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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| Annual report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the fiscal year ended July 31, 2004
OR
|_| Transition report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the transition period from ____ to ____
Commission File 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)
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(212) 271-7640
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(Registrants telephone number, including area code)
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Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Class A Common Stock, $.01 par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X|No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|
As of October 27, 2004 the issuer had outstanding 19,057,230 shares of
Class A Common Stock. The aggregate market value of the Class A Common Stock
held by non-affiliates as of October 28, 2004 was approximately $15,756,865,
based on a closing price for the Class A Common Stock of $0.93 on the Nasdaq
SmallCap Market on that date.
DOCUMENTS INCORPORATED BY REFERENCE
The information required to be filed by Part III (Items 10, 11, 12, 13 and
14) is incorporated by reference from portions of the Registrant's proxy
statement in connection with its 2004 Annual Meeting of Stockholders. The
Compensation Committee Report, Stock Performance Graph and Audit Committee
Report of the Registrant's proxy statement are expressly not incorporated herein
by reference.
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INTERNET COMMERCE CORPORATION
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I ................................................................. 1
Item 1. Business................................................. 1
Item 2. Properties............................................... 12
Item 3. Legal Proceedings........................................ 12
Item 4. Submission of Matters to a Vote of Security
Holders................................................ 12
PART II ................................................................. 13
Item 5. Market for Internet Commerce Corporation's Common
Equity and Related Stockholder Matters................. 13
Item 6. Selected Consolidated Financial Data..................... 15
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......... 16
Risk Factors............................................. 35
Item 7A.Quantitative and Qualitative Disclosures About
Market Risk............................................ 40
Item 8. Financial Statements and Supplementary Data.............. 41
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................. 41
Item 9A. Controls and Procedures................................. 41
Item 9B. Other Information....................................... 41
PART III ................................................................. 42
Item 10. Directors and Executive Officers ....................... 42
Item 11. Executive Compensation.................................. 42
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................ 42
Item 13. Certain Relationships and Related Transactions.......... 42
Item 14. Principal Accounting Fees and Services.................. 42
PART IV ................................................................. 43
Item 15. Exhibits, Financial Statement Schedules and
Signatures............................................ 43
PART I
Item 1. Business
This annual report on Form 10-K 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 annual 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 annual
report, the words "anticipate," "believe," "estimate," "expect," "may," "will,"
"hope," "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 starting on page 35 of this
annual report under the heading "Risk Factors" and in our registration
statements and periodic reports filed with the Securities and Exchange
Commission 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
annual report as anticipated, believed, estimated, expected, hoped or intended.
References in this annual report to "ICC," "we," "us," and "our" refer to
Internet Commerce Corporation and our wholly-owned subsidiaries on a
consolidated basis, unless otherwise stated.
Overview
Internet Commerce Corporation is a pioneer in the use of the Internet for
business-to-business (B2B) e-commerce solutions. Thousands of customers rely on
our solutions, expertise and support to help balance cost, fit and function
required to meet their individual requirements for coordinating communications
with their trading partners in compliance with the specifications of their
trading partners. We are a trusted provider of business-to-business solutions to
businesses, regardless of size and level of technical sophistication. With our
sophisticated technological capabilities, industry-focused initiatives and
expertise, focus on business requirements and an expert support team, we help
enable our customers' strategies to conduct business electronically.
Organizationally, our operations are comprised of two segments:
o ICC.NET(TM) segment
o Service Bureau segment
These segments are complementary to each other and support our ability to
provide solutions to many different kinds of enterprises, from sole
proprietorships to large corporations, operating in a variety of industries and
business model formats.
Our principle executive offices are located at 805 Third Avenue, Ninth
Floor, New York, New York 10022, and our telephone number at that location is
212-271-7640. We plan to relocate our executive offices to Atlanta, Georgia in
January, 2005. See "Property."
Industry Background
During the past decade, enterprises have focused on improvement within
their "four walls" to enhance revenue growth, cash flow and asset productivity.
This focus led to substantial investment in enterprise systems and other
technologies that enable an "internally-aligned" business model to streamline
processes and maximize efficiencies of supply chain operations. As organizations
aligned their business models for internal supply chain effectiveness, they
began to recognize that looking beyond their "four walls" was necessary to
continue to broaden supply chain connections.
To that end, businesses started to establish strategies and programs to
extend and manage supply chain processes outside the "four walls" of their
enterprises. A critical requirement for those initiatives was the creation of a
networked system in which trading partners could transmit information to and
from one another in a secure and reliable manner.
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The requirement to create and support this network led to the emergence of
technology companies that developed core competencies in business-to-business
connectivity. Those core competencies have evolved over time to exploit the
Internet to handle information exchange requirements consistently, securely,
reliably and efficiently, including:
o Exchange of real-time transactions electronically;
o Compliance with unique hub specific and industry-specific standards;
o Conformity to the requirements for use of radio frequency
identification devices chips and synchronized product data; and
o Communication with and management of trading partners of all sizes.
Company Background
Internet Commerce Corporation was incorporated in the State of Delaware in
1991 under the name Infosafe Systems, Incorporated.
ICC combines knowledge of procurement processes, expertise in electronic
data interchange (EDI), and capabilities of the Internet for
business-to-business transaction workflows. As a pioneer in the use of the
Internet for business-to-business e-commerce solutions, we exploited the
Internet's capabilities to enable trading partners to exchange information just
as the Internet was entering mainstream commerce. We were able to offer
e-commerce solutions with significantly more user benefits at a lower price than
the competition. We believe that our entrance into a traditional market changed
the dynamics of the industry.
Initially, we offered complementary products and services designed to
enable paperless electronic commerce among trading partners. Our flagship
service, the ICC.NET value added network, was the mechanism to launch and grow
our revenues.
Through July 2000, we were entirely focused on ICC.NET value added network
services that allowed for the secure exchange of business-to-business electronic
forms and data files. Recognizing that the market required a more complete range
of services, we made two acquisitions during fiscal year 2001, as follows:
o We acquired Intercoastal Data Corporation (IDC) in August 2000 for
its service bureau; and
o We acquired Research Triangle Commerce Incorporated (RTCI) in
November 2000 for its professional services.
These acquisitions enabled us to offer a range of services to support
customers seeking to expand their e-commerce trading communities and to bridge
legacy systems to the Internet. With these newly acquired businesses, we were
able to offer complementary services that furthered our image in the industry
and expanded our business model.
This year, we began to realign our business with the cessation of a
non-profitable service and the investment in a strategic growth opportunity.
o We ceased providing our e-commerce and electronic data interchange
education and training services in February 2004.
o We acquired Electronic Commerce Systems, Inc. (ECS) in June 2004 for
its service bureau and software products.
With the ECS acquisition, our focus broadened from selling value added
network services and we expanded our ability to provide e-commerce solutions.
ECS provides Internet-based services, software and service bureau services for
the e-commerce business-to-business communication service market.
Business Strategy
Our objective is to extend our position as an innovator and leader in
business-to-business connectivity and communication. We hope to achieve this
objective by delivering software, services and solutions that help our customers
successfully interconnect and exchange information electronically. To accomplish
our objectives, we employ the following strategies in both our business
segments:
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o Develop innovative offerings. In order to provide on-going value to
our customers, we continue to focus our product development
resources on the enhancement of existing offerings and the
development of new offerings that address evolving market needs and
industry standards. We intend to develop superior and broad
solutions, founded upon innovation, to address all aspects of
trading community enablement and management.
o Increase brand awareness. We have an integrated marketing approach,
which is designed to employ and interweave a variety of marketing
disciplines with a consistent delivery of marketing messages. By
instituting an integrated approach to different media and
distribution points, we hope to build awareness and reputation and
achieve sustainability and coverage over time.
o Provide a single point of accountability for trading communities.
Our range of products and services offer the functionality and
scalability to enable trading partners of different sizes with
unique business models, diverse company infrastructures and various
levels of technical sophistication to electronically transport,
route and deliver information seamlessly, reliably and securely,
regardless of communication protocol or data format.
o Expand strategic alliances and indirect sales channels. We are
establishing and expanding strategic alliances and partnerships in
order to generate business growth outside the United States. By
leveraging complementary technologies, business resources and
diverse domain expertise, we have the opportunity to expand our
offerings in the marketplace, increase our value to customers and
extend our reach into new industries.
o Acquire or invest in complementary businesses. We intend to pursue
acquisitions that provide us with complementary service offerings,
expand our geographic presence and distribution channels and/or
further solidify our competitive position.
Products and Services
We provide offerings that enable a long-term relationship, add value to
ever-evolving supply chain structures, and offer migration paths for business
model evolutions. With our broad range of offerings, we offer solutions that
power and optimize reliable, secure, and real-time transaction workflows within
and across trading communities.
ICC.NET Segment
Network Services. ICC.NET is a complete value added network (VAN) solution
which meets electronic data interchange requirements in a secure, reliable,
available and flexible environment - all at an affordable price to enable the
movement of information seamlessly and efficiently and expedite transaction
processing regardless of file size, communication protocol or data format.
Our ICC.NET basic service includes:
o Alert System: ICC.NET provides proactive alerts to document
processing events, transmission issues or delivery receipts. The
alerts are received by the customer based on the preferred method
for communication: email, text messaging or fax. With ICC.NET's
real-time alert system, our customers are able to respond to their
trading partners and address critical supply chain events
immediately.
o Archival Storage: ICC.NET archives the information sent and received
on-line for a period of 30 days and off-line for several years.
ICC.NET's archival storage provides our customers with a safety net
should they need to resend or review a document or data. A longer
on-line archival period is available with our ICC.ARCHIVE service
capabilities.
o Audit Trails: ICC maintains detailed audit trails of all set-up,
configuration and document transmission events. By accessing audit
trail information, ICC's Technical Support team has the ability to
conduct the analysis required to answer questions and address
issues.
o Connectivity Options: ICC.NET provides a variety of communications
options. FTP communications is included with the basic service.
Other options are available with our ICC.COMMS service capabilities.
With ICC.NET's connectivity options, our customers can select from
multiple communication protocols and options to ensure effective
communications within a trading community of diverse communication
protocols and security standards.
o Information Transmission and Exchange: ICC.NET improves the basic
infrastructure of electronic communications by providing intelligent
messaging and real-time routing using the Internet, which
incorporates the speed, security, reliability, ease-of-use and
flexibility for our customers' business-to-business connectivity.
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o Platform and Standard Independence: ICC.NET enables trading partners
with unique business models, diverse company infrastructures and
various levels of technical sophistication to transport, route and
deliver information seamlessly, reliably and securely regardless of
IT infrastructure, communication protocol or data format.
o Protected Data Center: ICC.NET's redundant servers are housed in the
facility built for the New York and American Stock Exchanges.
ICC.NET servers are secured by guards 24 hours a day, seven days a
week, every day of the year, "man-trap" doorways and card-key
access. All visitors to the facility must be personally escorted at
all times.
o Real-time Data Transmission: ICC.NET delivers information in
real-time, on a schedule or on an ad-hoc basis for customers and
their trading partners. Real-time transmission reduces the problems
inherent in batch delivery, such as the potential for corruption of
data and time delays in delivery.
o Reporting: ICC.NET provides a wide selection of on-line, real-time
reports. Reports may be accessed on-line or batch and delivered to
our customers through a browser, email or EDI system.
o Reliable and Secure Transmission: ICC.NET offers a variety of
industry-standard encryption solutions to provide secure and
reliable transmissions over high-speed connections to the Internet.
Every transaction is authenticated and provides for non-repudiation
to secure supply chain communications.
o Technical Support: We provide U.S. based support representatives, 24
hours a day, seven days a week, every day of the year to set up
accounts, initiate proactive communications, solve problems or
answer questions.
o Web-based document manager: ICC.NET enables customers to the view
time stamp documents and transaction events through the use of our
real-time java-applet. The applet offers control over data,
including the flexibility to acknowledge, view, send, receive, hold,
release, sort or search documents and other data files.
Charges for our ICC.NET service are based upon the amount information that
customers transmit through our network to their trading partners.
