U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
-------------
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended April 30, 2004
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____ to ____
Commission File No. 000-24996
INTERNET COMMERCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-3645702
(State of incorporation) (I.R.S. Employer Identification Number)
805 Third Avenue, 9th Floor
New York, New York 10022
(Address of principal executive offices, including zip code)
(212) 271-7640
(Registrant's telephone number, including area code)
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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of June 14, 2004 the registrant had outstanding 17,096,344 shares of
Class A Common Stock.
INTERNET COMMERCE CORPORATION
INDEX TO FORM 10-Q
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets as of April 30, 2004 (unaudited)
and July 31, 2003.................................................. 3
Consolidated statements of operations and comprehensive
loss for the three and nine months ended April 30, 2004
(unaudited) and April 30, 2003 (unaudited)......................... 4
Consolidated statements of cash flows for the nine months
ended April 30, 2004 (unaudited) and April 30, 2003 (unaudited).... 5
Notes to consolidated financial statements (unaudited)............... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 35
Item 4. Controls and Procedures......................................... 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................... 36
Item 2. Changes in Securities and Use of Proceeds....................... 36
Item 3. Defaults Upon Senior Securities................................. 36
Item 4. Submission of Matters to a Vote of Security Holders............. 36
Item 5. Other Information............................................... 36
Item 6. Exhibits and Reports on Form 8-K ............................... 36
SIGNATURES
CERTIFICATIONS
2
INTERNET COMMERCE CORPORATION
Consolidated Balance Sheets
April 30, July 31,
2004 2003
------------ -----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 4,988,574 $ 2,283,339
Marketable securities -- 91,941
Accounts receivable, net of allowance for doubtful
accounts of $144,218 and $220,281, respectively 1,756,878 1,732,890
Prepaid expenses and other current assets 388,462 295,474
------------ ------------
Total current assets 7,133,914 4,403,644
Restricted cash 117,392 128,607
Property and equipment, net 303,346 556,812
Capitalized software development costs, net 31,256 127,841
Goodwill 1,211,925 1,211,925
Other intangible assets, net 1,434,000 2,151,000
Other assets 14,237 18,507
------------ ------------
Total assets $ 10,246,070 $ 8,598,336
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 521,326 $ 918,337
Accrued expenses 731,299 1,178,880
Accrued dividends - preferred stock 132,240 231,726
Short-term debt 646,922 --
Deferred revenue 31,810 96,952
Capital lease obligation 87,839 148,189
Other liabilities 45,164 129,985
------------ ------------
Total current liabilities 2,196,600 2,704,069
Capital lease obligation - less current portion 6,504 46,120
Other non-current liabilities -- 8,011
------------ ------------
Total liabilities 2,203,104 2,758,200
------------ ------------
Commitments and contingencies
Stockholders' Equity:
Preferred stock - 5,000,000 shares authorized,
including 10,000 shares of series A, 10,000 shares
of series C, 250 shares of series D and 175 shares of
series S:
Series A preferred stock - par value $.01 per share,
none issued and outstanding -- --
Series C preferred stock - par value $.01 per share,
44.76 votes per share; 10,000 shares issued and
outstanding (liquidation value of $10,132,340) 100 100
Series D preferred stock - par value $.01 per share,
769 votes per share; 250 shares issued and
outstanding (liquidation value of $250,000) 3 3
Common stock:
Class A - par value $.01 per share, 40,000,000
shares authorized, one vote per share; 17,096,344
and 13,797,566 shares issued and outstanding,
respectively 170,963 137,976
Additional paid-in capital 92,667,269 87,489,583
Accumulated deficit (84,795,369) (81,813,191)
Accumulated other comprehensive income -- 25,665
------------ ------------
Total stockholders' equity 8,042,966 5,840,136
------------ ------------
Total liabilities and stockholders' equity $ 10,246,070 $ 8,598,336
============ ============
See notes to consolidated financial statements.
3
INTERNET COMMERCE CORPORATION
Consolidated Statements of Operations and Comprehensive Loss (unaudited)
Three Months Ended Nine Months Ended
April 30, April 30,
------------------------------------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenue:
Services $ 2,892,390 $ 3,094,232 $ 8,751,474 $ 8,981,414
------------ ------------ ------------ ------------
Expenses:
Cost of services (excluding non-cash compensation
of $15,952 and $35,022 for the three and nine
months ended April 30, 2004, respectively) 1,561,756 1,920,077 5,173,050 5,727,615
Impairment of capitalized software development costs -- 133,960 44,983 133,960
Impairment of software inventory -- -- -- 248,077
Product development and enhancement (excluding non-cash
compensation of $6,638 and $118,278 for the three and
nine months ended April 30, 2004, respectively) 233,635 273,365 685,639 829,153
Selling and marketing (excluding non-cash compensation of
$16,739 and $92,154 for the three and nine months ended
April 30, 2004, respectively) 733,752 734,414 2,371,330 2,320,031
General and administrative (excluding non-cash compensation
of $72,610 and $392,571 for the three and nine months
ended April 30, 2004, respectively, and $71,819 and
$82,235 for the three and nine months ended April 30,
2003, respectively) 892,873 1,028,297 2,842,886 3,233,785
Non-cash charges for stock-based compensation and services 111,939 71,819 638,025 82,235
------------ ------------ ------------ ------------
3,533,955 4,161,932 11,755,913 12,574,856
------------ ------------ ------------ ------------
Operating loss (641,565) (1,067,700) (3,004,439) (3,593,442)
------------ ------------ ------------ ------------
Other income and (expense):
Interest and investment income 926 429 2,330 9,618
Investment gain (loss) -- -- 67,834 (19,072)
Interest expense (20,718) (6,811) (47,756) (21,098)
Impairment of marketable securities -- -- -- (317,924)
Loss on sale of asset (147) -- (147) --
------------ ------------ ------------ ------------
(19,939) (6,382) 22,261 (348,476)
------------ ------------ ------------ ------------
Net loss $ (661,504) $ (1,074,082) $ (2,982,178) $ (3,941,918)
Dividends on preferred stock (98,361) (97,285) (300,515) (299,475)
Beneficial conversion feature related to series D
preferred stock -- (106,730) -- (106,730)
------------ ------------ ------------ ------------
Loss attributable to common stockholders $ (759,865) $ (1,278,097) $ (3,282,693) $ (4,348,123)
============ ============ ============ ============
Basic and diluted loss per common share $ (0.05) $ (0.11) $ (0.23) $ (0.37)
============ ============ ============ ============
Weighted average number of common shares outstanding -
basic and diluted 14,544,859 11,998,516 14,050,246 11,818,148
============ ============ ============ ============
COMPREHENSIVE LOSS:
Net loss $ (661,504) $ (1,074,082) $ (2,982,178) $ (3,941,918)
Other comprehensive income:
Unrealized gain - marketable securities -- 7,372 42,169 1,265
Reclassification for impairment of marketable securities -- -- -- 317,924
Reclassification of unrealized (gain) loss on marketable
securities -- -- (67,834) 19,072
------------ ------------ ------------ ------------
Comprehensive loss $ (661,504) $ (1,066,710) $ (3,007,843) $ (3,603,657)
============ ============ ============ ============
See notes to consolidated financial statements.
4
INTERNET COMMERCE CORPORATION
Consolidated Statements of Cash Flows (unaudited)
Nine Months Ended April 30,
-------------------------------
2004 2003
----------- ----------
Cash flows from operating activities:
Net loss $(2,982,178) $(3,941,918)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,097,198 1,263,595
Bad debt expense 4,761 4,794
Non-cash interest expense 25,535 --
Realized (gain) loss on sale of marketable
securities (67,834) 19,072
Impairment of capitalized software development
costs 44,983 133,960
Impairment of marketable securities -- 317,924
Impairment of software inventory -- 248,077
Non-cash charges for equity instruments
issued for compensation and services 638,025 82,235
Changes in:
Accounts receivable (28,749) 1,229,100
Prepaid expenses and other assets (82,205) (34,397)
Accounts payable (420,396) (236,220)
Accrued expenses (426,140) (507,142)
Deferred revenue (65,142) (56,496)
Other liabilities (92,832) (66,867)
----------- -----------
Net cash used in operating activities (2,354,974) (1,544,283)
----------- -----------
Cash flows from investing activities:
Capitalization of software development costs -- (16,333)
Purchases of property and equipment (60,013) (55,639)
Proceeds from sales of marketable securities 134,110 55,494
----------- -----------
Net cash provided by (used in)
investing activities 74,097 (16,478)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock
and warrants, net 4,467,803 1,454,348
Proceeds from issuance of preferred stock and
warrants, net -- 250,000
Borrowings under accounts receivable
financing agreement 2,339,467 --
Repayment of borrowings under accounts
receivable financing agreement (1,692,545) --
Subscription received for common stock and
warrants -- 195,497
Payments of capital lease obligations (115,082) (149,457)
Dividends paid on preferred stock (60,000) --
Proceeds from exercise of warrants 42,404 --
Proceeds from exercise of employee stock
options 4,065 --
----------- -----------
Net cash provided by financing
activities 4,986,112 1,750,388
----------- -----------
Net increase in cash and cash equivalents 2,705,235 189,627
Cash and cash equivalents, beginning of period 2,283,339 2,087,915
----------- -----------
Cash and cash equivalents, end of period $ 4,988,574 $ 2,277,542
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest during the period $ 17,740 $ 21,098
Issuance of common stock and warrants in
exchange for services -- 45,635
Noncash investing and financing activities:
Issuance of common stock for dividends on
preferred stock 340,000 400,000
Issuance of warrants in exchange for private
placement fees 225,905 71,504
See notes to consolidated financial statements.
5
INTERNET COMMERCE CORPORATION
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Internet
Commerce Corporation (the "Company" or "ICC") have been prepared in
accordance with accounting principles generally accepted in the United
States of America ("GAAP") for interim financial information. In the
opinion of management, such statements include all adjustments (consisting
only of normal recurring adjustments) necessary for the fair presentation
of the Company's financial position, results of operations and cash flows
at the dates and for the periods indicated. Pursuant to the requirements
of the Securities and Exchange Commission (the "SEC") applicable to
Quarterly Reports on Form 10-Q, the accompanying financial statements do
not include all the disclosures required by GAAP for annual financial
statements. While the Company believes that the disclosures presented are
adequate to make the information not misleading, these unaudited interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the
Company's Annual Report on Form 10-K for the year ended July 31, 2003.
Operating results for the three and nine-month periods ended April 30,
2004 are not necessarily indicative of the results that may be expected
for the fiscal year ending July 31, 2004.
2. ORGANIZATION AND NATURE OF BUSINESS
ICC provides Internet-based services for the e-commerce
business-to-business communication services market. ICC.NET, our global
Internet-based value added network, or VAN, provides supply chain
connectivity solutions for electronic data interchange, or EDI, and
e-commerce and offers users a vehicle to securely send and receive files
of any format and size.
The ICC.NET system uses the Internet and proprietary technology to deliver
the Company's customers' documents and data files to members of their
trading communities, many of which have incompatible systems, by
translating the documents and data files into any format required by the
receiver. The system can be accessed using a standard Web browser or
virtually any other communications protocol.
The Company has the capability to facilitate the development and operation
of comprehensive business-to-business electronic commerce solutions. The
Company can provide professional service electronic commerce solutions
involving EDI and EAI (Enterprise Application Integration) by providing
mission critical electronic commerce consulting, electronic commerce
software, outsourced electronic commerce services and technical resource
management.
ICC's capabilities also include an EDI service bureau, which provides EDI
services to small and mid-sized companies. The service bureau's services
include the conversion of electronic forms into hard copies and the
conversion of hard copies to an EDI format. The service bureau also
provides Universal Product Code ("UPC") services and maintains UPC
catalogs for its customers.
6
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES
Principles of consolidation:
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary. All significant intercompany transactions
have been eliminated in consolidation.
Revenue recognition:
The Company derives revenue from subscriptions to its ICC.NET service,
which includes transaction, mailbox and fax transmission fees. The
subscription fees are comprised of both fixed and usage-based fees. Fixed
subscription fees are recognized on a pro-rata basis over the subscription
period, generally three to six months. Usage fees are recognized in the
period the services are rendered. The Company also derives revenue through
implementation fees, interconnection fees and by providing data mapping
services to its customers. Implementation fees are recognized over the
life of the subscription period. Interconnection fees are fees charged to
connect to another VAN service and are recognized when the data is
transmitted to the connected service. Revenue from data mapping services
is recognized when the map has been completed and delivered to the
customer. The Company has a limited number of fixed fee data mapping
services contracts. Under these arrangements, the Company is required to
provide a specified number of maps for a fixed fee. Revenue from such
arrangements is recognized using the percentage-of-completion method of
accounting (see below).
