summarized quarterly financial data presented below, in the opinion of
Management, reflects all adjustments which are of a normal and recurring nature
necessary to present fairly the results of operations for the periods presented.
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- -------- -------- -------- -------
2004 Unaudited
Net sales $ 2,429 $ 630 $3,669 $ 556 $ 7,284
Gross profit $ 2,396 $ 619 $3,663 $ 553 $ 7,231
Income (loss) before income
taxes, and minority interest $ 1,167 $ (678) $2,138 $ (1,026) $ 1,601
Net income (loss) $ 1,167 $ (678) $2,145 $ (1,014) $ 1,620
Basic and diluted income
(loss)per share $ 0.01 $(0.01) $ 0.02 $ (0.01) $ 0.02
F-24
Communication Intelligence Corporation
Notes to Consolidated Financial Statements
(In thousands)
13. Quarterly information (Unaudited) (continued)
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- -------- -------- -------- -------
2003 Unaudited
Net sales $ 1,108 $ 572 $ 936 $ 418 $ 3,034
Gross profit $ 875 $ 450 $ 704 $ 240 $ 2,269
Loss before income
taxes, andminority interest
$ (310) $ (693) $ (470) $ (888) $(2,361)
Net loss $ (310) $ (690) $ (472) $ (873) $(2,345)
Basic and diluted
loss per share $ (0.01) $(0.01) $(0.01) $ (0.01) $ (0.02)
2002 Unaudited
Net sales $ 1,157 $1,111 $ 525 $ 479 $ 3,272
Gross profit $ 716 $ 808 $ 321 $ 270 $ 2,115
Loss before income taxes,
and minority interest $ (688) $ (670) $(1,068) $(1,133) $(3,559)
Net loss $(688) $ (671) $(1,070) $(1,132) $(3,561)
Basic and diluted
loss per share $(0.01) $(0.01) $(0.01) $ (0.01) $(0.04)
14. Subsequent Events
Legal Proceedings
In February of 2005, Valyd, Inc. filed a complaint against the Company
seeking a declaratory judgment that Valyd is not infringing certain of the
Company's patents, that such patents are invalid or unenforceable, and that the
Company tortiously interfered with a contract between Valyd, Inc. and Interlink
Electronics, Inc. by delivering an infringement notice to Interlink Electronics,
Inc. The complaint also alleged unfair competition under California law. No
specific monetary claim is set forth in the complaint. The Company believes that
the complaint is without merit and intends to vigorously defend against the
claims. On March 3, 2005, the Company responded to the complaint, denying all
allegations, and filed counterclaims against Valyd, Inc. The counterclaim
asserted that Valyd, Inc. is infringing certain of the Company's patents and
asked for treble damages, alleging that the infringement is willful, deliberate
and in conscious disregard of CIC's rights. The ultimate outcome of this
litigation cannot presently be determined. However, in management's opinion, the
likelihood of a material adverse outcome is remote and any liability that might
be incurred would not have a material adverse effect on the Company's financial
position or its results of operations. Accordingly, adjustments, if any that
might result from the resolution of this matter have not been reflected in the
financial statements.
F-25
SCHEDULE II
Communication Intelligence Corporation
Valuation and Qualifying Accounts and Reserves
(In thousands)
Years Ended December 31, 2002, 2003, and 2004
Balance Charged to Balance
At Beginning Costs and At End
Of Period Expense Deductions Of Period
------------ -------- ---------- ---------
Year ended December 31, 2002:
Accounts receivable reserves.... $278 $129 $ (164) $243
Year ended December 31, 2003:
Accounts receivable reserves..... $243 $25 $ (12) $256
Year ended December 31, 2004:
Accounts receivable reserves..... $256 $234 $ (86) $404
S-1