For additional fees, our ICC.NET service can be extended with service
capabilities that augment the basic services and meet requirements that are
unique to businesses or trading communities. Those services are priced in
various ways, depending upon the service selected, and include:
o ICC.ARCHIVE: We support extended on-line archiving beyond the
standard 30 day period.
o ICC.CATALOG: We provide a fully-capable, VICS compliant EDI catalog
system with full EDI support as well as browser-based web
capability.
o ICC.COMMS: We offer a variety of customized communication options
including Internet-based, AS2 and browser-based accessibility with
added security provided by VPN, PGP and frame relay to meet unique
communication requirements.
o ICC.CONNECT: We connect to more than 50 private networks, public
interconnects, exchanges, service bureaus and value added networks.
o ICC.DATA SYNC: ICC.NET, which has received industry-standard
approval and certification for UCCnet(TM) services, is capable of
transforming and transmitting global data synchronization attributes
to and from the UCCnet data pool.
o ICC.FAX: We provide real-time and cost-effective EDI-to-fax
capabilities for any document to any fax machine worldwide.
o ICC.INFOSAFE(TM): We enable the publishing of virtually any file
type to a large number of subscribers effectively and efficiently.
o ICC.MBN: We provide an EDI gateway service to bridge Microsoft
Business Network customers to their EDI-enabled trading partners.
o ICC.TRANSLATE: We provide in-line translation capabilities for any
data format, including EDI, flat file, XML and many others.
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Managed Services. We offer a wide-range of Managed Services to simplify
business-to-business connectivity, including the management of initiatives and
programs and facilitation of the on-going alignment within business strategies.
o ICC EDI Infrastructure and Process Outsourcing: We offer a
cost-effective alternative to internal management of the day-to-day
operations and projects required to exchange supply chain
information with trading partners. By leveraging our extensive
experience in the industry, knowledge of industry trends and
direction and understanding of trading partner requirements, we
manage our customers' operational environments and transaction
workflows as well as strategic projects, from concept through
solution delivery, to optimize the extended supply chains.
o ICC Trading Partner Enablement and Management: We utilize our
resources, experience and service offerings to help manage the
complex tasks and various requirements associated with integrating
our customers' trading partners into their supply chains. Our
process begins with a survey that is designed to develop the
information required to customize a program based upon the readiness
of the trading partner participants. As a result of the survey, we
develop, implement and manage an integrated solution that allows our
customers and its trading partners to communicate electronically
in an efficient and effective way.
Our Managed Services involve customized pricing that can include a
combination of fixed pricing, hourly fees, set-up fees and transaction fees.
Consulting and Professional Services. We offer consulting and professional
services that assist customers with all phases of an e-commerce communication
and connectivity initiative, including planning, analyzing, designing and
constructing solutions. Our professional services unit assists clients to
conduct business electronically through a continuation of services including
e-Consulting, data transformation mapping (EDI, EAI, XML) and internetworking.
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o e-commerce Consulting: We bring subject matter expertise to help
customers achieve the intended results of their initiatives. The
professionals in our consulting teams conduct an independent,
fact-based business assessment and analysis of the customer's
current systems to identify gaps in technology, resources and
skills required to enable business-to-business connectivity through
e-commerce. At the conclusion of the consulting engagement, our
consultants deliver a blue print to achieve the desired state of
supply chain compliance, coordination and collaboration.
o EDI Mapping Factory(R): Our technical experts provide EDI data
mapping services to enable the translation between different data
formats. The EDI Mapping Factory conducts mapping using a variety of
translators on multiple platforms and employs data transformation
services for database conversions, customer-specific files, and
other tasks involved in the care and movement of documents and data
files.
Our Consulting and Professional Services are charged on an hourly basis,
although occasionally we enter into fixed price contracts for these services.
Service Bureau Segment
EC Service Center. At our EC Service Center, our professionals serve as an
extension of our customers' organizations by performing activities that enable
participation in the extended supply chain, including:
o EDI-to-Fax - We receive our customers' electronic formatted
information, convert it into a fax-readable file and route that
information to our customers' fax machines or email accounts.
o Fax-to-EDI - When the customers are ready to respond, we receive
their information via a fax or email. That information is then
entered into a Web form and transmitted to the trading partner in a
format that is consistent with trading partner specifications.
o Labels - For suppliers who are required to send an Advanced Ship
Notice to comply with retailers' requirements, we generate and print
UCC-128 case labels. Those printed labels are sent to our customers
so they can be applied to the cartons that will be shipped to a
retailer. We also print UPC stickers, tickets and hang tags for our
customers.
o UPC Catalog - We update on-line UPC catalogs for our customers. Once
we have received our customer's electronic or hard-copy product
information, we use that information to generate the necessary EDI
transaction and send it to the catalog service provider. Through
this process, our customer's product information is added, updated
or deleted from the UPC catalog.
Our Service Center enables customers to source electronic commerce
solutions reliably, without excessive investments. Our customers are billed
monthly for only the services they use.
Software Solutions. We also offer software solutions that are designed to
enable the management and exchange of vital information between trading partners
and that address a range of requirements for operations within the extended
supply chain. The applications operate on Microsoft Windows computing platforms,
feature "plug-and-play" installation, inter-operate with many pre-packaged
accounting systems and integrate easily to existing processes. Our software
includes:
o Performance EDI: The software enables the connection and
communication with trading partners cost-effectively by providing a
comprehensive solution for EDI translation. Performance EDI is an
easy-to-use application featuring a large collection of
pre-configured transaction maps, and connectivity to public and
private transaction networks. Key benefits include the ability to:
(1) implement rapidly using pre-configured trading partner
information; (2) keep up-to-date with new mandates by downloading
new maps directly into the application; and (3) comply with trading
partner mandates through support for all major EDI documents and
standards.
o Order Manager Software: We simplify and improve order management in
the front and back offices, while enabling the exchange of orders as
standards-based electronic transactions within trading communities.
Order Manager Software automates the handling, processing,
transmission and receipt of orders, Advanced Ship Notices and
invoices in accordance with preferred formats and specified
instructions. Key benefits include the ability to: (1) pick and pack
according to specified instructions; (2) catch errors in the picking
process by matching the item to the order; (3) create Advance Ship
Notice and invoice for each sales order; (4) generate UCC128 case
labels
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and batch print using a thermal transfer printer; (5) combine case
and shipping information for consistent record keeping; and (6)
translate EDI information to an in-house format and visa versa.
o Retail Product Manager: This application integrates seamlessly into
our other software products and provides the automation to keep UPC
codes up-to-date. Key benefits include the ability to: (1) keep
existing UPC codes current and generate new ones in accordance with
the proper standards; (2) create, add, track and delete UPC codes
for the retailers' catalogs; (3) utilize National Retail Foundation
guidelines to track active, inactive and dead UPC codes; (4)
transform UPC information into an electronic format for trading
partner information exchange; and (5) print UPC codes on bar code
labels for warehouse handling.
With our software solutions, we offer our customers timely upgrades and
enhancements for technology advancements, improved functionality, new industry
standards and trading partner compliance. This customer support program is
available for an annual fee, paid in advance.
Hosted Web Applications. We also offer hosted Web applications, giving our
customers an alternative to operating and supervising an electronic data
interchange environment. Simply by accessing a Web browser, our customers have
the technology required to participate in electronic data interchange with their
trading partners. Our hosted Web applications include:
o ICC Order Management Services: For suppliers and manufacturers, we
simplify the retailers' compliance mandates. ICC Order Management
Services provide our customers with immediate access to ready-made
EDI-to-forms and forms-to-EDI that comply with the retailers'
preferred formats and standards. By utilizing our connections in the
retail industry and employing our Web application development
expertise, we keep abreast of changes in the retailers' formats and
industry's standards and automatically incorporate those changes in
our Order Management Service.
In addition to helping meet retailer mandates, our Order Management
Services add sales order processing functionality. Using a standard
Web browser, we automate the receipt of electronic transactions,
giving the warehouse visibility to orders that require packing and
shipping, and we complete the order process by preparing and sending
invoices and shipping notices. Customers can also print their UCC128
case labels.
o ICC Sell-Thru, Analysis & Reporting: We provide a Web application
that presents sell-through data compiled from the items sold,
inventory on-hand and product levels for current and prior periods
at retail locations in an easy-to-navigate interface. The
easy-to-navigate interface offers a mechanism for the interpretation
of valuable data on product movement and retail performance.
Our hosted Web applications are available for set-up and service fees. We
charge additional transaction fees for Order Management Services.
Global Data Synchronization. At the end of fiscal year 2004, we launched a
solution that leverages the services offered in both our business segments to
capitalize on a supply chain initiative, commonly referred to as Global Data
Synchronization, to eliminate the inefficient and error-prone approaches for
exchanging and updating item information in buyer and seller systems.
Our broad range of solutions to address Global Data Synchronization meet
the needs of customers of all sizes in retail, distribution, and manufacturing
industries. As a certified UCCnet(TM) Solution Partner, we have completed a
certification process to ensure standards-compliance, technical expertise,
solution requirements and implementation tasks in accordance with UCCnet
standards.
o Education: We deliver education designed to help customers
understand the Global Data Synchronization program. The course
includes an overview of data synchronization, an explanation of the
GLN and GTIN numbering systems, a synopsis of data pools and the
global data registry and an examination of a data synchronization
implementation plan. At the conclusion of the class, customers have
explored all aspects of data synchronization and examined
alternative strategies for implementation.
o Consulting: We help develop an overall strategy and determine the
best technical approach for becoming data-sync-enabled. Working with
the customer, we conduct a business assessment and analyze the
customer's current systems to identify gaps in technology, resources
and skills required to align data items, create a master catalog,
connect to UCCnet and synchronize the information. At the conclusion
of the consulting engagement, the customer has a blueprint to
achieve UCCnet compliance.
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o EDI Mapping Factory: We provide the expertise required to establish
and apply the data conversion rules to convert the flat file to XML
for outbound transmission and the XML to HTML or flat file for
inbound messages.
o Connectivity: ICC.NET network service, which has received Drummond
Group approval and UCC certification for UCCnet services, utilizes
its AS2 connectivity capabilities to transmit data reliably,
securely and efficiently between the source / recipient data pools
and the UCCnet global registry.
o Outsourcing: Using UCCnet certified software, we will provide a
hosted solution that offers a simplified way to allow many
retailers, distributors and manufactures to receive the expertise
from trained professionals and technology from a certified solution
partner to validate item data, push information to UCCnet registry
and receive compliance to mandates.
o Software: We have partnered with a leading software company to
provide an integration solution for supply-side companies. The
software, a UCCnet certified solution, is a full-function
application for maintaining, managing and synchronizing item data.
It includes the ability to integrate business systems with disparate
data sources.
ICC Organizations
The following company wide organizations play key roles in our delivery of
value to customers in both our business segments.
Product Development
Our product development efforts are focused on adding enhanced and new
functionality to existing products, integrating the various product offerings
into our services delivery, supporting new and advanced technologies and
developing new products. Our success will depend in part upon our ability to
adopt technology and industry trends, respond to customer requirements and
market opportunities and incorporate emerging standards into our existing and
new products and services. To that end, our development efforts center on
requirements and features that have been identified through market research,
customer interactions, standards announcements and competitive analysis. As a
result, we intend to continue to offer products and services with increasing
functionality and scalability to meet the needs of customers regardless of size
and technical sophistication.
We conduct our development efforts in the United States. Most of our
development projects are performed internally; however, some projects require
specialized skills that are acquired through an outsourced arrangement with
contractors based in the United States.
Our research and development expenses for the years ended July 31, 2004,
2003 and 2002 were approximately $953,000, $1,111,000 and $977,000,
respectively.
Customer Support, Technical Support and Maintenance
By offering U.S.-based customer and technical support, we help our
customers maximize their investment in the offerings that connect them to their
trading partners and enable electronic information exchange. Our goal is to
ensure customer satisfaction each time a customers calls us to set up an
account, solve a problem, answer a question and provide a product upgrade.
Our Customer and Technical Support Centers consist of teams of
professionals who work together to provide dependable and timely resolution to
customer support and technical inquiries. For complex problems, our Customer and
Technical Support Center teams have immediate access to the experts in our
development laboratories, consulting organizations and IT operations, as
required.
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Sales and Marketing
We employ a hybrid sales strategy to leverage a complementary and adequate
coverage structure, capitalize on a balanced cost model and establish a
comprehensive management system. Deployed in conjunction with a customer
relationship management system, this hybrid model allows us to measure and
refine the allocation of resources to more effectively manage account coverage
and sales structure costs.