Through January 2004, the Company provided a range of EDI and electronic
commerce consulting services and EDI education and training seminars
throughout the United States. Revenue from EDI and electronic commerce
consulting services and education and training seminars were recognized
when the services were provided. The Company discontinued its EDI
education and training seminars in January 2004. Revenues from our EDI
education and training seminars were immaterial in all periods presented.
Revenue from fixed fee data mapping and professional service contracts are
recognized using the percentage-of-completion method of accounting, as
prescribed by SOP 81-1 "Accounting for Performance of Construction-Type
and Certain Production-Type Contracts."
The percentage of completion for each contract is determined based on the
ratio of direct labor hours incurred to total estimated direct labor hours
required to complete the contract. The Company may periodically encounter
changes in estimated costs and other factors that may lead to a change in
the estimated profitability of a fixed-price contract. In such
circumstances, adjustments to cost and profitability estimates are made in
the period in which the underlying factors requiring such revisions become
known. If such revisions indicate a loss on a contract, the entire loss is
recorded at such time. Amounts billed in advance of services being
performed are recorded as deferred revenue. Certain fixed-fee contracts
may have substantive customer acceptance provisions. The acceptance terms
generally include a single review and revision cycle for each deliverable
to incorporate the customer's suggested or required modifications.
Deliverables are considered accepted upon completion of the review and
revision cycle and revenue is recognized upon that acceptance.
The Company also derives revenue from its Service Bureau. Service Bureau
revenue is comprised of EDI services, including data translation services,
purchase order and invoice processing from EDI-to-print and print-to-EDI,
UPC services, including UPC number generation, UPC catalog maintenance and
UPC label printing. The Service Bureau also derives revenue from software
licensing and provides software maintenance and support. Revenue from the
EDI services and UPC services is recognized when the services are
provided. The Company accounts for its EDI software license sales in
accordance with the American Institute of Certified Public Accountants'
Statement of Position 97-2, "Software Revenue Recognition," as amended
("SOP 97-2"). Revenue from software licenses is recognized when all of the
following conditions are met: (1) a non-cancelable, non-contingent license
agreement has been signed; (2) the software product has been delivered;
(3) there are no material uncertainties regarding customer acceptance; and
(4) collection of the resulting receivable is probable. Revenue from
software maintenance
7
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONTINUED)
and support contracts is recognized ratably over the life of the contract.
The Service Bureau's software license revenue was not significant in any
of the periods presented.
In addition, SOP 97-2 generally requires that revenue from software
arrangements involving multiple elements be allocated among each element
of the arrangement based on the relative fair values of the elements, such
as software licenses, post contract customer support, installation or
training. Furthermore, SOP 97-2 requires that revenue be recognized as
each element is delivered and the Company has no significant performance
obligations remaining. The Company's multiple element arrangements
generally consist of a software license and post contract support. The
Company allocates the aggregate revenue from multiple element arrangements
to each element based on vendor specific objective evidence. The Company
has established vendor specific objective evidence for each of the
elements as it sells both the software and post contract customer support
independent of multiple element agreements. Customers are charged standard
prices for the software and post contract customer support and these
prices do not vary from customer to customer.
If the Company enters into a multiple element agreement where vendor
specific objective evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred
until all elements of the arrangement are delivered.
Service revenue from maintenance contracts is recognized ratably over the
term of the maintenance contract, on a straight-line basis. Other service
revenue is recognized at the time the service is performed.
Deferred revenue:
Deferred revenue is comprised of deferrals for subscription fees,
professional services, license fees and maintenance associated with
contracts for which amounts have been received in advance of services to
be performed or prior to the shipment of software.
Stock-based Compensation:
In January 2004, the Company adopted the fair value provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). SFAS 123 established a
fair-value-based method of accounting for stock-based compensation plans.
Pursuant to the transition provisions of SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" (SFAS 148), the
Company has elected the prospective method and will apply the fair value
method of accounting to all equity instruments issued to employees on or
after August 1, 2003. The fair value method is not applied to stock option
awards granted in fiscal years prior to 2004. Such awards will continue to
be accounted for under the intrinsic value method pursuant to Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), except to the extent that prior years' awards are
modified subsequent to August 1, 2003. Option awards granted prior to
August 1, 2003 that have not been modified or settled continue to be
accounted for under the intrinsic value method of APB 25. Therefore, the
cost related to stock-based employee compensation included in the
determination of the net loss for 2004 is less than that which would have
been recognized if the fair value based method had been applied to all
awards since their date of grant. The following table illustrates the
effect on net loss and net loss per common share if the fair value based
method had been applied to all outstanding and unvested awards in each
period.
8
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONTINUED)
Three Months Ended Nine Months Ended
April 30, April 30,
---------------------------- ----------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Loss attributable to common
stockholders, as reported $ (759,865) $(1,278,097) $(3,282,693) $(4,348,123)
Add: Stock-based employee
compensation expense
included in reported net loss,
net of related tax effects 111,939 71,819 638,025 82,235
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects (145,642) (1,221,302) (919,556) (4,659,800)
----------- ----------- ----------- -----------
Pro forma loss attributable
to common stockholders $ (793,568) $(2,427,580) $(3,564,224) $(8,925,688)
=========== =========== =========== ===========
Basic and diluted loss per common share:
As reported $ (0.05) $ (0.11) $ (0.23) $ (0.37)
Pro forma $ (0.05) $ (0.20) $ (0.25) $ (0.76)
Use of estimates:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts of
assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and reported amounts of revenue
and expense during the reporting period. Actual results could differ from
those estimates. Significant accounting estimates used in the preparation
of the Company's consolidated financial statements include the fair value
of equity securities underlying stock based compensation, the
realizability of deferred tax assets, the carrying value of goodwill,
intangible assets and long-lived assets, and depreciation and
amortization.
Recent Accounting Pronouncements:
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 supersedes
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS 146 requires
that costs associated with an exit or disposal plan be recognized when
incurred rather than at the date of a commitment to an exit or disposal
plan. SFAS 146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company adopted SFAS 146
on January 1, 2003. The adoption of this standard did not have a
significant impact on the Company's consolidated financial position or
results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others" which elaborates on the disclosures
to be made by a guarantor in its interim and annual financial statements
about its obligations under certain guarantees that it has issued. It also
clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provisions
of Interpretation No. 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosure
requirements in this Interpretation are effective for financial statements
of interim or annual periods ending after December 15, 2002. The Company
has provided information regarding commitments and contingencies relating
to guarantees in Note 9. The adoption of this standard did not have a
significant impact on the Company's consolidated financial position or
results of operations.
9
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONTINUED)
In November 2002, the Emerging Issues Task Force of the FASB ("EITF")
reached a consensus on Issue No. 00-21, "Revenue Arrangements with
Multiple Deliverables." EITF 00-21 addresses certain aspects of the
accounting by a vendor for arrangements under which the vendor will
perform multiple revenue generating activities. The EITF was effective for
revenue arrangements entered into in fiscal years and interim periods
beginning after June 15, 2003. The adoption of this consensus, effective
August 1, 2003, did not have a significant impact on the Company's
consolidated financial position or results of operations.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of FASB Statement No.
123" ("SFAS 148"). SFAS 148 amends SFAS 123, "Accounting for Stock-Based
Compensation" to provide alternative methods to account for the transition
from the intrinsic value method of recognition of stock-based employee
compensation in accordance with APB Opinion No. 25, "Accounting for Stock
Issued to Employees" to the fair value recognition provisions under SFAS
123. SFAS 148 provides two additional methods of transition and will no
longer permit the SFAS 123 prospective method to be used for fiscal years
beginning after December 15, 2003. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosure in
both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the pro-forma effects
had the fair value recognition provisions of SFAS 123 been used for all
periods presented. The adoption of SFAS 148 did not have a significant
impact on the Company's consolidated financial position and results of
operations. The Company adopted the fair-value recognition provisions of
SFAS 123 in January 2004 (Note 6).
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("Interpretation No. 46") and in December 2003
issued FIN No. 46 (Revised) ("FIN 46R") to address certain FIN 46
implementation issues. FIN 46R also requires additional disclosures by
primary beneficiaries and other significant variable interest holders.
Interpretation No. 46 clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to certain entities
in which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated financial
support from other parties. The Company adopted Interpretation No. 46 on
January 31, 2003. The adoption of this standard did not have a significant
impact on the Company's consolidated financial position or results of
operations.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"), which amends
and clarifies accounting for derivative instruments and for hedging
activities under SFAS 133. Specifically, SFAS 149 requires that contracts
with comparable characteristics be accounted for similarly. Additionally,
SFAS 149 clarifies the circumstances in which a contract with an initial
net investment meets the characteristics of a derivative and when a
derivative contains a financing component that requires special reporting
in the statement of cash flows. This Statement is generally effective for
contracts entered into or modified after June 30, 2003 and did not have a
significant impact on the Company's consolidated financial position or
results of operations.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS
150"). SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. This Statement is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. For
financial instruments created before the issuance date of this Statement
and still existing at the beginning of the interim period of adoption,
transition shall be achieved by reporting the cumulative effect of a
change in an accounting principle by initially measuring the financial
instruments at fair value or other measurement attribute required by this
Statement. The adoption of this Statement, effective August 1, 2003, did
not have a material impact on the Company's consolidated financial
position or results of operations.
10
INTERNET COMMERCE CORPORATION
4. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk primarily consist of accounts receivable.
The Company believes that any credit risk associated with receivables is
minimal due to the number and credit worthiness of its customers.
Receivables are stated at estimated net realizable value, which
approximates fair value. For the three and nine-month periods ended April
30, 2004 and 2003, no single customer accounted for more than 10% of
revenue. No single customer accounted for more than 10% of accounts
receivable at July 31, 2003 or April 30, 2004.
5. BUSINESS SEGMENT INFORMATION
The Company's two operating segments are:
o ICC.NET - the Company's global Internet-based value added network,
or VAN, uses the Internet and proprietary technology to deliver
customers' documents and data files to members of their trading
communities, many of which may have incompatible systems, by
translating the documents and data files into any format required by
the receiver, and the development and operation of comprehensive
business-to-business e-commerce solutions. Until January 2004, this
segment also conducted a series of product-independent, one-day EDI
seminars for e-commerce users. The Company discontinued offering
seminars in January 2004. Revenue from these seminars was immaterial
in all periods presented.
o Service Bureau - the Service Bureau manages and translates the data
of small and mid-sized companies that exchange EDI data with large
companies and provides various EDI and UPC (universal product code)
services. The Service Bureau also licenses EDI software.
In response to continuing weak demand for its professional services, in
February 2004 the Company combined these activities with ICC.NET to reduce
operating costs. As a result, effective February 2004, the Company no
longer reports the results for its professional services activities in a
separate segment and includes these results in the ICC.NET segment. These
activities were previously reported in the Professional Services segment.
11
INTERNET COMMERCE CORPORATION
5. BUSINESS SEGMENT INFORMATION (CONTINUED)
The tables below summarize information about operations and long-lived
assets as of and for the three and nine-month periods ended April 30, 2004
and 2003. Such information has been restated, for each period presented,
as if this reorganization had occurred on August 1, 2002.