We support how customers buy today while providing them with a knowledge
base to gain customer confidence. Our multi-disciplined direct sales team
consists of regional sales managers, inside sales representatives, technical
sales representatives and a sales support professional. Matching sales skills to
selling models, we deploy our inside sales resources to complete most of the
transactional selling while utilizing our regional sales manager resources for
consultative / strategic selling. Our technical sales representatives and sales
support professional work with the regional sales managers and inside
sales representatives to increase sales by performing the pre-sales and sales
support activities associated with generating new business, ensuring customer
satisfaction and strengthening customer relationships. In addition, our senior
management takes an active role in our sales efforts.
Although direct selling has been our primary focus, we intend to
significantly increase our efforts to utilize indirect sales channels. Through
arrangements with agents, resellers and other solution providers, we intend to
sell to companies around the world and expand our reach into markets that we do
not service directly. We believe that our broad array of innovative service
offerings enable a wide variety of companies to recommend, market and sell our
services.
Our marketing efforts consist of a variety of programs to support our
sales efforts, including:
o Customer marketing arrangements
o Direct mail
o e-Marketing
o Channel marketing
o Publicity
o Sales literature, presentations and tools
o Seminars
o Speaking engagements
o Trade shows
o Web site marketing
Customers
To date, our customers have been retailers, manufacturers, distributors,
and transportation providers in a variety of industries, including apparel,
consumer packaged goods, financial, grocery, media, pharmaceutical, publishing,
retail, third-party logistics and transportation. As of July 31, 2004, we
provided services to approximately 2,200 customers, of which approximately 1,115
subscribed to our ICC.NET value added network service. The following table sets
forth a representative list of our customers as of July 31, 2004.
Ace Hardware Nordstrom.com
Aerosoles Omni Sporting Goods
Alstom Power Philip Morris
Bed, Bath & Beyond Pearson Education
Birds Eye Foods Random House
CIT Group Reinhart FoodService
Colgate Palmolive Revlon Consumer Products
CVS Sealy Incorporated
Eveden Incorporated Simon and Schuster
GlaxoSmithKline Shamrock Foods Staples
Happy Kids The Sak
Harper Collins Publisher Time Warner Book Group
Ingram Entertainment Trustmark National Bank
Lady John Union Planters National Bank
Linens-n-Things University of Alabama
Jones Apparel Group USA ViewSonic Corporation
McGraw Hill Verizon Wireless
Modine Manufacturing Winn-Dixie Stores
National Industries for the Blind
9
For the fiscal years ended July 31, 2004 and 2003, no single customer
accounted for more than 10% of our consolidated revenue.
Competition
Our products and services are targeted at customers who utilize e-commerce
business-to-business transactions, which is a mature, fragmented and competitive
industry described by the following characteristics:
o Competitive pressures are intense, focusing on an increase in market
share;
o Growth and increasing profitability require companies to take
market share away from competitors;
o The industry is consolidating to a smaller number of key
participants;
o Severe price competition leads to lower revenues and profits for all
participants; and
o Profitability erosion has forced companies out of the industry.
We believe that we compete favorably in each of the foregoing seven
principal factors. We also believe that the combination of our technology,
performance and breadth of offerings is an important competitive factor.
The principal competitive factors affecting our market are:
o Compliance with industry standards;
o Functionality and features of offerings;
o Level of customer and technical support;
o Price of services;
o Reliability, security and availability of services;
o Technical and industry expertise; and
o Vendor and offering reputations.
We believe that we compete favorably in each of the foregoing seven
principal factors. We also believe that the combination of our technology,
performance and breadth of offerings is an important competitive factor.
We face a significant number of competitors, ranging from very large
enterprises or divisions of very large companies to a number of relatively small
organizations, including:
o Corporate Information Technology departments of current customers or
prospects that are capable of internal solution development and
support;
o Large companies with broad and diverse offerings, including a
division that offers business-to-business information exchange
services, such as IBM;
o Large e-Commerce business-to-business vendors with a broad array of
service offerings, including Global eXchange Services (GXS),
Sterling Commerce and Inovis, Inc.; and
o Small companies with a core competence in a particular industry,
including companies such as Pubnet in the publishing industry and
Covisint in the automotive industry.
These competitors are diverse in terms of their histories, business
models, corporate strategies, financial strength, name recognition, company
reputation, customer base and breadth of offerings.
Many of our large competitors have more history, significantly greater
financial resources, larger customer bases and more easily recognized names than
we do. However, those companies also carry legacy infrastructures that may add
cost to their business models. We believe that we have a cost advantage because
we do not have a legacy infrastructure to maintain.
We rely on many of our competitors to interconnect, at reasonable cost,
with our service. We have interconnection arrangements with more than 65
business-to-business networks for the benefit of our customers. Two of the
largest networks, GXS and Sterling Commerce, which we believe to account for
approximately 60% of the estimated EDI users, discontinued their interconnect
arrangements with us. GXS discontinued its interconnection with our service in
September 2001 and Sterling Commerce discontinued its interconnection with our
service in April 2002.
Patents and Trademarks
We hold four U.S. patents as of July 31, 2004. Those patents expire in
years 2012 through 2014 and are not currently material to our business.
Although ICC owns these patent rights, we believe that the protection of
our rights in our ICC.NET service will depend primarily on our proprietary
software and messaging techniques that constitute "trade secrets." We have made
no determination as to the patentability of these trade secrets and will
continue to evaluate, on a case-by case basis, whether applying for additional
10
patents in the future is in our best interest. There can be no assurance that
our technology will remain a secret or that others will not develop similar
technology and use such technology to compete with us.
In addition, there can be no assurance that any patents owned by us or our
trade secrets will afford us adequate protection or not be challenged,
invalidated, infringed upon or circumvented, or that patent applications
relating to our products or technologies that we may file or license in the
future, including any patent as to which a notice of allowance was issued, will
result in patents being issued, or that any rights granted thereunder will
provide competitive advantages to ICC. Although we believe that our technology
does not infringe upon the proprietary rights of others, it is possible that
others may have or be granted patents claiming products or processes that are
necessary for or useful to the development of our ICC.NET service and that legal
actions could be brought against us claiming infringement.
We have obtained U.S. federal trademark registration for seven word marks,
including ICC.NET, INFOSAFE and EDI MAPPING FACTORY. We believe that our
trademark of ICC.NET is material to our operations in the U.S. No assurance can
be given that registrations will be issued on the allowed applications or that
interested third parties will not petition the United States Patent and
Trademark Office to cancel our registration.
Employees
As of July 31, 2004, we had 91 employees. Of these employees, 14 engaged
in executive and administrative functions, 19 engaged in sales and marketing
activities, and 58 provided technical and technology support. All of our
employees are located in the United States, and none of our employees is covered
by a collective bargaining agreement. We consider our relations with our
employees to be satisfactory.
11
Item 2. Description of Properties
Our executive offices are located at 805 Third Avenue, New York, New York
under a lease that expires on January 31, 2005 and provides for annual base rent
of approximately $510,000. The lease covers approximately 12,300 square feet.
On September 28, 2004, we announced that the Board of Directors approved
the relocation of our executive offices to Atlanta, Georgia.
Our development and network administration groups and our technical
support call center are located in East Setauket, New York under a lease that
expires on June 30, 2009 and provides for annual base rent of approximately
$222,000. The lease covers approximately 8,900 square feet.
Our service bureau maintains locations in Carrollton and Norcross,
Georgia. The lease at the Carrollton location expires on July 31, 2009 and
covers approximately 8,000 square feet at an annual base rent of approximately
$96,000. The lease at the Norcross location expires on July 31, 2005 and covers
approximately 2,300 square feet at an annual base rent of approximately $45,000.
We lease general office space in Cary, North Carolina under a lease that
expires on October 31, 2004 and provides for annual base rent of approximately
$600,000. The lease covers approximately 27,300 square feet. Effective August 1,
2002, we entered into an agreement with the landlord of the Cary facility that
reduced the base rent with respect to approximately 13,000 square feet to
approximately $445,000 and the landlord recaptured the balance of the space and
released it to new tenants. We have subleased approximately 6,580 square feet of
our remaining space at an annual rent of $100,000. Effective February 1, 2004,
we entered into an agreement with the landlord of the Cary facility that further
reduced the base rent on our space to $315,000. As part of the February 1, 2004
agreement, we extended the lease with respect to 6,470 square feet for 3 years
until October 31, 2007 at an annual rent of $103,500.
Our main data center is located at the facilities of The Securities
Industry Automation Corporation (SIAC) under an agreement that expires in
December 2004. The agreement shall be renewed automatically for an additional
one-year term. In addition, we maintain a data center for our service bureau
operations in Atlanta, Georgia under a month-to-month agreement with Level(3)
Communications, Inc. cancelable by either party with sixty days notice.
We believe that these facilities should be adequate for our present and
reasonably foreseeable operating requirements.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
No meetings of stockholders took place during the fourth quarter of the
year ended July 31, 2004.
12
PART II
Item 5. Market for Internet Commerce Corporation's Common Equity and Related
Stockholder Matters
(a) Market Information
From September 20, 2000 until January 30, 2003, our class A common stock
was traded on the Nasdaq National Market under the symbol ICCA. Since January
30, 2003, the class A common stock has traded on the Nasdaq SmallCap Market
under the symbol ICCA. The following table sets forth the high and low closing
prices of our class A common stock for the periods indicated. These quotations
represent prices between dealers in securities, do not include retail mark-ups,
mark-downs or commissions and do not necessarily represent actual transactions.
Fiscal Year Ended July 31:
--------------------------
2004 2003
---- ----
High Low High Low
---- --- ---- ---
Class A Common Stock
- --------------------
First Quarter $ 1.66 $ 1.12 $ 3.17 $ 1.30
Second Quarter $ 1.34 $ 0.90 $ 2.10 $ 1.15
Third Quarter $ 2.55 $ 1.35 $ 1.41 $ 0.80
Fourth Quarter $ 1.54 $ 1.16 $ 2.04 $ 1.15
(b) Holders
As of October 27, 2004, there were approximately 231 record holders of our
class A common stock. Many of our shares of class A common stock are held by
brokers and other institutions on behalf of stockholders, and we are unable to
estimate the number of these stockholders.
(c) Dividends
We have not paid any cash dividends on our class A common stock and do not
intend to declare or pay cash dividends on the class A common stock in the
foreseeable future. The holders of the outstanding shares of series C preferred
stock are entitled to a 4% annual dividend payable in cash or in shares of class
A common stock, at the option of ICC. These dividends are payable on January 1st
of each year. We issued 361,702 shares of class A common stock in payment of the
dividend due January 1, 2004 and 302,343 shares of class A common stock in
payment of the dividend due on January 1, 2003. On October 14, 2004, the Board
of Directors declared a dividend on the series C preferred stock payable on
January 1, 2005 in shares of class A common stock in the amount of $400,000.
Pursuant to the terms of an Accounts Receivable Financing Agreement
between the Company and Silicon Valley Bank entered into in May 2003, without
the prior written consent of Silicon Valley Bank, we are not permitted to pay
any dividends or make any distribution or payment or redeem, retire or
repurchase any capital stock, other than in connection with the dividends
payable on our shares of Series C Preferred Stock in an amount not to exceed
$400,000 in any fiscal year or dividends payable in shares of our capital stock.
13
(d) Securities Authorized for Issuance under Equity Compensation Plans
Plan Category Shares of class A Weighted-average Shares of class A
common stock to be exercise price common stock
issued upon exercise of outstanding remaining
of outstanding options, available for
options, warrants warrants and future issuance
and rights (in rights under equity
thousands) compensation plans
(excluding
securities
reflected in
column (a)) (in
thousands)
(a) (b) (c)
- --------------------------------------------------------------------------------
Equity compensation 5,087 $2.87 941
plans approved by
security holders (1)
Equity compensation 732 $14.05 -
plans not approved
by security holders (2)
- --------------------------------------------------------------------------------
Total 5,819 $4.28 941
(1) Includes stock options to purchase 65,134 shares of class A common stock
with a weighted average exercise price of $5.62 per share under the
Employee Stock Option plan of Research Triangle Commerce, Inc, or RTCI,
which was assumed in connection with our acquisition of RTCI on November
6, 2000.
(2) Includes stock options to purchase 150,000 shares of class A common stock
and warrants to purchase 582,310 shares of class A common stock issued
pursuant to individual compensation arrangements. These stock options have
a weighted average exercise price of $60.00 per share and were awarded to
a former president and chief executive officer of the Company under an
employment contract. The warrants are described in Note 10, Stockholders'
Equity, of the Notes to Consolidated Financial Statements included
elsewhere in this annual report on Form 10-K. The issuance of all the
warrants set forth in Note 10 under the captions 2001 Private Placement
Commission Warrants, ING Warrants, 2003 Private Placement Commission
Warrants, Silicon Valley Bank Warrants and 2004 Private Placement
Commission Warrants constitute individual compensation arrangements. In
addition, warrants to purchase 38,460 shares of class A common stock set
forth in Note 10 under the caption 2003 Private Placement Warrants were
issued as settlement of certain outstanding payables for services and
constitute an individual compensation arrangement.
Recent Sales of Unregistered Securities
In the fiscal year ended July 31, 2004, we issued a total of 104,382
shares of class A common stock to six non-employee directors of ICC in payment
of directors' fees. The issuance of these securities was exempt from
registration under the Securities Act pursuant to Section 4(2).
On January 1, 2004, we issued 361,702 shares of class A common stock in
payment of the dividends due on our series C preferred stock.
14
Item 6. Selected Consolidated Financial Data
Our selected consolidated statement of operations data for each of the
years in the five-year period ended July 31, 2004 is presented below. Our
selected balance sheet data is presented below as of July 31, 2004, 2003, 2002,
2001 and 2000. The selected consolidated financial data set forth below is
qualified in its entirety by, and should be read in conjunction with, our
consolidated financial statements and the notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this annual report.
Year Ended July 31,
----------------------------------------------------------------
2004 2003 2002 2001 2000
--------- -------- -------- -------- --------
(In thousands, except per share data)
Statements of Operations Data:
Revenues $ 11,705 $ 12,083 $ 14,222 $ 9,743 $ 1,303
-------- -------- -------- -------- --------
Expenses:
Cost of services 6,736 7,622 8,776 9,354 2,514
Impairment of software inventory -- 248 -- -- --
Impairment of capitalized software 45 148 -- -- --
Product development and enhancement 953 1,111 977 931 702
Selling and marketing 3,070 3,035 3,499 5,384 3,273
General and administrative 4,205 4,439 5,849 9,683 4,814
Non-cash charges for stock-based
compensation, services and legal
settlements 802 139 250 991 5,161
Impairment of goodwill and acquired
intangibles -- 982 1,711 16,708 --
-------- -------- -------- -------- --------
Total operating expenses 15,811 17,724 21,062 43,051 16,464
-------- -------- -------- -------- --------
Operating loss (4,106) (5,641) (6,840) (33,308) (15,161)
-------- -------- -------- -------- --------
Other income (expense), net 19 (363) 292 523 675
-------- -------- -------- -------- --------
Loss before income taxes (4,087) (6,004) (6,548) (32,785) (14,486)
Income tax benefit -- -- -- 1,930 --
-------- -------- -------- -------- --------
Net Loss (4,087) (6,004) (6,548) (30,855) (14,486)
Dividends on preferred stock (401) (400) (365) (420) (458)
Dividends to preferred stockholders for
beneficial conversion feature -- (107) -- -- (4,549)
Beneficial conversion feature from repricing
and issuance of warrants -- -- (461) -- --
-------- -------- -------- -------- --------
Loss attributable to common stockholders $ (4,488) $ (6,511) $ (7,374) $(31,275) $(19,493)
======== ======== ======== ======== ========
Basic and diluted loss per common share $ (0.30) $ (0.53) $ (0.68) $ (3.57) $ (4.49)
======== ======== ======== ======== ========
Weighted average common shares outstanding -
basic and diluted 15,026 12,303 10,867 8,768 4,337
======== ======== ======== ======== ========
July 31,
----------------------------------------------------------------
2004 2003 2002 2001 2000
--------- ------- ------- -------- --------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents $ 3,790 $ 2,283 $ 2,088 $ 2,223 $ 14,003
Working capital 4,198 1,700 2,622 646 17,831
Total assets 11,429 8,598 12,625 15,674 22,332
Capital lease obligations 55 194 374 255 231
Total liabilities 1,994 2,758 3,244 4,487 2,242
Stockholders' equity 9,434 5,840 9,381 11,187 20,090
15
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This annual report on Form 10-K 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 annual 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 annual
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,"
those described starting on page 37 of this annual report under the heading
"Risk Factors" 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
annual report as anticipated, believed, estimated, expected or intended.
Overview
As the Company approaches cash flow break-even, we are strengthening 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.
We are a pioneer in the use of the Internet for business-to-business (B2B)
e-commerce solutions. Thousands of customers rely on our solutions, expertise
and support to help balance cost, fit and function required to meet their
individual requirements for coordinating communications with their trading
partners in compliance with the specifications of their trading partners. We are
a trusted provider of business-to-business solutions to businesses, regardless
of size and level of technical sophistication. With our sophisticated
technological capabilities, industry-focused initiatives and expertise, focus on
business requirements and an expert support team, we help enable our customers'
strategies to conduct business electronically.
Organizationally, our operations are comprised of two segments:
o ICC.NET(TM) segment, which provides a variety of services,
including Network Services, Managed Services and Consulting and
Professional Services. ICC.NET is a complete value added network
solution which meets electronic data interchange requirements in a
secure, reliable, available and flexible environment.
o Service Bureau segment, which offers a variety of services including
our EC Service Center, Software Solutions and Hosted Web
Applications.
These segments are complementary to each other and support our ability to
provide solutions to many different kinds of enterprises, from sole
proprietorships to large corporations, operating in a variety of industries and
business model formats. For a description of our business segment, see "Products
and Services" under Item 1, beginning on page 3 of this annual report.
Prior to February 2004, we also operated a professional services segment.
Our professional services unit assists clients to conduct business
electronically through a continuum of services including eConsulting, data
transformation mapping (EDI, EAI, XML) and internetworking. In response to
continuing weak demand for our professional services, in February 2004 we
combined these activities with ICC.NET to reduce operating costs. As a result,
effective February 2004, we no longer report the results for our professional
services activities in a separate segment and include these results in the
ICC.NET segment. These activities were previously reported in the Professional
Services segment.
The Company completed its acquisition of Electronic Commerce Systems, Inc.
(ECS) on June 22, 2004. The operating results of ECS will be included in the
Service Bureau segment. ECS provides Internet-based services, software and
service bureau services for the e-commerce business-to-business communication
service market. We
16
believe that the integration of ECS into our Service Bureau segment will
substantially strengthen this operating segment and provide positive cash flow
from its operating activities.
The Value Added Network business has become significantly more price
competitive over the past year, with major networks restructuring to reduce
their overhead costs 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 have added revenue
through the acquisition of ECS and have developed new product and service
offerings (AS2 and Data Synchronization) to improve our value proposition. AS2
capabilities have 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 agreed-upon information 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 solutions and connectivity provider and are currently offering
training and consulting services to capitalize on this emerging initiative.
During the quarter ended July 31, 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. An
impairment loss of $982,142 was recognized as a result of this evaluation. The
fair value of the Service Bureau reporting unit was estimated using the net
present value of expected future cash flows.
Due to a continued decline in its revenues throughout the course of fiscal
2002, continued operating losses and a significant reduction in forecasted
future operating profits, the Professional Services segment was tested for
impairment during the quarter ended July 31, 2002. An impairment loss of
$1,710,617 was recognized as a result of this evaluation. The fair value of the
Professional Services segment unit was estimated using the net present value of
expected future cash flows. During the quarter ended July 31, 2002, the Company
integrated its data mapping and XML services and personnel into the ICC.NET
business segment. These products and services had previously been part of the
Company's Professional Services segment. These products and services are
primarily utilized to support customers of the ICC.NET VAN service. The
reorganization was undertaken to more closely align these data transfer services
with the customers they serve. The segment information presented below in the
results of operations has been recasted for 2003 to reflect this reorganization
as if it had occurred August 1, 2001.
We rely on many of our competitors to interconnect, at reasonable cost,
with our service. We have interconnection arrangements with more than 65
business-to-business networks for the benefit of our customers. Two of the
largest networks, Global eXchange Services ("GXS") and Sterling Commerce, which
we believe to account for approximately 60% of the estimated EDI users,
discontinued their interconnect arrangements with us. GXS discontinued its
interconnection with our service in September 2001 and Sterling Commerce
discontinued its interconnection with our service in April 2002. We have entered
into arrangements with Inovis, Inc. (formerly a division of Peregrine Systems,
Inc. and now an independent company) and IBM Corporation so our customers can
continue to communicate through us with their trading communities. As a result
of these interconnection arrangements, we will continue to incur additional
costs and may lose existing customers if the arrangements we have provided are
inadequate for their business purposes. We believe, however, that the
arrangements we have made satisfy our existing customers.
17
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 elsewhere in this annual report. 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 our critical accounting policies:
Revenue Recognition: We derive revenue from subscriptions to our 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. We also derive 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. We have a limited number of fixed fee data mapping
services contracts. Under these arrangements we are 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).
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. We
account for 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 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 our part. Our multiple
element arrangements generally consist of a software license and post contract
support. We allocate the aggregate revenue from multiple element arrangements to
each element based on vendor specific objective evidence. We have 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 we enter 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.
18
We also provide a broad range of professional services consisting
primarily of EDI, electronic commerce consulting, EDI education and training at
seminars throughout the United States. Revenue from EDI and electronic commerce
consulting and education and training are recognized when the services are
provided.
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. We 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.
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. Our 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. We did not have any indefinite lived intangible assets other than
goodwill that were not subject to amortization.
Impairment of long-lived assets: Our long-lived assets, 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,
we test 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, we 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 No. 123 establishes
a fair-value method of accounting for stock-based compensation plans.
Stock-based awards to non-employees are accounted for at fair value in
accordance with SFAS No. 123.
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
19
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 our 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. The
following discussion reviews items incorporated into our financial statements
for the years ended July 31 2004, 2003 and 2002 that required the use of
significant management estimates.
We have entered into several transactions involving the issuance of
warrants and options to purchase shares of our 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 private placement that closed in April 2004, we
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 $225,905 by utilizing the
Black-Scholes option pricing model.
In January 2004, we implemented a voluntary stock option exchange program
whereby we offered to exchange certain outstanding options to purchase shares of
class A common stock held by eligible employees, with exercise prices per share
greater than or equal to $11.50, for new options to purchase shares of class A
common stock. Under this exchange program, the 26 participating employees agreed
to cancel as of January 30, 2004 their existing options to purchase 823,500
shares of the class A common stock and were granted options to purchase 494,100
shares of class A common stock with an exercise price of $1.25 per share, the
closing market price per share on January 20, 2004. In addition, under this
exchange program, two directors cancelled as of January 30, 2004 existing
options to purchase 250,000 shares of class A common stock and were granted
options to purchase 150,000 shares of the class A common stock with an exercise
price of $2.00 per share. Management estimated the value of the options granted
under the exchange program using the Black Scholes option-pricing model.
On May 30, 2003, we executed an Accounts Receivable Financing Agreement
("Financing Agreement") with Silicon Valley Bank ("Bank") with a term of 1 year.
On October 22, 2003 and August 31, 2004, we amended the Financing Agreement to
extend its term to August 31, 2004 and December 29, 2004, respectively. In
connection with the Financing Agreement, the we issued the Bank warrants to
purchase 40,000 shares of 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 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.
On March 10, 2003, we 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 by utilizing the Black-Scholes option pricing model.
The allocation of the proceeds from the sale of the series D preferred
stock and warrants issued in our 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, we 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 by
utilizing the Black-Scholes option pricing model.
20
In connection with a warrant exchange offer in April 2002, we valued the
repriced and newly issued warrants at $461,084 using the Black-Scholes
option-pricing model. This amount has been added to our net loss to increase the
net loss attributable to common stockholders during fiscal 2002.
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 to purchase shares of our class A common stock,
providing the holders the right to receive, upon exercise, an aggregate of
394,905 shares of 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 our 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, 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. We allocate 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 in an amount equal to that excess.
We estimate the fair value of our 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
our weighted average cost of capital. Estimating the 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 we prepared our
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 our reporting units.