Service
ICC.NET Bureau Total
------- ------ -----
(As restated)
Three Months - April 30, 2004
Revenues from external customers $ 2,561,875 $ 330,515 $ 2,892,390
=========== =========== ===========
Operating loss $ (670,483) $ 28,918 $ (641,565)
Other expense, net (19,939) -- (19,939)
----------- ----------- -----------
Net income (loss) $ (690,422) $ 28,918 $ (661,504)
=========== =========== ===========
Supplemental segment information:
Amortization and depreciation $ 324,155 $ 6,454 $ 330,609
Non-cash charges for stock-based
compensation and services $ 111,939 $ -- $ 111,939
Nine Months - April 30, 2004
Revenues from external customers $ 7,841,765 $ 909,708 $ 8,751,474
=========== =========== ===========
Operating loss $(2,904,656) $ (99,783) $(3,004,439)
Other income, net 22,261 -- 22,261
----------- ----------- -----------
Net loss $(2,882,395) $ (99,783) $(2,982,178)
=========== =========== ===========
Supplemental segment information:
Amortization and depreciation $ 1,064,167 $ 33,031 $ 1,097,198
Impairment of capitalized software
development costs $ -- $ 44,983 $ 44,983
Non-cash charges for stock-based
compensation and services $ 638,025 $ -- $ 638,025
As of April 30, 2004
Property and Equipment, net $ 282,159 $ 21,187 $ 303,346
Capitalized software development
costs, net -- 31,256 31,256
Goodwill 26,132 1,185,793 1,211,925
Other intangibles assets, net 1,434,000 -- 1,434,000
----------- ----------- -----------
Long lived assets, net $ 1,742,291 $ 1,238,236 $ 2,980,527
=========== =========== ===========
12
INTERNET COMMERCE CORPORATION
5. BUSINESS SEGMENT INFORMATION (CONTINUED)
Service
ICC.NET Bureau Total
------- ------ -----
(As restated)
Three Months - April 30, 2003
Revenues from external customers $ 2,753,478 $ 340,754 $ 3,094,232
=========== =========== ===========
Operating loss (1) $ (925,076) $ (142,624) $(1,067,700)
Other expense, net (6,382) -- (6,382)
----------- ----------- -----------
Net loss $ (931,458) $ (142,624) $(1,074,082)
=========== =========== ===========
Supplemental segment information:
Amortization and depreciation $ 378,698 $ 10,835 $ 389,533
Impairment of capitalized software
development costs $ -- $ 133,960 $ 133,960
Non-cash charges for stock-based
compensation and services $ 71,819 $ -- $ 71,819
Nine Months - April 30, 2003
Revenues from external customers $ 7,784,765 $ 1,196,649 $ 8,981,414
=========== =========== ===========
Operating loss (1) $(3,495,300) $ (98,142) $(3,593,442)
Other expense, net (348,476) -- (348,476)
----------- ----------- -----------
Net loss $(3,843,776) $ (98,142) $(3,941,918)
=========== =========== ===========
Supplemental segment information:
Amortization and depreciation $ 1,191,470 $ 72,125 $ 1,263,595
Impairment of capitalized software
development costs $ -- $ 133,960 $ 133,960
Impairment of software inventory $ 248,077 $ -- $ 248,077
Non-cash charges for stock-based
compensation and services $ 82,235 $ -- $ 82,235
Impairment of marketable securities $ 317,924 $ -- $ 317,924
As of April 30, 2003
Property and Equipment, net $ 656,663 $ 50,380 $ 707,043
Capitalized software development
costs, net -- 162,826 162,826
Goodwill 26,132 2,167,935 2,194,067
Other intangible assets, net 2,390,000 -- 2,390,000
----------- ----------- -----------
Long lived assets, net $ 3,072,795 $ 2,381,141 $ 5,453,936
=========== =========== ===========
(1) Commencing in the second quarter of fiscal 2003, certain costs for
executive management, human resources, accounting and finance were
allocated to the Service Bureau from ICC.NET based on the level of
services performed. In an effort to operate more efficiently and to reduce
costs, these functions were consolidated and are now performed by ICC.NET
personnel. ICC.NET allocated $45,000 and $90,000 to the Service Bureau
during the three and nine-month periods, respectively.
6. STOCKHOLDERS' EQUITY
2004 Private Placement of Common Stock:
On April 20, 2004, the Company completed a private placement of common
stock and warrants to purchase shares of common stock (the "2004 Private
Placement") for aggregate gross proceeds of approximately $4,955,500.
13
INTERNET COMMERCE CORPORATION
6. STOCKHOLDERS' EQUITY (CONTINUED)
In the 2004 Private Placement the Company sold 2,831,707 shares of class A
common stock and warrants to purchase 849,507 shares of class A common
stock. These warrants are exercisable for five years commencing on October
20, 2004 at an exercise price of $2.22 per share.
In connection with the 2004 Private Placement, the Company incurred fees
and expenses of $713,602, of which $423,274 was paid in cash at closing,
$64,423 is payable in cash and $225,905 was paid by issuing warrants to
purchase 283,170 shares of class A common stock. The fair value of the
warrants was estimated by management using the Black Scholes
option-pricing model. These warrants have substantially the same terms as
the warrants issued in the 2004 Private Placement.
No directors, officers or entities with which the Company's directors or
officers are affiliated participated in the 2004 Private Placement.
In connection with the 2004 Private Placement, the Company entered into a
registration rights agreement with the investors, dated as of April 20,
2004, and filed a registration statement with the SEC on April 30, 2004
pursuant to this agreement. If the registration statement is not declared
effective by August 18, 2004, or if its effectiveness is not maintained
for the period required by the registration rights agreement, the Company
may be required to pay to the holders of shares issued in the 2004 Private
Placement liquidated damages of one percent (1%) of the purchase price
paid for the shares by the holders for each 30 day period (or portion
thereof on a pro rata basis) that the registration statement is not
declared effective or its effectiveness is not maintained.
2003 Private Placement of Common Stock and Preferred Stock:
During April and May 2003, the company completed a private placement of
common stock, convertible preferred stock and warrants to purchase shares
of common stock (the "2003 Private Placement") for aggregate gross
proceeds of approximately $2,085,000.
In the 2003 Private Placement, the Company sold 1,682,683 shares of class
A common stock and warrants to purchase 1,346,140 of class A common stock
for gross proceeds of approximately $1,835,000 and 250 shares of series D
convertible redeemable preferred stock ("series D preferred") and warrants
to purchase 153,845 shares of class A common stock for $250,000. All
warrants are immediately exercisable and have an exercise price of $1.47
per share. The warrants are exercisable until the fifth anniversary of the
date of issuance. In addition, the warrants are redeemable at the
Company's option, if the closing bid price of the Company's class A common
stock exceeds 200% of the exercise price of the warrants for 30
consecutive trading days. The redemption price is $0.10 per share for each
share issuable under the warrants.
The 250 shares of series D preferred are convertible into 192,307 shares
of class A common stock. The allocation of the proceeds from the sale of
the series D preferred between the fair value of the series D and the fair
value of the detachable warrants resulted in a beneficial conversion
feature in the amount of $106,730. The discount was immediately accreted
and treated as a deemed dividend to the holder of the series D preferred,
as all of the series D preferred stock was immediately convertible upon
issuance.
In connection with the 2003 Private Placement, the Company incurred fees
of $325,750 of which $237,938 was paid in cash and $87,802 was paid by
issuing warrants to purchase 110,680 shares of class A common stock. These
warrants have substantially the same terms as the warrants issued in the
2003 Private Placement.
In connection with the 2003 Private Placement, the Company issued 48,076
shares of class A common stock and warrants to purchase 38,460 shares of
class A common stock in settlement of certain outstanding payables. The
common stock and warrants were valued at $50,000, the invoice amount of
the services provided to the Company.
Approximately 21%, or $432,000, of the gross proceeds from the 2003
Private Placement was received from directors and officers and entities
with which the Company's directors are affiliated.
Subsequent to the completion of the 2003 Private Placement, the Company
determined that in order to comply with NASD Marketplace Rule
4350(i)(1)(A), the purchase price per share for the shares of class A
common stock purchased by directors and officers in the private placement
should be increased to market value, and on June 17, 2003 the directors
and officers agreed to do so. As a result, two directors and three
officers agreed to pay an additional $0.58 per share, or an aggregate of
$85,502, for the shares of class A common stock they purchased in the
private placement. In August of 2003 the Company paid bonuses of
14
INTERNET COMMERCE CORPORATION
6. STOCKHOLDERS' EQUITY (CONTINUED)
$40,000 to reimburse the officers for their additional $0.58 per share
payment and in January 2004, at the request of the NASD, these officers
returned to the Company an aggregate of 11,091 shares of class A common
stock they purchased in the private placement in order to increase their
purchase price to $1.45 per share without regard to the bonuses.
Stock Based Compensation:
On March 10, 2003, options and stock were awarded to a non-employee member
of the board of directors as compensation for consulting services. This
individual was awarded 20,000 shares of class A common stock, valued at
$18,000, which was recorded as a non-cash charge for stock-based
compensation in the quarter ended April 30, 2003. At the same time, this
individual was also granted on March 10, 2003, options to purchase 100,000
shares of class A common stock. Options to purchase 60,000 shares at an
exercise price of $1.00 per share vest six months from the date of
issuance, and options to purchase 40,000 shares at an exercise price of
$1.25 per share vest one year from the date of issuance. The options have
a fair value of $67,000, of which $15,440 has been recorded as a non-cash
stock-based compensation charge for services during the three months ended
October 31, 2003. In November 2003, this individual surrendered the
100,000 options noted above to the Company with no additional compensation
charge recorded.
Each non-employee member of the board of directors receives annual
compensation of $25,000 for his current term of office, payable quarterly,
in class A common stock of the Company. The Company has recorded a
compensation charge of $104,167 for the nine months ended April 30, 2004.
Stock Options Cancellation and Exchange:
In January 2004, the Company implemented a voluntary stock option exchange
program whereby the Company offered to exchange certain outstanding
options to purchase shares of the Company's common stock held by eligible
employees of the Company, with exercise prices per share greater than or
equal to $11.50, for new options to purchase shares of the Company's
common stock (the "Offer to Exchange"). Under the terms of the Offer to
Exchange, the 26 participating employees agreed to cancel as of January
30, 2004 their existing options to purchase 823,500 shares of the
Company's common stock and were granted options to purchase 494,100 shares
of the Company's common stock with an exercise price of $1.25 per share,
the closing market price per share on January 20, 2004. Each new employee
option was fully vested at the date of grant. Additionally, under the
terms of the Offer to Exchange, two directors cancelled as of January 30,
2004 existing options to purchase 250,000 shares of the Company's common
stock and were granted options to purchase 150,000 shares of the Company's
common stock with an exercise price of $2.00 per share. The options
granted to directors vest in 2 equal annual installments commencing one
year after the date of grant. One director was eligible but declined to
participate in the exchange and surrendered to the Company options to
purchase 50,000 shares of common stock at an exercise price of $19 per
share.
Prior to August 1, 2003, the Company accounted for its employee stock
options under the intrinsic value method of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
No stock-based employee compensation expense is reflected in the statement
of operations for options granted to employees to purchase common stock
granted with an exercise price equal to or greater that the market value
of the underlying common stock on the date of grant. Effective August 1,
2003, the Company adopted the fair value recognition provisions of FASB
Statement No. 123, "Accounting for Stock-Based Compensation." The fair
value method has been applied prospectively to all employee awards
granted, modified or settled after August 1, 2003. Option granted prior to
August 1, 2003 that have not been modified or settled continue to be
accounted for under the intrinsic value method of APB 25. During the three
and nine months ended April 30, 2004, the Company recorded non-cash
charges for stock-based compensation of $53,723 and $491,453,
respectively, as a result of the adoption of the fair value recognition
provisions of FASB Statement No. 123.
15
INTERNET COMMERCE CORPORATION
7. IMPAIRMENT OF SOFTWARE DEVELOPMENT COSTS, INVESTMENTS AND SOFTWARE
INVENTORY
In January 2004, the Company recorded an impairment charge of
approximately $45,000 for previously capitalized software development
costs related to a completed development project of its Service Bureau.
The Company determined during the quarter ended January 31, 2004 that
projected sales of this software were not sufficient to support its
carrying value.
In April 2003, the Company recorded an impairment charge of approximately
$134,000 for previously capitalized software development costs related to
an in-process software development project of its Service Bureau. The
Company decided during the quarter ended April 30, 2003, not to complete
this project due to unfavorable market conditions for the foreseeable
future. In January 2003, the Company recorded an impairment charge of
approximately $318,000 to write down available-for-sale marketable
securities due to an other than temporary decline in value. Additionally,
in January 2003, the Company recorded an impairment charge of
approximately $248,000 for software inventory held by the Professional
Services segment based on historical and projected sales, which indicated
that its net carrying value was not recoverable. The Company had
previously recorded an impairment charge of $100,000 for software
inventory in July 2002. Such software inventory was classified as other
current assets in the consolidated balance sheet. The Company's carrying
value of inventory at April 30, 2004 is not significant.
8. GOODWILL AND OTHER INTANGIBLE ASSETS
On August 1, 2001, the Company adopted the provisions of SFAS No. 141,
"Business Combinations" ("SFAS 141") and SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 142 requires that intangible assets
with indefinite useful lives no longer be amortized, but rather be tested
at least annually for impairment. The Company's reporting units utilized
for evaluating the recoverability of goodwill are the same as its
operating segments.
At April 30, 2004 and July 31, 2003, Other Intangible assets are comprised
of the proprietary data mapping technology acquired in the acquisition of
Research Triangle Commerce, Inc. in November 2000. The gross carrying
value of the mapping technology was $4,780,000 at April 30, 2004 and July
31, 2003. Accumulated amortization relating to mapping technology was
$3,346,000 and $2,629,000 at April 30, 2004 and July 31, 2003,
respectively. The data mapping technology is being amortized over five
years and amortization expense is recorded in cost of services. The
aggregate amortization expense for other intangible assets was $239,000
during each of the three-month periods ended April 30, 2004 and 2003 and
$717,000 for each of the nine-month periods ended April 30, 2004 and 2003.