Impairments of goodwill and acquired intangibles in the amount of $982,000
and $1,711,000 were as recorded during the years ended July 31 2003 and 2002,
respectively. During fiscal 2002, due to a continued decline in its revenues
throughout the course of 2002, continued operating losses and a significant
reduction in forecasted future operating profits, our professional services
reporting unit was tested for impairment during the fourth quarter of fiscal
2002. An impairment loss of $1,711,000 was recognized as a result of this
evaluation. The fair value of the professional services reporting unit was
estimated using the net present value of expected future cash flows. 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. An impairment
loss of $982,142 was recognized as a result of this evaluation. The fair value
of the Service Bureau reporting unit was estimated using the net present value
of expected future cash flows.
Results of Operations and Financial Condition
Fiscal Year Ended July 31, 2004 Compared with Fiscal Year Ended July 31, 2003.
Results of Operations - Consolidated
The following table reflects consolidated operating data by reported
segment. All significant intersegment activity has been eliminated. Accordingly,
the segment results below exclude the effect of transactions with our
subsidiaries.
21
Year Ended
July 31,
-----------------------------
Loss before income taxes: 2004 2003 (1)
------------ -------------
ICC.NET $ (3,974,708) $ (4,872,216)
Service Bureau (111,901) (1,132,102)
------------ -------------
Consolidated loss before income taxes $ (4,086,609) $ (6,004,318)
============ =============
(1) Recasted to include the results of professional services activities in the
ICC.NET segment. These activities were previously reported in the Professional
Services segment.
Results of Operations - ICC.NET
The ICC.NET service, our 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 ICC.NET:
22
Year Ended
July 31,
----------------------------
2004 2003 (1)
------------ ------------
Revenues:
VAN services $ 9,065,373 $ 8,237,525
Professional services 907,706 1,728,447
Mapping services 300,731 571,063
Services to Triaton -- 58,333
------------ ------------
10,273,810 10,595,368
Expenses:
Cost of services 5,940,278 6,886,672
Impairment of software inventory -- 248,092
------------ ------------
Total cost of services 5,940,278 7,134,764
Product development and enhancement 789,535 975,583
Selling and marketing 2,953,102 2,899,315
General and administrative 3,785,157 3,955,108
Non-cash charges for stock-based compensation 800,840 139,415
------------ ------------
14,268,912 15,104,185
------------ ------------
Operating loss $ (3,995,102) $ (4,508,817)
Other (expense) income, net 20,394 (363,399)
------------ ------------
Loss before income taxes $ (3,974,708) (4,872,216)
------------ ------------
(1) Recasted to include the results of professional services activities in the
ICC.NET segment. These activities were previously reported in the Professional
Services segment.
Revenues - ICC.NET - Revenues from ICC.NET were 88% of our total
consolidated revenues for both the fiscal year ended July 31, 2004 ("2004") and
the fiscal year ended July 31, 2003 ("2003"). Total ICC.NET revenue decreased
$322,000 in 2004 from 2003, or approximately 3%. Revenue from VAN services and
services to Triaton increased $770,000, or approximately 9%, in 2004 from the
prior year. The increase in VAN services revenue is attributable to an increase
in transaction volume and an increase in mailbox fees. Professional services
revenue decreased $821,000 in 2004 from 2003 or approximately 47%; revenue from
EDI educational services and seminars decreased $450,000 and revenue from other
professional services decreased $371,000 in 2004 from 2003. We discontinued our
EDI educational services and seminars in January 2004; the decrease in revenue
from other professional service is attributable to continued slow demand for
these services resulting from increased in-house performance by potential
customers and from a highly competitive environment. Mapping services revenue
decreased $270,000 or approximately 47% in 2004 from 2003 primarily due to
continued slow demand for these services resulting from overseas competition.
Cost of services - ICC.NET - Cost of services relating to ICC.NET was 58%
of revenue derived from the ICC.NET service in 2004, compared to 67% of revenue
derived from this service in 2003. Excluding the impairment of software
inventory, the total cost of services was 58% of revenue derived from this
service in 2004 compared to 65% of this revenue in 2003. Cost of services
related to ICC.NET consists primarily of salaries and employee benefits,
contract labor, connectivity fees, amortization, rent and product development
and enhancement allocation. Cost of services excluding impairment of software
inventory decreased $946,000 in 2004 from 2003. Salaries and employee benefits
decreased $636,000 primarily due to a reduction of personnel to 25 at the end of
2004 from 36 at the beginning of 2003. Contract labor decreased $217,000 in 2004
from 2003 due to a decrease in the use of consultants attributable to a decrease
in the number of professional services projects. Cost of services relating to
VAN services decreased to $3,568,000 in 2004 from $3,744,000 in 2003. Cost of
services relating to
23
mapping services increased to $1,452,000 in 2004 from $1,424,000 in 2003. There
were no costs of services relating to services provided to Triaton in 2004 or
2003. Impairment of software inventory of $248,000 in 2003 represents an
impairment for software inventory held by the professional services reporting
unit resulting from insufficient historical and projected revenue from these
products to support the recoverability of that carrying value. We anticipate
that ICC.NET cost of services will decline as a percentage of revenue in future
periods due to increased utilization of our existing communications
infrastructure as we expect the use of our VAN service to increase.
Product development and enhancement - ICC.NET - Product development and
enhancement costs relating to ICC.NET consist primarily of salaries and employee
benefits. Product development and enhancement costs decreased $186,000 in 2004
from 2003. Salaries and employee benefits decreased $123,000 in 2004 from 2003
due primarily to a reduction in headcount to 9 at the end of 2004 from 10 at the
end of 2003. Consulting costs decreased $22,000 in 2004 from 2003 due to
increased reliance on staff. In addition, allocation of product development and
enhancement salaries to non-development departments increased $29,000 in 2004
from 2003.
Selling and marketing - ICC.NET - Selling and marketing expenses relating
to ICC.NET service consist primarily of salaries and employee benefits,
travel-related costs, rent and advertising and trade show costs. Selling and
marketing expenses related to ICC.NET service increased $54,000 in 2004 from
2003. Consulting costs increased $59,000 in 2004 from 2003 primarily due to the
use of a consultant for trade shows. Rent increased $41,000 in 2004 from 2003
primarily due to an allocation of rent to selling and marketing departments in
2004. Publications, dues and subscription expenses increased $34,000 in 2004
from 2003 due to increased use of industry publications and services. Travel and
entertainment expenses increased $22,000 in 2004 from 2003 due to more travel to
sales calls and trade shows. Allocation of product development and enhancement
salaries to selling and marketing increased $18,000 in 2004 from 2003 due to
increased technical sales activity. Severance payments were $12,000 in 2004 and
there were no such payments in 2003. These increases were partially offset by a
decrease in salaries and benefits of $188,000 in 2004 from 2003 due to a
reduction in headcount to 14 at the end of 2004 from 17 at the end of 2003.
General and administrative - ICC.NET - General and administrative expenses
supporting ICC.NET consist primarily of salaries and employee benefits, legal
and professional fees, facility costs, travel meals and entertainment,
depreciation, amortization and telephone charges. General and administrative
costs supporting the ICC.NET service decreased $170,000 in 2004 from 2003.
Depreciation decreased $202,000 in 2004 from 2003 primarily as a result of fewer
assets being acquired and more assets becoming fully depreciated. Equipment
rental and maintenance expense decreased $98,000 in 2004 from 2003 as a result
of an increased proportion of these expenses being allocated to non-general and
administrative departments. Investor relation fees decreased $78,000 in 2004
from 2003 as a result of discontinuing the use of an external public relations
firm and performing public relations functions in house. These decreases were
partially offset by increases in salaries and employee benefits of $224,000 due
primarily to the strengthening of executive management through the addition of a
new Chief Executive Officer and Chief Operating Officer. Commencing in the
quarter ended January 31, 2003, ICC.NET began allocating the costs of executive
management, human resources, accounting and finance tasks to the Service Bureau
segment based on the level of services provided. In 2004, these allocations
totaled $180,000.
Non-cash charges - ICC.NET - In 2004, we recorded non-cash charges of
$801,000. The adoption of FASB Statement No. 123, "Accounting for Stock-Based
Compensation," resulted in an expense of $656,000 in 2004. In January 2004, we
implemented a voluntary stock option exchange program under which we offered to
exchange certain outstanding options to purchase shares of our class A common
stock held by eligible employees, with exercise prices per share greater than or
equal to $11.50 per share, for new options to purchase shares of class A common
stock. The fair value method has been applied prospectively to all employee and
director awards granted, modified, or settled after July 31, 2003. In 2004,
Director's fees paid to nonemployee board members payable in shares of class A
common stock resulted in an expense of $130,000. In 2003, we recorded non-cash
charges of $139,000. In 2003, Director's fees paid to nonemployee board members
payable in shares of class A common stock resulted in an expense of $79,000. In
addition, $60,000 of expense was recognized during 2003 for class A common stock
and options issued to a non-employee member of our board of directors as
compensation for consulting services.
24
Other income, net - ICC.NET - The sale of marketable securities held for
investment resulted in investment income of $68,000 in 2004 and in investment
loss of $19,000 in 2003. An impairment charge of $318,000 was recorded in 2003
for the write down of available-for-sale marketable securities due to an other
than temporary decline in value.
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. On June 22, 2004 we acquired Electronic Commerce Systems, Inc., the
operating results of which are reported in the service bureau segment. The
following table summarizes operating results for our service bureau:
Year Ended
July 31,
--------------------------
2004 2003
----------- -----------
Revenues:
Services $ 1,430,993 $ 1,487,946
Expenses:
Cost of services 796,212 735,136
Impairment of capitalized software 44,983 148,479
----------- -----------
Total cost of services 841,195 883,615
Product development and enhancement 163,478 135,358
Selling and marketing 117,328 135,411
General and administrative 420,158 483,522
Impairment of acquired intangible -- 982,142
----------- -----------
1,542,159 2,620,048
----------- -----------
Operating income (loss) $ (111,166) $(1,132,102)
----------- -----------
Other income, net (735) --
----------- -----------
Income (loss) before income taxes $ (111,901) $(1,132,102)
=========== ===========
Revenues - Service Bureau - Revenue related to our service bureau were 12%
of our total consolidated revenue in 2004 and in 2003. The service bureau's
revenue was primarily generated from services performed, customer support and
software licensing fees. Revenue decreased $57,000 or approximately 4% in 2004
from 2003.
Cost of services - Service Bureau - Cost of services related to our
service bureau consists primarily of salaries and employee benefits, costs of
software, product development and enhancement allocation and rent. Total cost of
services relating to our service bureau was 59% of revenue derived from the
service bureau in 2004 compared to 58% of these revenues in 2003. Excluding
impairment of capitalized software, cost of services was 56% of service bureau
revenue in 2004 compared to 49% of service bureau revenue in 2003. Excluding the
capitalized software impairment charge, cost of services increased $61,000 in
2004 from 2003. The cost of sales of ECS software made prior to the acquisition
of ECS in June 2004 increased $92,000 in 2004 from 2003 due to increased sales.
Salaries and employee benefits decreased $39,000 in 2004 from 2003. Excluding
the effects of the acquisition of ECS, salaries and employee benefits decreased
$94,000 in 2004 from 2003 due to a reduction in headcount to 7 at the end of
2004 from 14 at the end of 2003, and the acquisition of ECS resulted in an
increase in salaries and employee benefits of $55,000 in 2004. Cost of services
- - Charges for impairment of capitalized software for in-process projects that
management decided, due to unfavorable market conditions continuing into the
foreseeable future, not to complete were $45,000 in 2004 and $148,000 in 2003.
25
Product development and enhancement - Service Bureau - Product development
and enhancement costs consist primarily of salaries and employee benefits and
rent. Product development and enhancement costs incurred by our service bureau
increased $28,000 in 2004 from 2003. In 2003, $16,000 of product development and
enhancement salaries were capitalized, and no salaries were capitalized in 2004.
The acquisition of ECS resulted in an increase in salaries and employee benefits
of $12,000 in 2004.
Selling and marketing - Service Bureau - Selling and marketing expenses
relating to our service bureau consist primarily of salaries and employee
benefits and rent. Selling and marketing expenses decreased $18,000 in 2004 from
2003. Excluding the acquisition of ECS, salaries and employee benefits decreased
$50,000 in 2004 from 2003 due to a reduction in headcount to 1 at the end of
2004 from 3 at the end of 2003, and the acquisition of ECS resulted in an
increase in salaries and employee benefits of $47,000 in 2004.
General and administrative - Service Bureau - General and administrative
expenses relating to our service bureau consist primarily of salaries and
employee benefits, office expenses, depreciation, telephone and rent. General
and administrative costs decreased $63,000 in 2004 from 2003. Excluding the
acquisition of ECS, salaries and employee benefits decreased $180,000 in 2004
from 2003 due to a reduction in headcount to 1 in 2004 from 4 in 2003, and the
acquisition of ECS resulted in an increase in salaries and employee benefits of
$41,000 in 2004. This was offset by an increase of $45,000 in general and
administrative support staff salary and benefits allocated to the service bureau
in 2004 from 2003. See "General and administrative - ICC.NET" above for a
discussion of the allocation of general and administrative expenses between
segments.
Impairment of Acquired Intangibles - Service Bureau - 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. An impairment
loss of $982,142 was recognized as a result of this evaluation. The fair value
of the service bureau reporting unit was estimated using the net present value
of expected future cash flows.
Fiscal Year Ended July 31, 2003 Compared with Fiscal Year Ended July 31, 2002.
Results of Operations - Consolidated
The following table reflects consolidated operating data by reported
segment. All significant intersegment activity has been eliminated. Accordingly,
the segment results below exclude the effect of transactions with our
subsidiary.
26
Year Ended
July 31,
------------------------------
Income (loss) before income taxes: 2003 (1) 2002 (1)
----------- -----------
ICC.NET $(4,872,216) $(6,552,502)
Service Bureau (1,132,102) 4,949
----------- -----------
Consolidated loss before income taxes $(6,004,318) $(6,547,553)
=========== ===========
(1) Recasted to include the results of professional services activities in the
ICC.NET segment. These activities were previously reported in the Professional
Services segment.
Results of Operations - ICC.NET
ICC.NET includes our 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. 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 ICC.NET:
27
Year Ended
July 31,
--------------------------------
2003 2002
------------ ------------
Revenues:
VAN services $ 8,237,525 $ 6,266,277
Mapping services 571,063 1,064,387
Services to Triaton 58,333 105,626
Professional services 1,728,447 2,152,323
Technology license -- 3,000,000
------------ ------------
10,595,368 12,588,613
Expenses:
Cost of services 6,886,672 7,936,337
Impairment of software inventory 248,092 --
------------ ------------
Total cost of services 7,134,764 7,936,337
Product development and enhancement 975,583 822,314
Selling and marketing 2,899,315 3,376,400
General and administrative 3,955,108 5,337,983
Non-cash charges for stock-based compensation 139,415 250,008
Impairment of acquired intangibles -- 1,710,617
------------ ------------
15,104,185 19,433,659
------------ ------------
Operating loss $ (4,508,817) $ (6,845,046)
Other (expense) income, net (363,399) 292,544
------------ ------------
Loss before income taxes $ (4,872,216) $ (6,552,502)
------------ ------------
Revenues - ICC.NET - Revenues from ICC.NET were 88% of our total
consolidated revenues for the fiscal year ended July 31, 2003 ("2003") compared
to 89% of our total consolidated revenues for the fiscal year ended July 31,
2002 ("2002"). Total ICC.NET revenue decreased $1,993,000 in 2003 from 2002, or
approximately 16%. VAN and services to Triaton revenues increased $1,924,000, or
approximately 30%, in 2003 from the prior year. The increase in VAN services
revenue is attributable to an increase in the number of customers to
approximately 1,100 in July 2003 from approximately 600 in July 2002.
Approximately 300 of these new customers signed up for our service during the
month of April 2003. Mapping services revenue decreased $493,000 or
approximately 46% in 2003 from 2002 primarily due to the continued slowdown in
the economy. Revenue generated from professional services consists of consulting
and educational services. As a result of the continued slowdown in the economy,
which has resulted in a decrease in capital expenditures for information
technology and related services, revenue from our professional services
decreased $424,000 in 2003 from 2002. During 2002, we recognized technology
license revenue of $3,000,000 from Triaton GmbH, a subsidiary of Thyssen Krupp
Information Services, GmbH, for the license of our ICC.NET service. Under the
terms of the July 2002 license agreement, we granted Triaton a non-exclusive
license to use ICC's electronic data interchange system in its most recent
version anywhere in the continent of Europe, Great Britain and Ireland for a
five-year term. Triaton has the right to use and provide the ICC.NET service to
its customers. Triaton paid us $1,500,000 in July 2002 and an additional
$1,500,000 in October 2002 under this license agreement. We will not report any
additional revenues under the July 2002 agreement with Triaton, except that, at
Triaton's request, we will provide sales support, customer support and software
support on our standard terms and conditions. 2002 included $105,000 of fees
from Triaton under a July 2001 agreement.
28
Cost of services - ICC.NET - Cost of services relating to ICC.NET was 67%
of revenue derived from the ICC.NET service in 2003, compared to 63% of this
revenue in 2002. Excluding the impairment of software inventory, the total cost
of services was 65% of revenue derived from the ICC.NET in 2003 compared to 63%
of this revenue in 2002. Cost of services related to our ICC.NET consists
primarily of salaries and employee benefits, contract labor, connectivity fees,
amortization and rent. Cost of services excluding impairment of software
inventory decreased $1,050,000 in 2003 from 2002. Salaries and employee benefits
decreased $470,000 primarily due to a reduction of personnel to 36 at the end of
2003 from 62 at the beginning of 2002. Product development personnel who were
temporarily assigned to cost of services during 2002 represented $278,000 of
this decrease. These employees were used to implement alternative connectivity
solutions for the ICC.NET service when GXS and Sterling disconnected our service
from their networks during 2002. Amortization decreased $246,000 in 2003 from
2002 primarily due to certain capitalized software costs becoming fully
amortized during 2002. In addition, consulting costs decreased $159,000 in 2003
from 2002 due primarily to a decrease in costs associated with technology
license revenue from Triaton. Travel, meals and entertainment decreased $104,000
in 2003 from 2002 due to lower travel requirements associated with projects. In
addition, costs for rental of space for educational seminars decreased $62,000
in 2003 from 2002 due to the use of lower cost facilities. However, these
savings were partially offset by increased connectivity costs of $306,000 in
2003 from 2002. The increase in connectivity fees was primarily due to
additional fees incurred to offer our customers and their trading partners
alternative connectivity when GXS and Sterling disconnected our service from
their networks during 2002. Cost of services relating to VAN services decreased
to $3,744,000 in 2003 from $4,009,000 in 2002. Cost of services relating to
mapping services decreased to $1,424,000 in 2003 from $1,683,000 in 2002. Cost
of services relating to services provided to Triaton was $53,000 in 2002
compared to no costs in 2003. Impairment of software inventory of $248,000 in
2003 represents an impairment for software inventory held by the professional
services reporting unit resulting from insufficient historical and projected
revenue from these products to support the recoverability of that carrying
value. We anticipate that ICC.NET cost of services will decline as a percentage
of revenue in future periods due to increased utilization of our existing
communications infrastructure as we expect the use of our VAN service to
increase.
Product development and enhancement - ICC.NET - Product development and
enhancement costs relating to ICC.NET consist primarily of salaries and employee
benefits. The increase of $153,000 in 2003 from 2002 was primarily attributable
to an increase of $267,000 of costs relating to product development personnel
who had been temporarily assigned to cost of services during 2002. The personnel
were utilized to implement alternative connectivity solutions for the ICC.NET
service when GXS and Sterling disconnected our service from their networks
during 2002. The prior year allocation was partially offset by a decrease of
$78,000 in salaries and employee benefits as a result of reduction in staff to 8
at the end of 2003 from 14 at the beginning of 2002. Also, consulting costs
decreased $17,000 in 2003 from 2002 due to increased reliance on staff.
Selling and marketing - ICC.NET - Selling and marketing expenses relating
to ICC.NET consist primarily of salaries and employee benefits, advertising and
trade show costs and travel-related costs. Selling and marketing expenses
related to the ICC.NET service were reduced $477,000 in 2003 from 2002. The
decrease in selling and marketing expenses was primarily attributable to a
decrease in salaries and benefits of $196,000 in 2003. Advertising and trade
show costs were reduced $175,000 because we attended fewer trade shows and
placed fewer print advertisements. In addition, rent, travel and entertainment
and severance decreased $28,000, $26,000 and $21,000, respectively, in 2003 from
2002.
General and administrative - ICC.NET - General and administrative expenses
supporting ICC.NET consist primarily of salaries and employee benefits, facility
costs, legal and professional fees, depreciation, amortization and telephone
charges. General and administrative costs supporting ICC.NET decreased
$1,383,000 in 2003. Legal fees decreased $465,000 in 2003 relating to our
disconnection from other VAN's and resolution of a legal matter in 2002. Rent
expense decreased $393,000 in 2003 as a result of the renegotiation of our
leases. In addition, salary and benefits decreased $258,000 primarily due to a
reduction in personnel in our professional service reporting unit to 3 at the
end of 2003 from 6 at the end of 2002 and 10 at the beginning of 2002. Bad debt
expense decreased $173,000 in 2003 from 2002 due to a decrease in customer
defaults from the prior year. In addition, depreciation and amortization
decreased $93,000 in 2003 from 2002 due to assets reaching the end of their
depreciable or amortizable lives. These decreases were partially offset by an
increase in accounting fees of $130,000 in 2003 from 2002 due to services
provided in connection with SEC filings and other matters. For cost reduction
purposes, executive management, human resources, accounting and finance
functions for both of our reporting segments were
29
centralized and are now performed by ICC.NET personnel. Commencing in the second
fiscal quarter of 2003, ICC.NET began allocating the costs of executive
management, human resources, accounting and finance tasks to the service bureau
segment based on the level of services provided. In 2003, these allocations
totaled $135,000.
Non-cash charges - ICC.NET - Non-cash charges decreased $111,000 in 2003
from 2002. In 2003, $60,000 of expense was recognized for common stock and
options issued to a non-employee member of our board of directors as
compensation for consulting services. In addition, expense recognized for common
stock to be issued to non-employee members of our board of directors as
compensation increased $19,000 in 2003 from 2002. Non-cash charges of $190,000
in 2002 consisted of stock-based compensation expense related to assumed
unvested restricted shares issued to RTCI employees in connection with our
acquisition of RTCI.
Other (expense) income, net - ICC.NET - Other expenses increased $656,000
in 2003 from 2002. An impairment charge of $318,000 was recorded in 2003 for the
write down of available-for-sale marketable securities due to an other than
temporary decline in value. In 2002 other income includes a legal settlement
from a competitor of $63,000 and the favorable settlement of an
acquisition-related liability of $145,000. In addition, net gains from the
disposition of marketable securities decreased $140,000 in 2003 from 2002.
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:
Year Ended
July 31,
---------------------------
2003 2002
------------ -----------
Revenues:
Services $ 1,487,946 $ 1,633,183
Expenses:
Cost of services 735,136 839,217
Impairment of capitalized software 148,479 --
----------- -----------
Total cost of services 883,615 839,217
Product development and enhancement 135,358 154,589
Selling and marketing 135,411 123,100
General and administrative 483,522 511,328
Impairment of acquired intangible 982,142
----------- -----------
2,620,048 1,628,234
----------- -----------
Operating income (loss) (1,132,102) 4,949
----------- -----------
Other income, net -- --
----------- -----------
Income (loss) before income taxes $(1,132,102) $ 4,949
=========== ===========
Revenues - Service Bureau - Revenue related to our service bureau was 12%
of our total consolidated revenue in 2003 compared to 11% of total consolidated
revenue in 2002. The service bureau's revenue was primarily generated from
services performed, customer support and licensing fees. The decrease in revenue
of $145,000 in 2003 from 2002 was primarily the result of a decrease in revenue
of $122,000 due the bankruptcy of a major customer.