The Company did not have any indefinitely lived intangible assets that
were not subject to amortization as of April 30, 2004 and July 31, 2003.
At April 30, 2004, estimated amortization expense for other intangible
assets for the remaining life of those assets is as follows:
Year Estimated Remaining Amortization Expense
---- ----------------------------------------
2004 $239,000
2005 $956,000
2006 $239,000
There was no change in the carrying amount of goodwill for the three and
nine-month periods ended April 30, 2004.
During the fourth quarter of fiscal 2003, the goodwill of the Service
Bureau was tested for impairment due to a significant decline in revenue
and operating income resulting primarily from the bankruptcy of its
largest customer. An impairment loss of $982,142 was recognized as a
result of this evaluation. The fair value of the Service Bureau was
estimated using the net present value of expected future cash flows.
16
INTERNET COMMERCE CORPORATION
8. GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
As of August 1, 2003, the Company performed its annual test for impairment
on the carrying value of goodwill of its ICC.NET and Service Bureau
reporting units. The Company concluded that no impairment existed at that
date.
9. GUARANTEES AND INDEMNIFICATIONS
As part of its standard license agreements, the Company agrees to
indemnify its customers against liability if the Company's products
infringe a third party's intellectual property rights. Historically, the
Company has not incurred any significant costs related to performance
under these indemnities. As of April 30, 2004, the Company was not subject
to any litigation alleging that the Company's products infringe the
intellectual property rights of any third parties.
10. ACCOUNTS RECEIVABLE FINANCING AGREEMENT
On May 30, 2003, the Company executed an Accounts Receivable Financing
Agreement ("Financing Agreement") with Silicon Valley Bank ("the Bank")
with a term of 1 year. Under the Financing Agreement, the Company may
borrow, subject to certain conditions, up to 80% of its outstanding
accounts receivable up to a maximum borrowing of $2,000,000. Interest
accrues at the prime rate plus .35% plus a collateral handling fee equal
to .20% on the average daily outstanding financed receivable balance.
Interest is payable monthly. The Financing Agreement contains certain
restrictive covenants that are customary for a commercial transaction of
this type, including, without limitation, restrictions on the disposition
or encumbrance of the collateral pledged to the Bank, restrictions on
incurring additional indebtedness and restrictions on the payment of
dividends and the redemption or repurchase of any capital stock. In
addition, the Company is required to maintain at all times a ratio of
Quick Assets (i.e., consolidated, unrestricted cash, cash equivalents, net
accounts receivable and investments with maturities of fewer than 12
months determined according to GAAP) to Current Liabilities (i.e., all
obligations and liabilities of the Company to Bank, plus, without
duplication, the aggregate amount of the Company's total liabilities which
mature within one (1) year) minus Deferred Revenue (i.e., all amounts
received in advance of performance under contracts and not yet recognized
as revenue) of at least 1.10 to 1.0. The Bank has been granted a security
interest in substantially all of the Company's assets. In connection with
the Financing Agreement, the Company issued the bank warrants to purchase
40,000 shares of the Company's class A common stock. The warrants are
immediately exercisable at an exercise price of $1.39, equal to the fair
market value of the Company's class A common stock at the date of closing
of the Financing Agreement. The warrants are exercisable for a seven-year
period. The fair value of the warrants in the amount of approximately
$34,000 is being amortized to interest expense over the term of the
Financing Agreement. During the three and nine-month periods ended April
30, 2004, the Company recorded interest expense in the amount of
approximately $8,300 and $26,000, respectively, for the amortization of
the fair value of the warrants. On October 22, 2003, the Company and the
Bank amended the Financing Agreement to extend the term of the agreement
to August 31, 2004. At April 30, 2004, there was approximately $647,000
outstanding under the Financing Agreement. On May 3, 2004 the Company
repaid its entire outstanding balance under the Financing Agreement with
proceeds from the 2004 Private Placement (See Note 6).
11. SUBSEQUENT EVENT - ACQUISITION OF ELECTRONIC COMMERCE SYSTEMS
On May 25, 2004, the Company entered into a definitive agreement to
acquire Electronic Commerce Systems, Inc. ("ECS"). ECS will become a
wholly-owned subsidiary of the Company. ECS provides Internet-based
e-business solutions to suppliers needing to comply with EDI mandates from
major retailers, as well as services to the banking industry and special
electronic solutions for a range of customers. ECS was founded in 1996 and
is headquartered in Norcross, Georgia.
ICC will issue a total of approximately 1,941,434 shares of its class A
common stock with a value of approximately $2,485,000 in connection with
the merger, including approximately 415,596 shares that will be issued in
exchange for outstanding debt of ECS in the amount of approximately
$471,016 and in payment of certain legal fees of counsel to ECS.
17
INTERNET COMMERCE CORPORATION
11. SUBSEQUENT EVENT - ACQUISITION OF ELECTRONIC COMMERCE SYSTEMS (CONTINUED)
Completion of the merger is subject to the approval of shareholders of ECS
and other customary conditions. ECS shareholders owning more than a
majority of its stock have agreed to vote in favor of the merger at its
shareholders meeting. Upon the consummation of the merger, ICC will enter
into a registration rights undertaking in favor of the shareholders of ECS
pursuant to which ICC will agree to register the resale of the shares of
class A common stock issued to the ECS shareholders as a result of the
merger.
The Company believes that its merger with ECS will enhance its presence in
the retail industry with the addition of more than 600 customers. ECS has
developed easy-to-use EDI implementation services to enable its customers
to rapidly become EDI compliant and trade with large retailers.
18
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This quarterly report on Form 10-Q contains a number of "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), and Section 21E of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). Specifically, all statements other
than statements of historical facts included in this Quarterly Report regarding
our financial position, business strategy and plans and objectives of management
for future operations are forward-looking statements. These forward-looking
statements are based on the beliefs of management, as well as assumptions made
by and information currently available to management. When used in this
Quarterly Report, the words "anticipate," "believe," "estimate," "expect,"
"may," "will," "continue" and "intend," and words or phrases of similar import,
as they relate to our financial position, business strategy and plans, or
objectives of management, are intended to identify forward-looking statements.
These statements reflect our current view with respect to future events and are
subject to risks, uncertainties and assumptions related to various factors
including, without limitation, those described below the heading "Overview" and
in our registration statements and periodic reports filed with the SEC under the
Securities Act and the Exchange Act.
Although we believe that our expectations are reasonable, we cannot assure
you that our expectations will prove to be correct. Should any one or more of
these risks or uncertainties materialize, or should any underlying assumptions
prove incorrect, actual results may vary materially from those described in this
Quarterly Report as anticipated, believed, estimated, expected or intended.
In this Item 2, references to the "Company," "we," or "us" means Internet
Commerce Corporation.
Overview
We are in the e-commerce ("EC") business-to-business communication
services market providing complete EC infrastructure solutions. Our business
operates in two segments: namely, ICC.NET and Service Bureau.
As the Company approaches cash flow break-even, we have strengthened the
executive management team by the addition of a new Chief Executive Officer and
Chief Operating Officer in order to capitalize on the individual skills of
senior management and more precisely align those skills with the many new
opportunities currently developing. We are focusing on the future direction of
the markets in which we compete, mergers and acquisitions and the development of
important strategic relationships, such as our Microsoft Business Network
opportunity, that have potential to increase our revenues and profits.
ICC.NET includes the Company's global Internet-based value added network,
or VAN, which uses the Internet and our proprietary technology to deliver our
customers' documents and data files to members of their trading communities,
many of which may have incompatible systems, by translating the documents and
data files into any format required by the receiver. We believe that our ICC.NET
service has significant advantages over traditional VANs as well as email-based
and other Internet-based software systems, because our service is provided at a
low cost, with greater transmission speed that is nearly real-time and offers
more features. In addition, ICC.NET facilitates the development and operation of
comprehensive business-to-business e-commerce solutions. Professional Services
assists its clients to conduct business electronically through a continuum of
services including eConsulting, data transformation mapping (EDI, EAI, XML) and
internetworking. Our Service Bureau manages and translates the data of small and
mid-sized companies that exchange EDI data with large companies that require
that data be transmitted to them electronically. The Service Bureau delivers
business-to-business EDI standards-based documents for companies that do not
have EDI departments.
The Value Added Network business has become significantly more price
competitive over the past year, with major networks restructuring to reduce
their overhead cost to be better positioned to compete on a price point basis
against Internet based networks such as ICC.NET. We have been successful in
maintaining, and in fact have improved, our margins, but we have experienced
some price erosion in competing for larger customers. Although we expect to
continue to add new customers and increase the volume of data transmitted
through our service, we do not expect our revenue from VAN services to continue
to grow as rapidly as in the past. This trend is expected to continue in the
short term until such time as a cost-based pricing floor is reached by our
larger competitors. To counteract this negative impact on our revenue growth,
management has deployed a new dual pronged strategy. We expect to add revenue
through acquisition of Electronic Commerce Systems, Inc. ("ECS") and have
developed new product and service offerings (AS2 and Data Synchronization) to
improve our value proposition. AS2 capabilities has refocused the attention of
industry. AS2 is a service offering on the Internet, which handles primary XML
documents, which are an extension of traditional EDI. We have incorporated this
communication methodology into our standard network services and are achieving
success in stemming a migration of our customers network traffic to those who
could otherwise purchase an AS2 software offering.
Data synchronization has forced the industry to change its focus from cost
savings to compliance. Data synchronization is a methodology by which
descriptive data identifying an item or items is stored in a central depository
resulting in one common source of truth about the product description. We
believe this will be an industry focus for a year or so and thereafter be a
standard business practice. We have become a certified data synchronization
"on-boarder" and are currently offering training and consulting services to
capitalize on this emerging initiative.
During the fiscal quarter ended April 30, 2004, we further improved our
operational leverage by reducing our operating loss by $915,000 from the quarter
ended January 1, 2004, and increased our consolidated revenue by $137,000 from
the previous quarter. We believe that this is a significant benefit going
forward as the majority of any increases in revenue should increase our
profitability.
We strengthened our balance sheet by completing a private placement that
provided net proceeds of $4,467,000. With total cash and cash equivalents of
$4,989,000 as of April 30, 2004, we now have our highest cash balances in over
19
INTERNET COMMERCE CORPORATION
three years. Subsequent to fiscal quarter end we repaid the $646,922 outstanding
as of April 30, 2004 under our Accounts Receivable Financing Agreement with
Silicon Valley Bank, eliminating our short-term debt.
The Company signed a definitive merger agreement to acquire Electronic
Commerce Systems, Inc. (ECS) on May 25, 2004. The acquisition is subject to
approval of the shareholders of ECS and other customary closing conditions. We
believe that if the acquisition and the integration of ECS and our Service
Bureau are completed, it will substantially strengthen this operating segment
and provide positive cash flow from their operating activities.
Consolidated revenue for the nine months ended April 30, 2004 decreased
from the nine months ended April 30, 2003 by $230,000; however, our EDI
educational services and seminars unit that was discontinued in January 2004 due
to continued operating losses produced revenue of $323,000 in the nine months
ended April 30, 2003. VAN services revenue increased $733,000 or approximately
12%. Service Bureau revenue, which decreased $287,000, or 24%, should improve
significantly if the ECS acquisition is completed. Professional services and
mapping revenues continue to be weak due to slow demand for these services and
commencing in the third quarter of fiscal 2004 we combined the Professional
Services operating segment with ICC.NET to further minimize operating costs.
As a result, the Company, effective February 2004, no longer separately
reports the operating results for its professional services activities as a
separate segment and began including these results in the ICC.NET segment. These
activities were previously reported in the Professional Services segment.
We rely on many of our competitors to interconnect, at reasonable cost,
with our service and have interconnection arrangements with more than 65
business-to-business networks for the benefit of our customers. We believe that
these arrangements will satisfy the business requirements of our existing
customers.
20
INTERNET COMMERCE CORPORATION
Critical Accounting Policies and Significant Use of Estimates in Financial
Statements
Critical accounting policies are those policies that require application
of management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain and may change in subsequent periods.
The following list of critical accounting policies is not intended to be a
comprehensive list of all of our accounting policies. Our significant accounting
policies are more fully described in note 2 of the notes to the consolidated
financial statements included in our Annual Report on Form 10-K for the year
ended July 31, 2003. In many cases, the accounting treatment of a particular
transaction is specifically dictated by generally accepted accounting principles
with no need for management's judgment in their application. There are also
areas in which management's judgment in selecting any available alternative
would not produce a materially different result. We have identified the
following to be critical accounting policies of the Company:
Revenue Recognition: The Company derives revenue from subscriptions to its
ICC.NET service, which includes transaction, mailbox and fax transmission fees.