Cost of services - Service Bureau - Total cost of services relating to our
service bureau was 58% of revenue derived from the service bureau in 2003
compared to 51% of such revenues in 2002. Excluding the impairment of the
capitalized software, costs of services was 49% of revenue derived from the
service bureau in 2003 compared to
30
51% of revenue derived from the service bureau in 2002. Cost of services related
to our service bureau consists primarily of salaries and employee benefits and
rent. Cost of services, excluding the capitalized software impairment charge,
decreased $104,000 in 2003. This decrease in cost of services was primarily the
result of an $80,000 decrease in the use of consultants for customer service and
support and data entry services and a decrease in salary and benefits of
$22,000. Delivery charges to customers decreased $11,000 in 2003 from 2002 due
to customers paying these cost directly to the delivery agent. Cost of services
- - impairment of capitalized software of $148,000 in 2003 represents an
impairment of capitalized software for in-process projects that management
decided, due to unfavorable market conditions continuing into 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
rent. Product development and enhancement costs incurred by our service bureau
decreased $19,000 in 2003 from 2002. This decrease was primarily attributable to
a decrease in salaries and employee benefits of $16,000 as a result of a
reduction of staff to 4 at the end of 2003 from 5 at the beginning of 2002.
Selling and marketing - Service Bureau - Selling and marketing expenses
relating to our service bureau consist primarily of salaries and employee
benefits and rent. Selling and marketing expenses increased $12,000 in 2003
primarily due to an increase in salaries and employee benefits of $8,000, and a
$5,000 severance payment in 2003.
General and administrative - Service Bureau - General and administrative
expenses relating to our service bureau consist primarily of salaries and
employee benefits, depreciation, rent, telephone and office expenses. General
and administrative costs decreased $28,000 in 2003 from 2002. Salaries decreased
$160,000 in 2003 from 2002 as a result of a reduction in staff to 1 at the end
of 2003 from 4 at the end of 2002, and 6 at the beginning of 2002. This was
offset by an increase of $135,000 in general and administrative support staff
salaries and benefits allocated by ICC.NET to the service bureau in 2003. See
"General and administrative - ICC.NET" above for a discussion of the allocation
of general and administrative expenses between segments.
Impairment of Acquired Intangibles - Service Bureau - During the quarter
ended July 31, 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. An impairment
loss of $982,142 was recognized as a result of this evaluation. The fair value
of the service bureau reporting unit was estimated using the net present value
of expected future cash flows.
Liquidity and Capital Resources
Our principal sources of liquidity, which consist of cash and cash
equivalents, increased to $3,790,000 as of July 31, 2004 from $2,283,000 as of
July 31, 2003. We believe these resources are expected to provide us with
sufficient liquidity to continue in operation through July 31, 2005.
On a sequential quarterly basis, cash used in operating activities for the
first, second, third and fourth quarters of fiscal 2004 was $1,103,000,
$819,000, $433,000 and $521,000, respectively.
We have financed our operations through various private placements of
equity and debt securities during fiscal 1994, our initial public offering
during fiscal 1995 (the "IPO"), a private placement in March 1997, a private
placement of bridge note units during fiscal 1998 and 1999, a private placement
of series A preferred stock in April 1999, private placements of our class A
common stock, series C preferred stock and warrants in November 1999, a private
placement of our class A common stock and warrants in October 2001, a warrant
exchange offer in May 2002, a private placement of our class A common stock and
warrants and series D preferred stock and warrants in April and May 2003, and a
private placement of our class A common stock and warrants in April 2004.
In the October 2001 private placement, we sold 1,159,716 shares of class A
common stock and warrants to purchase 347,915 additional shares of class A
common stock for gross proceeds of $3,189,219. The warrants expire in October
2006 and are exercisable at $3.58 per share, subject to adjustment pursuant to
customary antidilution adjustments for stock splits, dividends and combinations.
In addition, the warrants are redeemable at our option if
31
the closing bid price of our 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. In connection with the
private placement, we incurred fees of $152,511, of which $35,000 has been paid
in cash and $117,511 was paid by issuing warrants to purchase 50,000 shares of
class A common stock. The warrants have substantially the same terms and
conditions as the warrants issued in the October 2001 private placement.
On April 23, 2002, we commenced a warrant exchange offer that ended on May
31, 2002. The offer was extended to investors who participated in the private
placement in October 2001 and to holders of warrants issued as fees in
connection with that private placement. The offer reduced the exercise price of
the warrants issued in the private placement to $2.50 per share of class A
common stock for those investors that agreed to exercise those warrants. In
addition, for each share of class A common stock purchased pursuant to the
warrant exercise, a new warrant (the "New Warrants") to purchase an equivalent
number of shares of class A common stock was issued. The New Warrants have an
exercise price of $3.50 per share and otherwise contain the same terms as the
warrants issued in the private placement. In addition, the warrants are
redeemable at our option if the closing bid price of our 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 warrant exchange offer was originally set to expire on April 30, 2002, but
was extended by the board of directors until May 31, 2002. We received $659,288
in gross proceeds and issued a total of 263,715 shares of class A common stock
and New Warrants to purchase 263,715 shares of class A common stock.
During April and May 2003, we completed a private placement of class A
common stock, series D convertible preferred stock and warrants to purchase
shares of class A common stock (the "2003 Private Placement") for aggregate
gross proceeds of approximately $2,085,000. In the 2003 Private Placement we
sold 1,682, 683 shares of class A common stock and warrants to purchase
1,346,116 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
our option if the closing bid price of our 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, subject to adjustment pursuant to customary
antidilution adjustments for stock splits, dividends and combinations. 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, we 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, we issued 48,706 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
us.
Approximately 21%, or $432,000, of the gross proceeds from the 2003
Private Placement were received from directors and officers and entities with
which directors are affiliated. Subsequent to the completion of the 2003 Private
Placement, we 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 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 2003, we paid bonuses of approximately
$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.
32
In addition, on May 30, 2003, we executed an Accounts Receivable Financing
Agreement ("Financing Agreement") with Silicon Valley Bank ("Bank") with a term
of one year. Under the Financing Agreement, we may borrow, subject to certain
conditions, up to 80% of our 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 Bank has been granted a
security interest in substantially all of our assets. In connection with the
Financing Agreement, we issued the bank warrants to purchase 40,000 shares of
class A common stock. The warrants are immediately exercisable at an exercise
price of $1.39, equal to the fair market value of the 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 years ended July 31, 2004 and 2003 we recorded
interest expense for the amortization of the fair value of the warrants in the
amount of approximately $28,400 and $5,700, respectively. At July 31, 2004,
there were no amounts outstanding under the financing arrangement. On October
22, 2003 and August 31, 2004, we amended the Financing Agreement to extend its
term to August 31, 2004 and December 29, 2004, respectively.
On April 20, 2004, we completed a private placement of class A common
stock and warrants to purchase shares of our class A common stock (the "2004
Private Placement") for aggregate gross proceeds of approximately $4,955,500.
In the 2004 Private Placement we 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. No directors, officers or entities with which
directors or officers are affiliated participated in the 2004 Private Placement.
In connection with the 2004 Private Placement, we incurred fees and
expenses of $748,488, of which $423,274 was paid in cash at closing, $99,309 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.
We have a net operating loss carryforward of approximately $78.5 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 2024.
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 the 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 and subsequent to the
initial public offering is subject to an annual limitation of approximately $1
million until that portion of the net operating loss is utilized or expires. 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. Also, due to a 100% ownership change of
ECS in June 2004, the acquired net operating loss of approximately $1.1 million
incurred prior to the ownership change is subject to an annual limitation of
approximately $128,000 until that portion of the net operating loss is utilized
or expires.
Consolidated Working Capital
Our consolidated working capital increased by $2,498,000 to $4,198,000 at
July 31, 2004 from $1,700,000 at July 31, 2003. Our cash increased by $1,506,000
to $3,790,000 at July 31, 2004 from $2,283,000 at July 31, 2003 due primarily to
the completion of the 2004 Private Placement. Our accounts receivable increased
by $421,000 to $2,154,000 at July 31, 2004 from $1,733,000 at July 31, 2003 due
primarily to the addition of $262,000 in accounts receivable in connection with
the acquisition of Electronic Commerce Systems, Inc. in June 2004.
33
Analysis of Cash Flows
Cash used in our operating activities increased by $1,175,000 to
$2,876,000 in 2004 from $1,701,000 in 2003. Net loss before impairment charges,
depreciation and amortization, bad debt expense, gains and losses, and noncash
charges decreased $763,000 to $1,658,000 in 2004 from $2,422,000 in 2003. This
improvement was offset by an increase of $309,000 in accounts receivable in 2004
from a decrease of $1,200,000 in accounts receivable in 2003 due to the
collection of $1,500,000 from Triaton in 2003.
Cash provided by our investing activities increased by $133,000 to
$140,000 in 2004 from $7,000 in 2003. This increase is primarily attributable to
an increase in cash received from the sale of marketable securities of $79,000
to $134,000 in 2004 from $55,000 in 2003. In the addition, the acquisition of
ECS provided net cash of $69,000 in 2004.
Cash provided by our financing activities increased $2,353,000 to
$4,242,000 in 2004 from $1,889,000 in 2003. This increase is due primarily to an
increase in cash received from the issuance of class A common stock, preferred
stock and warrants of $2,345,000 to $4,410,000 in 2004 from $2,065,000 in 2003.
Tabular Disclosure of Contractual Obligations
We enter into many contractual and commercial undertakings during the
ordinary course of business. The following table summarizes information about
certain of our obligations at July 31, 2004. The table should be read together
with the Notes to the Consolidated Financial Statements included elsewhere in
this annual report.
- ---------------------------------------------------------------------------------------------------------
Payments due by period
Contractual Obligation Total Less than one year 1-2 years More than 2 years
- ---------------------------------------------------------------------------------------------------------
Capital lease obligations $ 58,363 54,480 3,883 --
Operating lease obligations 2,254,035 762,658 831,005 660,372
- ------------------------------- ---------- ---------- ---------- ---------
Total $2,312,398 817,138 834,888 660,372
- ------------------------------- ---------- ---------- ---------- ---------
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.
We adopted SFAS 146 on January 1, 2003. The adoption of this standard did not
have a significant impact on our 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. We have provided information regarding commitments and
contingencies relating to guarantees in Note 13. The adoption of this standard
did not have a significant impact on our 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 our consolidated financial position or results of operations.
34
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 our consolidated financial position and results of
operations. We adopted the fair-value recognition provisions of SFAS 123 in
January 2004 (Note 6).
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities ("FIN 46"). FIN 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. In December 2003, the FASB
issued FIN No. 46 (Revised) ("FIN 46R") to address certain FIN 46 implementation
issues. This interpretation requires that the assets, liabilities and results of
activities of a Variable Interest Entity ("VIE") be consolidated into the
financial statements of the enterprise that is the primary beneficiary of the
VIE. FIN 46R also requires additional disclosures by primary beneficiaries and
other significant variable interest holders. This interpretation is effective no
later than the end of the first interim or reporting period ending after March
15, 2004, except for those VIE's that are considered to be special purpose
entities, for which the effective date is no later than the end of the first
interim or annual reporting period ending after December 15, 2003. We adopted
FIN 46 in its entirety as of January 31, 2003. Since we have no VIE's, the
adoption of FIN 46 did not have an impact on our 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 our 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 our
consolidated financial position or results of operations.
Risk Factors
This annual report on Form 10-K contains a number of "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Specifically, all statements other than statements of historical facts included
in this annual 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 annual report, the words "anticipate,"
"believe," "estimate," "expect," "may," "will," "hope," "continue" and "intend,"
and words or phrases of similar import, as they relate to our financial
position,
35
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 under this heading "Risk Factors" and in our registration
statements and periodic reports filed with the Securities and Exchange
Commission 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
annual report as anticipated, believed, estimated, expected or intended.
Risks Relating to ICC
We have never earned a profit, may incur losses in the future and cannot
assure that we will be profitable in the future on an operating basis or
otherwise. We have incurred significant losses since we were founded in 1991. We
have never earned a profit in any fiscal quarter and, as of July 31, 2004, we
had an accumulated deficit of approximately $86 million.
Our primary focus has been on growing the ICC.NET value added network, or
VAN, service. The success of our VAN service, as well as the success of our
other services, depends to a large extent on the future of business-to-business
electronic commerce, our ability to effectively compete in the marketplace and
our ability to earn a profit, each of which is uncertain. In particular, the
success of the VAN service depends on the number of customers that subscribe to
our VAN service, the volume of the data, documents or other information they
send or retrieve utilizing this service and the price we are able to charge for
this service.