The subscription fees are comprised of both fixed and usage-based fees. Fixed
subscription fees are recognized on a pro-rata basis over the subscription
period, generally three to six months. Usage fees are recognized in the period
the services are rendered. The Company also derives revenue through
implementation fees, interconnection fees and by providing data mapping services
to its customers. Implementation fees are recognized over the life of the
subscription period. Interconnection fees are fees charged to connect to another
VAN service and are recognized when the data is transmitted to the connected
service. Revenue from data mapping services is recognized when the map has been
completed and delivered to the customer. The Company has a limited number of
fixed fee data mapping services contracts. Under these arrangements the Company
is required to provide a specified number of maps for a fixed fee. Revenue from
such arrangements is recognized using the percentage-of-completion method of
accounting (see below).
Through January 2004, the Company provided a range of EDI and electronic
commerce consulting services and EDI education and training seminars throughout
the United States. Revenue from EDI and electronic commerce consulting services
and education and training seminars were recognized when the services were
provided. The Company discontinued its EDI education and training seminars in
January 2004. Revenues from our EDI education and training seminars were
immaterial in all periods presented.
Revenue from fixed fee data mapping and professional service contracts is
recognized using the percentage-of-completion method of accounting, as
prescribed by SOP 81-1 "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts."
The percentage of completion for each contract is determined based on the
ratio of direct labor hours incurred to total estimated direct labor hours
required to complete the contract. The Company may periodically encounter
changes in estimated costs and other factors that may lead to a change in the
estimated profitability of a fixed-price contract. In such circumstances,
adjustments to cost and profitability estimates are made in the period in which
the underlying factors requiring such revisions become known. If such revisions
indicate a loss on a contract, the entire loss is recorded at such time. Amounts
billed in advance of services being performed are recorded as deferred revenue.
Certain fixed-fee contracts may have substantive customer acceptance provisions.
The acceptance terms generally include a single review and revision cycle for
each deliverable to incorporate the customer's suggested or required
modifications. Deliverables are considered accepted upon completion of the
review and revision and revenue cycle is recognized upon acceptance.
Service Bureau revenue is comprised of EDI services including data
translation services, EDI-to-print and print-to-EDI purchase order and invoice
processing, UPC services including UPC number generation, UPC catalog
maintenance and UPC label printing. The Service Bureau also derives revenue from
licensing software and providing software maintenance and support. Revenue from
EDI services and UPC services is recognized when the services are provided. The
Company accounts for its EDI software license sales in accordance with the
American Institute of Certified Public Accountants' Statement of Position 97-2,
"Software Revenue Recognition," as amended ("SOP 97-2"). Revenue from software
licenses is recognized when all of the following conditions are met: (1) a
non-cancelable non-contingent license agreement has been signed; (2) the
software product has been delivered; (3) there are no material uncertainties
regarding customer acceptance; and (4) collection of the resulting receivable is
21
INTERNET COMMERCE CORPORATION
probable. Revenue from software maintenance and support contracts is recognized
ratably over the life of the contract. The Service Bureau's software license
revenue was not significant in any of the periods presented.
In addition, SOP 97-2 generally requires that revenue from software
arrangements involving multiple elements be allocated among each element of the
arrangement based on the relative fair values of the elements, such as software
licenses, post contract customer support, installation or training. Furthermore,
SOP 97-2 requires that revenue be recognized as each element is delivered with
no significant performance obligation remaining on the part of the Company. The
Company's multiple element arrangements generally consist of a software license
and post contract support. The Company allocates the aggregate revenue from
multiple element arrangements to each element based on vendor specific objective
evidence. The Company has established vendor specific objective evidence for
each of the elements as it sells both the software and post contract customer
support independent of multiple element agreements. Customers are charged
standard prices for the software and post contract customer support and these
prices do not vary from customer to customer.
If the Company enters into a multiple element agreement for which vendor
specific objective evidence of fair value for each element of the arrangement
does not exist, all revenue from the arrangement is deferred until all elements
of the arrangement are delivered.
Service revenue from maintenance contracts is recognized ratably over the
term of the maintenance contract, on a straight-line basis. Other service
revenue is recognized at the time the service is performed.
Goodwill: Goodwill consists of the excess purchase price over the fair
value of identifiable net assets of acquired businesses. The carrying value of
goodwill is evaluated for impairment on an annual basis. Management also reviews
goodwill for impairment whenever events or changes in circumstances indicate
that the carrying amount of goodwill may be impaired. If it is determined that
an impairment in value has occurred, goodwill is written down to its implied
fair value. The Company's reporting units utilized for evaluating the
recoverability of goodwill are the same as its operating segments.
Other Intangible Assets: Other intangible assets are carried at cost less
accumulated amortization. Other intangible assets are amortized on a
straight-line basis over their expected lives, which are estimated to be five
years. The Company did not have any indefinite lived intangible assets other
than goodwill that were not subject to amortization.
Impairment of long-lived assets: Long-lived assets of the Company,
including amortizable intangibles, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset may
not be recoverable. Management also reevaluates the periods of amortization of
long-lived assets to determine whether events and circumstances warrant revised
estimates of useful lives. When such events or changes in circumstances occur,
the Company tests for impairment by comparing the carrying value of the
long-lived asset to the estimated undiscounted future cash flows expected to
result from use of the asset and its eventual disposition. If the sum of the
expected undiscounted future cash flows is less than the carrying amount of the
asset, the Company would recognize an impairment loss. The amount of the
impairment loss will be determined by comparing the carrying value of the
long-lived asset to the present value of the net future operating cash flows to
be generated by the asset.
Stock-based compensation: In January 2004, the Company adopted the fair
value provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 established a
fair-value-based method of accounting for stock-based compensation plans.
Pursuant to the transition provisions of SFAS 148, "Accounting for Stock Based
Compensation - Transition and Disclosure" (SFAS 148), the Company has elected
the prospective method and will apply the fair value method of accounting to all
equity instruments issued to employees on or after August 1, 2003. The fair
value method is not applied to stock option awards granted in fiscal years prior
to 2004. Such awards will continue to be accounted for under the intrinsic value
method pursuant to Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), except to the extent that prior years'
awards are modified subsequent to August 1, 2003. Option grants issued prior to
August 1, 2003 that have not been modified or settled continue to be accounted
for under the intrinsic value method of APB 25. Therefore, the cost related to
stock-based employee compensation
22
INTERNET COMMERCE CORPORATION
included in the determination of the net loss for 2004 is less than that which
would have been recognized if the fair value based method had been applied to
all awards since their date of grant.
Income Taxes: Deferred income taxes are determined by applying enacted
statutory rates in effect at the balance sheet date to the differences between
the tax bases of assets and liabilities and their reported amounts in the
consolidated financial statements. A valuation allowance is provided based on
the weight of available evidence, if it is considered more likely than not that
some portion, or all, of the deferred tax assets will not be realized.
Use of Estimates: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and reported amounts of revenue and expense
during the reporting period. Actual results could differ from those estimates.
The following discussion reviews items incorporated in our financial statements
during the three and nine month periods ended April 30, 2004 and 2003 or as of
April 30, 2004 and July 31, 2003 that required the use of significant management
estimates.
As discussed above, in January 2004 the Company adopted the fair value
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123"). During the three and nine months
ended April 30, 2004, the Company recorded non-cash charges for stock-based
compensation of $53,723 and $491,453 respectively as a result of the adoption of
the fair value recognition provisions of SFAS 123. The Black-Scholes
option-pricing model was used to determine the estimated fair value of stock
options issued and modified. The use of this model required management to make
certain estimates for values of variables used by the model. Management
estimated the values for stock price volatility, the expected life of the equity
instruments and the risk free rate based on information that was available to
management at the time the Black-Scholes option-pricing calculations were
performed. Changes in such estimates could have a significant impact on the
estimated fair value of those equity instruments.
The Company has entered into several transactions involving the issuance
of warrants and options to purchase shares of the Company's class A common stock
to consultants, lenders, warrant holders, placement agents and other business
associates and vendors. The issuance of these securities required management to
estimate their value using the Black-Scholes option-pricing model. The
Black-Scholes option-pricing model requires management to make certain estimates
for values of variables used by the model. Management estimated the values for
stock price volatility, the expected life of the equity instruments and the risk
free rate based on information that was available to management at the time the
Black-Scholes option-pricing calculations were performed. Changes in such
estimates could have a significant impact on the estimated fair value of those
equity instruments.
In connection with the Company's April 2004 private placement, the Company
incurred fees which were paid by issuing warrants to purchase 283,170 shares of
class A common stock at an exercise price of $2.22 per share. The fair value of
the warrants was determined by management to be $255,905.
On May 30, 2003, the Company executed an Accounts Receivable Financing
Agreement ("Financing Agreement") with Silicon Valley Bank ("the Bank") with a
term of 1 year. On October 22, 2003, the Company and Silicon Valley Bank amended
the Financing Agreement to extend the term of the agreement to August 31, 2004.
In connection with the Financing Agreement, the Company issued the Bank warrants
to purchase 40,000 shares of the Company's class A common stock. The warrants
are immediately exercisable at an exercise price of $1.39 per share, equal to
the fair market value of the Company's class A common stock on the date of
closing of the Financing Agreement. The warrants are exercisable for a
seven-year period. The value of the warrants in the amount of $34,000 is being
amortized over the life of the Financing Agreement. At April 30, 2004, there was
approximately $647,000 outstanding under the financing arrangement. Subsequent
to fiscal quarter end, we repaid the entire amount outstanding as of April 30,
2004 under the Financing Agreement, eliminating our debt.
On March 10, 2003, the Company issued options to purchase 100,000 shares
of class A common stock to a non-employee member of the board of directors as
compensation for consulting services. The estimated fair value of the options
was determined by management to be $42,000. In November 2003, this individual
surrendered his 100,000 options noted above to the Company with no additional
compensation charge recorded.
23
INTERNET COMMERCE CORPORATION
The allocation of the proceeds from the sale of the series D preferred
stock and warrants issued in the Company's April 30, 2003 private placement
between the fair value of the series D preferred stock and the fair value of the
detachable warrants required management to estimate the fair value of the
warrants. Management's estimate resulted in a beneficial conversion feature in
the amount of $106,730. The discount was immediately accreted and treated as a
deemed dividend to the holder of the series D preferred as all of the series D
preferred stock was eligible for conversion upon issuance.
In connection with the private placement that closed during April and May
of 2003, the Company incurred fees which were paid by issuing warrants to
purchase 110,680 shares of class A common stock at an exercise price of $1.47
per share. The fair value of the warrants was determined by management to be
$87,800.
In connection with the acquisition of RTCI on November 6, 2000, issued and
outstanding options and warrants to purchase RTCI common stock were exchanged
for options and warrants of ICC, providing the holders the right to receive,
upon exercise, an aggregate of 394,905 shares of ICC class A common stock and
$343,456 of cash. The options and warrants were valued using the Black-Scholes
option-pricing model. The fair value of the vested portion of the options was
included in the purchase price for RTCI.
Goodwill is evaluated for impairment at least annually and whenever events
or circumstances indicate impairment may have occurred. The assessment requires
the comparison of the fair value of each of the Company's reporting units to the
carrying value of its respective net assets, including allocated goodwill. If
the carrying value of the reporting unit exceeds its fair value, the Company
must perform a second test to measure the amount of impairment. The second step
of the goodwill impairment test compares the implied fair value of reporting
unit goodwill with the carrying amount of that goodwill. The Company allocates
the fair value of a reporting unit to all of the assets and liabilities of that
unit as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the price paid to acquire the reporting
unit. The excess of the fair value of a reporting unit over the amounts assigned
to its assets and liabilities is the implied fair value of goodwill. If the
carrying amount of reporting unit goodwill exceeds the implied fair value of
that goodwill, an impairment loss is recognized by the Company in an amount
equal to that excess.
The Company estimates the fair value of its reporting units based on the
net present value of expected future cash flows. The use of this method requires
management to make estimates of the expected future cash flows of the reporting
unit and the Company's weighted average cost of capital. Estimating the
Company's weighted average cost of capital requires management to make estimates
for long-term interest rates, risk premiums, and beta coefficients. Management
estimated these items based on information that was available to management at
the time the Company prepared its estimate of the fair value of the reporting
unit. Changes in either the expected cash flows or the weighted average cost of
capital could have a significant impact on the estimated fair value of the
Company's reporting units.
During the fourth quarter of fiscal 2003, the goodwill of the Service
Bureau was tested for impairment due to a significant decline in revenues and
operating income resulting primarily from the bankruptcy of its largest
customer. The fair value of the Service Bureau reporting unit was estimated
using the net present value of expected future cash flows. An impairment of
goodwill in the amount of approximately $982,000 was recorded during the year
ended July 31, 2003.
24
INTERNET COMMERCE CORPORATION
Three Months Ended April 30, 2004 Compared with Three Months Ended April 30,
2003.
Results of Operations - Consolidated
The following table reflects consolidated operating data by reported
segments. All significant intersegment activity has been eliminated.
Accordingly, the segment results below exclude the effect of transactions with
our subsidiary.
Three Months Ended
April 30,
---------------------------
Consolidated net loss: 2004 2003 (1)
----------- ------------
ICC.NET $ (690,422) $ (931,458)
Service Bureau 28,918 (142,624)
----------- ------------
Consolidated loss $ (661,504) $ (1,074,082)
========== ============
(1) Restated to reflect the inclusion of Professional Services with
the ICC.NET segment.
Results of Operations - ICC.NET
Our ICC.NET service, the Company's global Internet-based value added
network, or VAN, uses the Internet and our proprietary technology to deliver our
customers' documents and data files to members of their trading communities,
many of which may have incompatible systems, by translating the documents and
data files into any format required by the receiver. In addition, ICC.NET
facilitates the development and operation of comprehensive business-to-business
e-commerce solutions. These professional services assist our clients to conduct
business electronically through a continuum of services including eConsulting,
data transformation mapping (EDI, EAI, XML) and internetworking. The following
table summarizes operating results for our ICC.NET service for the three months
ended April 30, 2004 and 2003:
Three Months Ended
April 30,
-------------------------------
2004 2003 (1)
--------------- -------------
Revenue:
VAN services $ 2,297,016 $ 2,204,631
Professional services 182,194 455,896
Mapping services 82,665 92,951
----------- -----------
2,561,875 2,753,478
Expenses:
Cost of services 1,395,564 1,744,943
Product development and enhancement 192,766 238,826
Selling and marketing 718,546 708,690
General and administrative 813,543 914,277
Non-cash charges for stock-based
compensation 111,939 71,818
----------- -----------
3,232,358 3,678,554
----------- -----------
Operating loss (670,483) (925,076)
Other expense, net (19,939) (6,382)
----------- -----------
Net loss $ (690,422) $ (931,458)
=========== ===========
(1) Restated to reflect the inclusion of Professional Services with
the ICC.NET segment.
Revenue - ICC.NET - Revenue related to our ICC.NET service was 89% of
consolidated revenue for the quarter ended April 30, 2004 ("2004 Quarter") and
the quarter ended April 30, 2003 ("2003" Quarter). Total ICC.NET revenue
decreased $192,000 in the 2004 Quarter from the 2003 Quarter, or approximately
7%. VAN services revenue increased $92,000, or approximately 4%, in the 2004
Quarter from the 2003 Quarter. The increase in VAN services revenue is primarily
attributable to an increase in the number of customers from approximately 1,025
in April 2003 to approximately 1,115 in April 2004. Professional Services
revenue decreased $274,000, or approximately 60%, in the 2004 Quarter from the
2003 Quarter due to a decrease in EDI educational services and seminars of
$133,000. We discontinued our EDI educational services and seminars in January
2004. In addition, our professional services decrease $141,000, or approximately
44%, in the 2004 Quarter from the 2003 Quarter due
25
INTERNET COMMERCE CORPORATION
to a continued slow demand for these services. Mapping revenue decreased
$10,000, or approximately 11%, in the 2004 Quarter from the 2003 Quarter
primarily due to a decrease in the number of customers and smaller mapping
projects resulting from the continued slow demand for these services.
Cost of services - ICC.NET - Cost of services relating to our ICC.NET
service was 54% of revenue derived from the ICC.NET service in the 2004 Quarter,
compared to 63% of such revenue in the 2003 Quarter. Cost of services related to
our ICC.NET service consists primarily of salaries and employee benefits,
connectivity fees, amortization and rent. Total cost of services decreased
$349,000 in the 2004 Quarter from the 2003 Quarter. Salaries and benefits and
fees paid to consultants decreased $277,000 in the 2004 Quarter from the 2003
Quarter, primarily due to a decrease in headcount to 26 in April 2004 from 37 in
April 2003 and a decrease in the use of consultants. In addition, travel and
entertainment decreased $28,000 in the 2004 Quarter from the 2003 Quarter due to
the completion of professional service projects requiring travel and the
discontinuance of our educational services and seminars in January 2004.
Additionally, seminar costs decreased $18,000 and severance costs decreased
$13,000 in the 2004 Quarter from the 2003 Quarter.
Product development and enhancement - ICC.NET - Product development and
enhancement costs relating to our ICC.NET service consist primarily of salaries
and employee benefits. Product development and enhancement costs decreased
$46,000 in the 2004 Quarter from the 2003 Quarter. Salaries and benefits
decreased $32,000 in the 2004 Quarter from the 2003 Quarter primarily due to a
decrease in the number of employees to 10 at the end of the 2004 Quarter from 12
at the end of the 2003 Quarter. Allocation of product development salaries
to other departments increased $12,000 in the 2004 Quarter from the 2003
Quarter.
Selling and marketing - ICC.NET - Selling and marketing expenses relating
to our ICC.NET service consist primarily of salaries and employee benefits,
travel-related costs, rent, advertising and trade-show costs. Selling and
marketing expenses related to our ICC.NET service increased $10,000 in the 2004
Quarter from the 2003 Quarter. Consulting costs increased $28,000 primarily due
to use of a consultant for trade shows. Allocation of product and development
salaries to selling and marketing departments increased $8,000 in the 2004
Quarter from the 2003 Quarter. These increases were partially offset by
forfeitures of accrued vacation of $15,000 due to a revision in the Company's
vacation policy and a decrease in commissions of $13,000 in the 2004 Quarter
from the 2003 Quarter.
General and administrative - ICC.NET - General and administrative expenses
supporting our ICC.NET service consist primarily of salaries and employee
benefits, facility costs, legal and professional fees, insurance, travel meals
and entertainment and depreciation. General and administrative costs supporting
our ICC.NET service decreased $101,000 in the 2004 Quarter from the 2003
Quarter. Legal and professional fees decreased $100,000 in the 2004 Quarter from
the 2003 Quarter due to non-recurring expenses.
Non-cash charges - ICC.NET - Of the non-cash charges of approximately
$112,000 in the 2004 Quarter, $81,000 relates to the adoption of FASB Statement
No. 123, "Accounting for Stock-Based Compensation". In January 2004, the Company
implemented a voluntary stock option exchange program under which the Company
offered to exchange certain outstanding options to purchase shares of the
Company's common stock held by eligible employees of the Company, with exercise
prices per share greater than or equal to $11.50 per share, for new options to
purchase shares of the Company's common stock. The fair value method has been
applied prospectively to all employee and director awards granted, modified, or
settled after July 31, 2003. Non-cash charges of $31,000 during the 2004 Quarter
relate to common stock to be issued to non-employee members of our board of
directors as compensation for 2004 directors' fees. Non-cash charges were
approximately $72,000 in the 2003 Quarter and are partially attributable to
common stock to be issued to non-employee members of our board of directors as
compensation for 2003 directors' fees in the amount of $31,000. In addition,
$33,000 of expense was recognized during the 2003 Quarter for common stock and
options issued to a non-employee member of our board of directors as
compensation for consulting services.
Other expense - ICC.NET - Other expense increased $14,000 in the 2004
Quarter from the 2003 Quarter. The increase is primarily attributable to an
increase in interest expense relating the Company's accounts receivable
financing agreement in the 2004 Quarter.
26
INTERNET COMMERCE CORPORATION
Results of Operations - Service Bureau
Our service bureau manages and translates the data of small and mid-sized
companies that exchange EDI data with large companies and provides various EDI
and UPC (universal product code) services. Our service bureau also licenses EDI
software. The following table summarizes operating results for our service
bureau for the three months periods ended April 30, 2004 and 2003:
Three Months Ended
April 30,
2004 2003
--------- ---------
Revenue:
Services $ 330,515 $ 340,754
--------- ---------
Expenses:
Cost of services 166,192 175,134
Impairment of capitalized software
development costs -- 133,960
--------- ---------
Total cost of services 166,192 309,094
Product development and enhancement 40,869 34,539
Selling and marketing 15,207 25,725
General and administrative 79,329 114,020
--------- ---------
301,597 483,378
--------- ---------
Operating income (loss) 28,918 (142,624)
Other income, net -- --
--------- ---------
Net income (loss) $ 28,918 $(142,624)
========= =========
Revenue - Service Bureau - Revenue related to our service bureau was 11%
of our consolidated revenue in both the 2004 and 2003 Quarters. The service
bureau's revenue was primarily generated from services performed, customer
support and licensing fees. Revenue in 2004 Quarter decreased $10,000 or 1% from
the 2003 Quarter.
Cost of services - Service Bureau - Cost of services relating to our
service bureau was 50% of revenue derived from the service bureau in the 2004
Quarter compared to 51% of such revenue in the 2003 Quarter. Cost of services
related to our service bureau consists primarily of salaries and employee
benefits, cost of software, product development allocation and rent. Cost of
services relating to our service bureau decreased $9,000 in the 2004 Quarter
primarily due to a decrease salary and employee benefits of $32,000 resulting
from a decrease in headcount to 10 in April 2004 from 14 in April 2003, and a
reduction of amortization of $3,000. This was offset by an increase in the cost
of software sold of $30,000 due to sales of a new version of third-party
software. Cost of services - impairment of capitalized software of $134,000 in
the 2003 Quarter represents an impairment of capitalized software for an
in-process project that management decided, due to unfavorable market conditions
now and in the foreseeable future, not to complete.
Product development and enhancement - Service Bureau - Product development
and enhancement costs consist primarily of salaries and employee benefits and
product development allocation to other departments. Product development and
enhancement costs incurred by our service bureau increased $9,000 in the 2004
Quarter primarily due to an increase in headcount to 4 in April 2004 from 3 in
April 2003.
Selling and marketing - Service Bureau - Selling and marketing expenses
relating to our service bureau consist primarily of salaries and employee
benefits. The decrease in selling and marketing expenses of $11,000 in the 2004
Quarter from the 2003 Quarter was primarily due to a severence payment to a
terminated employee of $9,000 in the 2003 Quarter.
27
INTERNET COMMERCE CORPORATION
General and administrative - Service Bureau - General and administrative
expenses relating to our service bureau consist primarily of salaries and
employee benefits, depreciation, rent, and office expenses. The decrease in
general and administrative expense of $35,000 in the 2004 Quarter from the 2003
Quarter is primarily attributable to a decrease in Service Bureau salaries and
employee benefits of $38,000 due to a reduction in personnel to 2 at the end of
the 2004 Quarter from 3 at the end of the 2003 Quarter.
Nine Months Ended April 30, 2004 Compared with Nine Months Ended April 30,
2003.
Results of Operations - Consolidated
The following table reflects consolidated operating data by reported
segments. All significant intersegment activity has been eliminated.
Accordingly, the segment results below exclude the effect of transactions with
our subsidiary.
Nine Months Ended
April 30,
------------------------------
Consolidated net loss: 2004(1) 2003 (1)
-------------- -----------
ICC.NET $ (2,882,394) $(3,843,776)
Service Bureau (99,784) (98,142)
-------------- -----------
Consolidated loss $ (2,982,178) $(3,941,918)
============= ===========
(1) Restated to reflect the inclusion of Professional Services with
the ICC.NET segment.
Results of Operations - ICC.NET
The following table summarizes operating results for our ICC.NET service
for the nine months ended April 30, 2004 and 2003:
Nine Months Ended
April 30,
-------------------------------
2004(1) 2003 (1)
------------ -------------
Revenue:
VAN services $ 6,772,216 $ 6,039,148
Professional services 816,484 1,324,274
Mapping services 253,065 421,343
------------ ------------
7,841,765 7,784,765
Expenses:
Cost of services 4,606,370 5,166,913
Impairment of software inventory -- 248,077
------------ ------------
Total cost of services 4,606,370 5,414,990
Product development and enhancement 580,517 717,647
Selling and marketing 2,318,178 2,201,982
General and administrative 2,603,331 2,863,211
Non-cash charges 638,025 82,235
------------ ------------
10,746,421 11,280,065
------------ ------------
Operating loss (2,904,656) (3,495,300)
Other income (expense), net 22,261 (348,476)
------------ ------------
Loss before income taxes $ (2,882,395) $ (3,843,776)
============ ============
(1) Restated to reflect the inclusion of Professional Services with
the ICC.NET segment.
Revenue - ICC.NET - Revenue related to our ICC.NET service was 90% of
consolidated revenue for the Nine Months ended April 30, 2004 ("2004 Nine
Months") compared to 87% of consolidated revenue for the Nine Months ended April
30, 2003 ("2003 Nine Months"). Total ICC.NET revenue increased $57,000 in the
2004 Nine Months from the 2003 Nine Months. VAN services revenue increased
$733,000, or approximately 12%, in the 2004 Nine Months from the 2003 Nine
Months due to an increase in customers from approximately 1,025 at April 2003 to
approximately 1,115 at April 2004 and greater transaction volume. Professional
Services revenue decreased $508,000, or approximately 38%, in the 2004 Nine
Months from the 2003 Nine Months due to a decrease in EDI
28
INTERNET COMMERCE CORPORATION
educational services and seminars of $323,000. We discontinued our EDI
educational services and seminars in January 2004. In addition, revenue from our
professional services decreased $185,000 in the 2004 Nine Months from the 2003
Nine Months due to continued slow demand for these services due to these types
of activities being performed in-house by potential customers and by a highly
competitive environment. Mapping revenue decreased $168,000, or approximately
40%, in the 2004 Nine Months from the 2003 Nine Months due primarily to
continued slow demand for these services resulting from overseas competition.
Cost of services - ICC.NET - Cost of services relating to our ICC.NET
service was 59% of revenue derived from the ICC.NET service in the 2004 Nine
Months, compared to 66% of such revenue in the 2003 Nine Months. Cost of
services related to our ICC.NET service consists primarily of salaries and
employee benefits, connectivity fees, amortization, product development
allocation and rent. The decrease in cost of services of $561,000 in the 2004
Nine Months from the 2003 Nine Months was primarily the result of a decrease in
salaries and benefits and fees paid to consultants of $572,000 in the 2004 Nine
Months from the 2003 Nine Months because of a decrease in headcount to 26 in
April 2004 from 37 in April 2003 and a decrease in the use of consultants due to
fewer professional services projects requiring the use of consultants. Cost of
services - impairment of software inventory of $248,000 in the 2003 Nine Months
represents an impairment of software inventory resulting from insufficient
historical and projected revenue from these products to support the
recoverability of that carrying value.
Product development and enhancement - ICC.NET - Product development and
enhancement costs relating to our ICC.NET service consist primarily of salaries
and employee benefits. Product development and enhancement costs decreased
$137,000 in the 2004 Nine Months from the 2003 Nine Months. Salaries and
benefits decreased $81,000 in the 2004 Nine Months from the 2003 Nine Months
primarily due to a decrease in the number of employees to 10 at the end of the
2004 Nine Months from 12 at the end of the 2003 Nine Months. Additionally,
allocation of product development salaries to non-development departments
increased $45,000 in the 2004 Nine Months from the 2003 Nine Months.
Selling and marketing - ICC.NET - Selling and marketing expenses relating
to our ICC.NET service consist primarily of salaries and employee benefits,
travel-related costs, rent, advertising and trade-show costs. Selling and
marketing expenses related to our ICC.NET service increased $116,000 in the 2004
Nine Months from the 2003 Nine Months. Rent increased $58,000 in the 2004 Nine
Months from the 2003 Nine Months due primarily to a distribution of rent to
selling and marketing departments in the 2004 Nine Months. Additionally,
consulting costs increased $48,000 primarily due to the use of a consultant for
trade shows, and outside commissions increased $35,000 due to an increase in the
use of outside sales agents in the 2004 Nine Months from the 2003 Nine Months.
In addition, travel and entertainment increased $18,000 in the 2004 Nine Months
from the 2003 Nine Months due to more travel to sales calls and trade shows.
These increases were partially offset by forfeitures of accrued vacation due to
a revision to the Company's vacation policy of $52,000 in the 2004 Nine Months
from the 2003 Nine Months.
General and administrative - ICC.NET - General and administrative expenses
supporting our ICC.NET service consist primarily of salaries and employee
benefits, facility costs, legal and professional fees, insurance, travel, meals
and entertainment and depreciation. General and administrative costs supporting
our ICC.NET service decreased $260,000 in the 2004 Nine Months from the 2003
Nine Months. Depreciation decreased $149,000 in the 2004 Nine Months primarily
as a result of fewer assets being acquired and more assets becoming fully
depreciated. In addition, investor relation fees decreased $78,000 resulting
from discontinuing the use of an external public relations firm and performing
the public relations function in house and from a decrease in state corporate
taxes of $71,000 in the 2004 Nine Months from the 2003 Nine Months. Fees paid to
Nasdaq decreased $64,000 in the 2004 Nine Months from the 2003 Nine Months due
primarily to fees incurred for initial listing on the Nasdaq SmallCap Market in
the 2003 Nine Months. These decreases were partially offset by increases in
salary and employee benefits of $127,000 due primarily to strengthening of
executive management through the addition of a new Chief Executive Officer and
Chief Operating Officer.
Non-Cash charges - ICC.NET - Of the non-cash charges of approximately
$638,000 in the 2004 Nine Months, $534,000 relates to the adoption of FASB
Statement No. 123, "Accounting for Stock-Based Compensation". In January 2004,
the Company implemented a voluntary stock option exchange program under which
the Company offered to exchange certain outstanding options to purchase shares
of the Company's common stock held by eligible employees of the Company, with
exercise prices per share greater than or equal to $11.50 per share, for new
options to purchase shares of the Company's common stock. The fair value method
has been applied prospectively to all employee and director awards granted,
modified, or settled after July 31, 2003. Non-cash charges of $104,000 during
the 2004 Nine Months relate to common stock to be issued to non-employee members
of our board of directors as compensation for 2004 directors' fees. Non-cash
charges of $82,000 in the 2003 Nine Months relate in part to common stock issued
to non-employee members of our board of directors as compensation for 2003
directors' fees in the amount of $41,000. In addition, $33,000 of expense was
recognized during the 2003 Nine Months for
29
INTERNET COMMERCE CORPORATION
common stock and options issued to a non-employee member of our board of
directors as compensation for consulting services.
Other income (expense) - ICC.NET - Other income increased $371,000 in the
2004 Nine Months from the 2003 Nine Months. The increase is primarily
attributable to a charge in the 2003 Nine Months of $318,000 for the impairment
of available-for-sale marketable securities due to a non-temporary decline in
value. In addition, the Company realized a gain on the sale of marketable
securities of $68,000 in the 2004 Nine Months compared to loss on the sale of
marketable securities of $19,000 in the 2003 Nine Months.
Results of Operations - Service Bureau
The following table summarizes operating results for our Service Bureau
for the nine months ended April 30, 2004 and 2003:
Nine Months Ended
April 30,
------------------------------
2004 2003
-------------- -------------
Revenue:
Services $ 909,708 $ 1,196,649
----------- -----------
Expenses:
Cost of services 566,681 560,701
Impairment of capitalized software
development costs 44,983 133,960
----------- -----------
Total costs of services 611,664 694,661
Product development and enhancement 105,122 111,506
Selling and marketing 53,152 118,049
General and administrative 239,553 370,575
----------- -----------
1,009,491 1,294,791
----------- -----------
Operating loss (99,783) (98,142)
Other income, net -- --
----------- -----------
Loss before income taxes $ (99,783) $ (98,142)
=========== ===========
Revenue - Service Bureau - Revenue related to our Service Bureau was 10%
of our consolidated revenue in the 2004 Nine Months compared to 13% of
consolidated revenue in the 2003 Nine Months. The service bureau's revenue was
primarily generated from services performed, customer support and licensing
fees. The decrease in revenue of $287,000, or 24%, was primarily the result of a
decrease in its EDI service business attributable to the loss of several large
customers offset by additional revenue from existing customers.
Cost of services - Service Bureau - Cost of services relating to our
Service Bureau was 62% of revenue derived from the service bureau in the 2004
Nine Months, compared to 47% of revenue derived from the service bureau in the
2003 Nine Months. Cost of services related to our service bureau consists
primarily of salaries and employee benefits, product development allocation,
costs of software and rent. Cost of services increased $6,000 in the 2004 Nine
Months due to sales of a new version of third-party software and a $32,000
increase in the allocation of salaries and employee benefits from the product
development department due to a greater number of projects requiring product
development and enhancement personnel. These increases were partially offset by
lower salaries and benefits of $63,000, primarily due to a decrease in headcount
to 10 in April 2004 from 14 in April 2003, and a $21,000 decrease in
amortization expense. Cost of services - impairment of capitalized software of
$45,000 in the 2004 Nine Months and $134,000 in the 2003 Nine Months represent
impairment of capitalized software for in-process projects that management
decided, due to unfavorable market conditions now and in the foreseeable future,
not to complete.
Product development and enhancement - Service Bureau - Product development
and enhancement costs consist primarily of salaries and employee benefits,
product development allocation to other departments and rent. Product
development and enhancement costs incurred by our service bureau decreased
$6,000 in the 2004 Nine Months from the 2003 Nine Months. This decrease was
primarily attributable to an increase of $36,000 in the allocation of salaries
and employee benefits from the product development and enhancement department to
the cost of service department for non-development work.
30
INTERNET COMMERCE CORPORATION
This was offset by $16,000 in capitalized labor costs for developed software in
the 2003 Nine Months with no amounts capitalized in the 2004 Nine Months.
Additionally, salary and employee benefits increased $13,000 in the 2004 Nine
Months primarily due to an increase in headcount to 4 in April 2004 from 3 in
April 2003.
Selling and marketing - Service Bureau - Selling and marketing expenses
relating to our service bureau consist primarily of salaries and employee
benefits. Selling and marketing decreased $65,000 in the 2004 Nine Months from
the 2003 Nine Months primarily due to a decrease in salaries and employee
benefits of $54,000 as of result of a decrease in headcount to 1 in 2004 Nine
Months from 3 in 2003 Nine Months, and $14,000 in severance payments in the 2003
Nine Months compared to no severance payments in the 2004 Nine Months.
General and administrative - Service Bureau - General and administrative
expenses relating to our service bureau consist primarily of salaries and
employee benefits, intercompany allocations, depreciation, rent, telephone and
office expenses. The decrease in general and administrative expenses of $131,000
in the 2004 Nine Months from the 2003 Nine Months is primarily attributable to a
decrease in salaries and employee benefits of $158,000 as a result of a staff
reduction to 2 employees in the 2004 Nine Months from 4 employees in the 2003
Nine Months. In addition, depreciation expense decreased $18,000 in the 2004
Nine Months from the 2003 Nine Months as a result of fewer assets being acquired
and more assets becoming fully depreciated resulting in a lower depreciable
base. This was partially offset by an increase of $45,000 in general and
administrative support staff salary and benefits allocated by ICC.NET to the
Service Bureau in the 2004 Nine Months.
Liquidity and Capital Resources
Our principal sources of liquidity, which consist of unrestricted cash and
cash equivalents, increased to $4,989,000 as of April 30, 2004 from $2,375,000
as of July 31, 2003.
Competitive or other factors described under the heading "Risk Factors"
included in our annual report on Form 10-K for the year ended July 31, 2003 may
prevent us from achieving positive cash flow from operations, and therefore, we
may need to undertake additional cost reduction activities or raise additional
capital. There can be no assurance that additional capital, if required, will be
available to us on reasonable terms or at all.
On April 20, 2004, the Company completed a private placement of common
stock and warrants to purchase shares of common stock (the "2004 Private
Placement") that provided aggregate gross proceeds of approximately $4,955,000.
In the 2004 Private Placement the Company sold 2,831,707 shares of class A
common stock and warrants to purchase 849,507 shares of our class A common
stock. These warrants are exercisable for five years commencing on October 20,
2004 at an exercise price of $2.22 per share.
In connection with the 2004 Private Placement, the Company incurred fees
and expenses of $713,602, of which $423,274 was paid in cash at closing, $64,423
is payable in cash and $225,905 was paid by issuing warrants to purchase 283,170
shares of class A common stock. These warrants have substantially the same terms
as the warrants issued in the 2004 Private Placement. No directors, officers or
entities with which the Company's directors, or officers are affiliated
participated in the 2004 Private Placement.
31
INTERNET COMMERCE CORPORATION
These proceeds will be used for funding growth initiatives and general
working capital, which may include any agreements we may enter into with
Microsoft Corporation.
During April and May 2003, the Company completed a private placement of
common stock, convertible preferred stock and warrants to purchase shares of
common stock (the "2003 Private Placement") for aggregate gross proceeds of
approximately $2,085,000.
In the 2003 Private Placement the Company sold 1,682,683 shares of class
A common stock and warrants to purchase 1,346,140 of class A common stock
providing gross proceeds of approximately $1,835,000 and 250 shares of series D
convertible redeemable preferred stock ("series D preferred") and warrants to
purchase 153,845 shares of class A common stock for $250,000. All warrants are
immediately exercisable and have an exercise price of $1.47 per share. The
warrants are exercisable until the fifth anniversary of the date of issuance. In
addition, the warrants are redeemable at the Company's option, if the closing
bid price of the Company's class A common exceeds 200% of the exercise price of
the warrants for 30 consecutive trading days. The redemption price is $0.10 per
share for each share issuable under the warrants.
The 250 shares of series D preferred are convertible into 192,307 shares
of class A common stock. The allocation of the proceeds from the sale of the
series D preferred between the fair value of the series D and the fair value of
the detachable warrants resulted in a beneficial conversion feature in the
amount of $106,730. The discount was immediately accreted and treated as a
deemed dividend to the holder of the series D preferred as all of the series D
preferred was eligible for conversion upon issuance.
In connection with the 2003 Private Placement, the Company incurred fees
of $325,750, of which $237,938 was payable in cash and $87,802 was paid by
issuing warrants to purchase 110,680 shares of class A common stock. These
warrants have substantially the same terms as the warrants issued in the 2003
Private Placement.
In connection with the 2003 Private Placement, the Company issued 48,076
shares of class A common stock and warrants to purchase 38,460 shares of class A
common stock in settlement of certain outstanding payables. The common stock and
warrants were valued at $50,000, the invoice amount of the services provided to
the Company.
Approximately 21%, or $432,000, of the gross proceeds from the 2003
Private Placement was received from directors and officers and entities with
which the Company's directors are affiliated.
On May 30, 2003, the Company executed an Accounts Receivable Financing
Agreement ("Financing Agreement") with Silicon Valley Bank ("the Bank") with a
term of one year. Under the Financing Agreement, the Company may borrow, subject
to certain conditions, up to 80% of its outstanding accounts receivable up to a
maximum of $2,000,000. The applicable interest rate is the prime rate plus .35%
plus a collateral handling fee equal to .20% on the average daily outstanding
receivable balance, and interest is payable monthly. The Financing Agreement
contains certain restrictive covenants that are customary for a commercial
transaction of this type, including, without limitation, restrictions on the
disposition or encumbrance of the collateral pledged to the Bank, restrictions
on incurring additional indebtedness and restrictions on the payment of
dividends and the redemption or repurchase of any capital stock. In addition,
the Company is required to maintain at all times a ratio of Quick Assets (i.e.,
consolidated, unrestricted cash, cash equivalents, net accounts receivable and
investments with maturities of fewer than 12 months determined according to
GAAP) to Current Liabilities (i.e., all obligations and liabilities of the
Company to Bank, plus, without duplication, the aggregate amount of the
Company's total liabilities which mature within one (1) year) minus Deferred
Revenue (i.e., all amounts received in advance of performance under contracts
and not yet recognized as revenue) of at least 1.10 to 1.0. The Bank has been
granted a security interest in substantially all of the Company's assets. In
connection with the Financing Agreement, the Company issued the Bank warrants to
purchase 40,000 shares of the Company's class A common stock. The warrants are
immediately exercisable at an exercise price of $1.39, equal to the fair market
value of the Company's class A common stock on the date of closing of the
Financing Agreement. The warrants are exercisable for a seven-year period. The
fair value of the warrants in the amount of approximately $34,000 will be
amortized to interest expense over the term of the Financing Agreement. During
the three and nine-month periods ended April 30, 2004 the Company recorded
interest expense in the amount of approximately $8,300 and $25,500,
respectively, for the amortization of the fair value of the warrants. On October
22, 2003, the Company and the Bank amended the Financing Agreement to
32
INTERNET COMMERCE CORPORATION
extend the term of the agreement to August 31, 2004. At April 30, 2004, there
was approximately $647,000 outstanding under the Financing Agreement. Subsequent
to April 30, 2004, we repaid the entire amount outstanding as of April 30, 2004
under the Financing Agreement, eliminating our debt.
We have a net operating loss carryforward of approximately $75 million to
offset future taxable income for federal income tax purposes. The utilization of
the loss carryforward to reduce any such future income taxes will depend on our
ability to generate sufficient taxable income prior to the expiration of the net
operating loss carryforwards. The carryforward expires from 2007 to 2021. The
Internal Revenue Code of 1986, as amended, and the regulations promulgated
thereunder contain provisions which limit the use of available net operating
loss carryforwards in any given year should significant changes (greater than
50%) in ownership interests occur. Due to the IPO, the net operating loss
carryover of approximately $1.9 million incurred prior to the IPO is subject to
an annual limitation of approximately $400,000 until that portion of the net
operating loss is utilized or expires. Due to our private placement of series A
preferred stock in April 1999, the net operating loss carryover of approximately
$18 million incurred prior to the private placement is subject to an annual
limitation of approximately $1 million until that portion of the net operating
loss is utilized or expires. Also, due to the 100% ownership change when we
acquired RTCI, RTCI's net operating loss of approximately $6.5 million incurred
prior to the ownership change is subject to an annual limitation of
approximately $1.4 million until that portion of the net operating loss is
utilized or expires.
Consolidated Working Capital
Consolidated working capital increased to $4,937,000 at April 30, 2004
from $1,700,000 at July 31, 2003. This increase is due to a $2,613,000 increase
in cash and marketable securities, and a decrease of $845,000 in accounts
payable and accrued expenses as well as continued operating losses during the
2004 Nine Months. In addition, at April 30, 2004, the Company had outstanding
short-term borrowings of $647,000 under its Accounts Receivable Financing
Agreement. There were no amounts outstanding under this Agreement at July 31,
2003.
Analysis of Cash Flows
Cash used in operating activities was $2,355,000 in the 2004 Nine Months
compared to $1,544,000 in the 2003 Nine Months. The increase in the 2004 Nine
Months is primarily the result of decreases in accounts payable and accrued
expense of $847,000 and continued cash operating losses. Excluding the effects
of a collection from Triaton of a receivable for $1,500,000 in October 2002,
cash used in operating activities would have decreased by $689,000 in the 2004
Nine Months from the 2003 Nine Months. The cash used in operating activities
during the 2003 Nine Months was primarily the result of cash operating losses
during the 2003 Nine Months and a decrease in accounts payable and accrued
expenses of $743,000 offset by the collection from Triaton of a receivable of
$1,500,000 in October 2002.
Cash provided by investing activities increased to $74,000 in the 2004
Nine Months from $16,000 used in investing activities in the 2003 Nine Months.
Cash provided by investing activities in the 2004 Nine Months primarily resulted
from the sale of marketable securities of $134,000 offset by expenditures from
the purchase of property and equipment of $60,000. Cash used in investing
activities in the 2003 Nine Months was primarily the result of $55,000 of
proceeds from the sale of marketable securities, offset by the purchases of
property and equipment of $56,000 and capitalized software of $16,000.
Cash provided by financing activities was $4,986,000 in the 2004 Nine
Months compared to $1,750,000 in the 2003 Nine Months. Cash provided by
financing activities in the 2004 Nine Months is primarily the result of net
proceeds from the issuance of common stock and warrants of $4,468,000 and
financing agreement borrowing of $647,000, offset by payments of capital leases
of $115,000. Cash provided by financing activities in the 2003 Nine Months was
primarily due to the net proceeds of approximately $1,704,000 from the April
private placement and subscription received in advance for common stock and
warrants of $195,000, offset by payments of capital leases of $149,000.
Recent Accounting Pronouncements
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 supersedes Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition
33
INTERNET COMMERCE CORPORATION
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS 146 requires that
costs associated with an exit or disposal plan be recognized when incurred
rather than at the date of a commitment to an exit or disposal plan. SFAS 146 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002. The Company adopted SFAS 146 on January 1, 2003. The adoption
of this standard did not have a significant impact on the Company's consolidated
financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others" which elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of Interpretation
No. 45 are applicable on a prospective basis to guarantees issued or modified
after December 31, 2002. The disclosure requirements in this Interpretation are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The Company has provided information regarding commitments
and contingencies relating to guarantees in Note 9. The adoption of this
standard did not have a significant impact on the Company's consolidated
financial position or results of operations.
In November 2002, the Emerging Issues Task Force of the FASB ("EITF")
reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple
Deliverables." EITF 00-21 addresses certain aspects of the accounting by a
vendor for arrangements under which the vendor will perform multiple revenue
generating activities. The EITF was effective for revenue arrangements entered
into in fiscal years and interim periods beginning after June 15, 2003. The
adoption of this consensus, effective August 1, 2003, did not have a significant
impact on the Company's consolidated financial position or results of
operations.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123"
("SFAS 148"). SFAS 148 amends SFAS 123, "Accounting for Stock-Based
Compensation" to provide alternative methods to account for the transition from
the intrinsic value method of recognition of stock-based employee compensation
in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees" to the fair value recognition provisions under SFAS 123. SFAS 148
provides two additional methods of transition and will no longer permit the SFAS
123 prospective method to be used for fiscal years beginning after December 15,
2003. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to
require prominent disclosure in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
pro-forma effects had the fair value recognition provisions of SFAS 123 been
used for all periods presented. The adoption of SFAS 148 did not have a
significant impact on the Company's consolidated financial position and results
of operations. The Company adopted the fair-value recognition provisions of SFAS
123 in January 2004 (Note 6).
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("Interpretation No. 46") and in December 2003
issued FIN No. 46 (Revised) ("FIN 46R") to address certain FIN 46 implementation
issues. FIN 46R also requires additional disclosures by primary beneficiaries
and other significant variable interest holders. Interpretation No. 46 clarifies
the application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The Company adopted
Interpretation No. 46 on January 31, 2003. The adoption of this standard did not
have a significant impact on the Company's consolidated financial position or
results of operations.
34
INTERNET COMMERCE CORPORATION
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"), which amends and
clarifies accounting for derivative instruments and for hedging activities under
SFAS 133. Specifically, SFAS 149 requires that contracts with comparable
characteristics be accounted for similarly. Additionally, SFAS 149 clarifies the
circumstances in which a contract with an initial net investment meets the
characteristics of a derivative and when a derivative contains a financing
component that requires special reporting in the statement of cash flows. This
Statement is generally effective for contracts entered into or modified after
June 30, 2003 and did not have a significant impact on the Company's
consolidated financial position or results of operations.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise shall be
effective at the beginning of the first interim period beginning after June 15,
2003. For financial instruments created before the issuance date of this
Statement and still existing at the beginning of the interim period of adoption,
transition shall be achieved by reporting the cumulative effect of a change in
an accounting principle by initially measuring the financial instruments at fair
value or other measurement attribute required by this Statement. The adoption of
this Statement, effective August 1, 2003, did not have a material impact on the
Company's consolidated financial position or results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is primarily exposed to interest rate risk and credit risk.
Interest Rate Risk - Interest rate risk refers to fluctuations in the
value of a security resulting from changes in the general level of interest
rates. Investments that are classified as cash and cash equivalents have
original maturities of three months or less. Changes in interest rates may
affect the value of these investments.
Credit Risk - Our accounts receivables are subject, in the normal course
of business, to collection risks. We regularly assess these risks and have
established policies and business practices to protect against the adverse
effects of collection risks. As a result we do not anticipate any material
losses in this area.
Item 4. Controls and Procedures
Our management, including our chief executive officer and our principal
accounting officer, have carried out an evaluation of the effectiveness of our
disclosure controls and procedures as of April 30, 2004, pursuant to Exchange
Act Rules 13a-15(e) and 15(d)-15(e). Based upon that evaluation, our chief
executive officer and our principal accounting officer have concluded that as of
such date, our disclosure controls and procedures in place are adequate to
ensure material information and other information requiring disclosure is
identified and communicated on a timely basis.
35
INTERNET COMMERCE CORPORATION
PART II. OTHER INFORMATION
- -------- -----------------
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3: Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
31.1 Certificate of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certificate of the Corporate Controller (Principal Accounting
Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Corporate Controller (Principal Accounting
Officer) pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
Current Report on Form 8-K dated March 16, 2004 (Items 5, 7 and 12).
Current Report on Form 8-K dated March 31, 2004 (Items 5 and 7).
Current Report on Form 8-K dated April 6, 2004 (Items 5 and 7).
Current Report on Form 8-K dated April 20, 2004 (Items 5 and 7).
36
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.
Date: June 18, 2004
INTERNET COMMERCE CORPORATION
by: /s/ Thomas Stallings
-----------------------------------
Thomas Stallings
Chief Executive Officer
by: /s/ Michael E. Piccininni
-----------------------------------
Michael E. Piccininni
Corporate Controller
(Principal Accounting Officer)
37