Over the past year, the VAN business has become significantly more price
competitive, with major networks restructuring to reduce their overhead and
other costs to better compete against Internet-based networks such as our
ICC.NET service. While we have been successful in maintaining, and in fact have
improved, our margins and we have increased the volume of data transmitted
through our van, we have experienced 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. If our revenues
grow at a slower rate than we anticipate, or decrease, and we are unable to
adjust spending in a timely manner or if our expenses increase without
commensurate increases in revenues, our operating results will suffer and we may
not ever achieve profitability.
We acquired ECS in June 2004 and expect to focus more on our Service
Bureau in the future. While we believe that the Service Bureau is approaching
profitability we cannot be certain that it will ever generate significant
profits.
We may not be able to compete effectively in the business-to-business
electronic commerce market, which could limit our market share and harm our
financial performance. We face a significant number of competitors, ranging from
very large enterprises or divisions of very large companies to a number of
relatively small organizations, including:
o Corporate information technology departments of current customers or
prospects that are capable of internal solution development and
support;
o Large companies with broad and diverse offerings, including a
division that offers business-to-business information exchange
services, such as IBM;
o Large e-Commerce business-to-business vendors with a broad array of
service offerings, including GXS, Sterling Commerce and Inovis; and
o Small companies with a core competence in a particular
industry, including companies such as Pubnet in the publishing
industry and Covisint in the automotive industry.
These competitors are diverse in terms of their histories, business
models, corporate strategies, financial strength, name recognition, company
reputation, customer base and breadth of offerings.
The principal competitive factors affecting our market for products and
services are:
o Compliance with industry standards;
o Functionality and features of offerings;
o Level of customer and technical support;
o Price of services;
o Reliability, security and availability of services;
o Technical and industry expertise; and
o Vendor and offering reputations.
Many of our large competitors have more history, significantly greater
financial resources, larger customer bases and more easily recognized names than
we do. As a result, our competitors may be able to respond more quickly to
changing technology and changes in customer requirements or be able to undertake
more extensive marketing campaigns, adopt more aggressive pricing policies and
make more attractive offers to potential customers and employees, or be able to
devote greater resources to the development, promotion and sale of their
services than we can. As a result, we may not be successful in competing against
our competitors.
36
New competition is emerging in the form of web services networks,
collaborative applications, application service providers, e-marketplaces and
integration broker suites. ICC has enhanced its technologies to communicate with
these AS2-based technologies. As described above, we have developed new product
and service offerings (AS2 and Data Synchronization) to improve our value
proposition; however, there can be no assurance that these new product and
service offerings will compete effectively and generate any significant
revenues. Competitors providing these alternatives include Cyclone Corporation
and Inovis. They offer software solutions that utilize the Internet to transmit
data between trading partners. We believe that the high cost of implementation
and the ongoing costs of supporting a company's trading partners are a barrier
to the wider acceptance of their product offerings in the marketplace.
Our catalog service competes with Quick Response Systems Corporation, or
QRS. QRS and Global eXchange Services have dominated the catalog service
industry for more than ten years, but we believe that our catalog pricing and
functionality may create competitive advantages for our service.
Furthermore, we rely on many of our competitors to interconnect with our
service to promote an "open community" so all businesses can take advantage of
the efficiencies of EDI, no matter what network they choose as their provider.
In September 2001 and April 2002, two of our competitors, GXS and Sterling
Commerce, terminated existing interconnect agreements with us and we made
alternative arrangements to serve our customers.
If we do not keep pace with rapid technological changes, customer demands
and intense competition, we will not be successful. Our market is characterized
by rapidly changing technology, customer demands and intense competition. The
satisfactory performance, reliability and availability of our network
infrastructure, customer support and document delivery systems and our web site
are critical to our reputation and our ability to attract customers and maintain
adequate customer service levels. If we cannot keep pace with these changes, and
maintain the performance and reliability of our network, our ICC.NET VAN service
could become uncompetitive and our business will suffer. The Internet's recent
growth and the intense competition in our industry require us to continue to
develop strategic business and Internet solutions that enhance and improve the
customer service features, functions and responsiveness of our ICC.NET and other
proposed services and that keep pace with continuing changes in information
technology and customer requirements. As indicated above, we have developed new
product and service offerings (AS2 and Data Synchronization) to improve our
value proposition and 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. Furthermore, we are actively searching for ways to expand our
business and the products and services we offer to keep pace with the rapidly
changing technology, customer demands and intense competition. However, there
can be no assurance that we will be able to keep pace with these changes and if
we are not successful in developing and marketing enhancements to our ICC.NET
VAN or other proposed services that respond to technological change or customer
demands, our business will suffer.
If we are unable to obtain necessary future capital, our business will
suffer. As of July 31, 2004, we had unrestricted cash in the amount of
approximately $3,790,000. We may need to raise additional funds if competitive
pressures or technological changes are greater than anticipated, if we are
unable to increase revenue at anticipated rates, if our expenses increase
significantly or if our customers delay payment of our receivables. We cannot
assure you that any additional financing will be available on reasonable terms
or at all. Raising additional funds in the future by issuing securities could
adversely affect our stockholders and negatively impact our operating results.
If we raise additional funds through the issuance of debt securities, the
holders of the debt securities will have a claim to our assets that will have
priority over any claim of our stockholders. The interest on these debt
securities would increase our costs and negatively impact our operating results.
If we raise additional funds through the issuance of class A common stock or
securities convertible into or exchangeable for class A common stock, the
percentage ownership of our then-existing stockholders will decrease and they
may experience additional dilution. In addition, any convertible or exchangeable
securities may have rights, preferences and privileges more favorable to the
holders than those of the class A common stock.
37
Failure of our third-party providers to provide adequate Internet and
telecommunications service could result in significant losses of revenue. Our
operations depend upon third parties for Internet access and telecommunications
service. Frequent or prolonged interruptions of these services could result in
significant losses of revenues. Each of them has experienced outages in the past
and could experience outages, delays and other difficulties due to system
failures unrelated to our online architecture. From the evening of April 6, 2004
until 6:00 a.m. on April 8, 2004, our network lost connectivity to the network
of one of our interconnection service providers because of equipment failure at
the supplier's data center. These types of occurrences could also cause users to
perceive our services as not functioning properly and therefore cause them to
use other methods to deliver and receive information. We have limited control
over these third parties and cannot assure you that we will be able to maintain
satisfactory relationships with any of them on acceptable commercial terms or
that the quality of services that they provide will remain at the levels needed
to enable us to conduct our business effectively.
We may suffer systems failures and business interruptions that would harm
our business. Our success depends in part on the efficient and uninterrupted
operation of our service which is required to accommodate a high volume of
traffic. Almost all of our network operating systems are located at the
Securities Industry Automation Corporation, or SIAC. SIAC runs all computing
operations for the New York Stock Exchange and the American Stock Exchange. Our
systems are vulnerable to events such as damage from fire, power loss,
telecommunications failures, break-ins and earthquakes. This could lead to
interruptions or delays in our service, loss of data or the inability to accept,
transmit and confirm customer documents and data. Our business may suffer if our
service is interrupted. Although we have implemented network security measures,
our servers may be vulnerable to computer viruses, electronic break-ins,
attempts by third parties deliberately to exceed the capacity of our systems and
similar disruptions.
If we are unable to manage our growth, our financial results will suffer.
Our ability to implement our business plan successfully in a new and rapidly
evolving market requires effective planning and growth management. If we cannot
manage our anticipated growth effectively, our business and financial results
will suffer. We expect that we will need to continue to manage and to expand
multiple relationships with customers, Internet service providers and other
third parties. We also expect that we will need to continue to improve our
financial systems, procedures and controls and will need to expand, train and
manage our workforce, particularly our information technology and sales and
marketing staffs.
If we lose our net operating loss carryforward of approximately $78.5
million, our financial results will suffer. Section 382 of the Internal Revenue
Code contains rules designed to discourage persons from buying and selling the
net operating losses of companies. These rules generally operate by focusing on
ownership changes among stockholders owning directly or indirectly 5% or more of
the common stock of a company or any change in ownership arising from a new
issuance of stock by a company. In general, the rules limit the ability of a
company to utilize net operating losses after a change of ownership of more than
50% of its common stock over a three-year period. Purchases of our class A
common stock in amounts greater than specified levels could inadvertently create
a limitation on our ability to utilize our net operating losses for tax purposes
in the future. We are currently subject to a limitation on the utilization of
our net operating loss carryforward.
If we cannot successfully expand our business outside of the United
States, our revenues and operating results will be adversely affected. Our
current and future customers are conducting their businesses internationally. As
a result, one component of our business strategy is to expand our international
marketing and sales efforts and if we do not successfully expand our business in
this way, we may lose current and future customers.
If we cannot hire and retain highly qualified employees, our business and
financial results will suffer. We are substantially dependent on the continued
services and performance of our executive officers and other key employees. If
we are unable to attract, assimilate and retain highly qualified employees, our
management may not be able to effectively manage our business, exploit
opportunities and respond to competitive challenges and our business and
financial results will suffer. Many of our competitors may be able to offer more
lucrative compensation packages and higher-profile employment opportunities than
we can.
38
We depend on our intellectual property, which may be difficult and costly
to protect. If we fail to adequately protect our proprietary rights, competitors
could offer similar products relying on technologies we developed, potentially
harming our competitive position and decreasing our revenues. We attempt to
protect our intellectual property rights by limiting access to the distribution
of our software, documentation and other proprietary information and by relying
on a combination of patent, copyright, trademark and trade secret laws. In
addition, we enter into confidentiality agreements with our employees and
certain customers, vendors and strategic partners. In some circumstances,
however, we may, if required by a business relationship, provide our licensees
with access to our data model and other proprietary information underlying our
licensed applications.
Despite the precautions we take, it may be possible for unauthorized third
parties to copy aspects of our current or future products or to obtain and use
information that we regard as proprietary. Policing unauthorized use of software
is difficult, and some foreign laws do not protect proprietary rights to the
same extent as United States laws. Litigation may be necessary in the future to
enforce our intellectual property rights, to protect our trade secrets or to
determine the validity and scope of the proprietary rights of others, any of
which could be costly and adversely affect our operating results.
Intellectual property infringement claims against us could harm our
business. Our business activities and our ICC.NET service may infringe upon the
proprietary rights of others and other parties may assert infringement claims
against us. Any such claims and any resulting litigation could subject us to
significant liability for damages and could invalidate our proprietary rights.
We could be required to enter into royalty and licensing agreements, which may
be costly or otherwise burdensome or which may not be available on terms
acceptable to us.
Risks Relating to the Internet and Online Commerce Aspects of Our Business
If Internet usage does not continue to grow or if its infrastructure
fails, our business will suffer. If the Internet does not gain increased
acceptance for business-to-business electronic commerce, the growth of our
business will be adversely affected. We cannot be certain that the
infrastructure or complementary services necessary to maintain the Internet as a
useful and easy means of transferring documents and data will continue to
develop. The Internet infrastructure may not support the demands that growth may
place on it and the performance and reliability of the Internet may decline.
Privacy concerns may prevent customers from using our services. Concerns
about the security of online transactions and the privacy of users may inhibit
the growth of the Internet as a means of delivering business documents and data.
We may need to incur significant expenses and use significant resources to
protect against the threat of security breaches or to alleviate problems caused
by security breaches. We rely upon encryption and authentication technology to
provide secure transmission of confidential information. If our security
measures do not prevent security breaches, we could suffer operating losses,
damage to our reputation, litigation and possible liability. Advances in
computer capabilities, new discoveries in the field of cryptography or other
developments that render current encryption technology outdated may result in a
breach of our encryption and authentication technology and could enable an
outside party to steal proprietary information or interrupt our operations.
Government regulation and legal uncertainties relating to the Internet
could harm our business. Changes in the regulatory environment in the United
States and other countries could decrease our revenues and increase our costs.
The Internet is largely unregulated and the laws governing the Internet remain
unsettled, even in areas where there has been some legislative action. It may
take years to determine whether and how existing laws such as those governing
intellectual property, privacy and taxation apply to the Internet. In addition,
because of increasing popularity and use of the Internet, any number of laws and
regulations may be adopted in the United States and other countries relating to
the Internet or other online services covering issues such as:
o user privacy;
o security;
o pricing and taxation;
o content; and
o distribution.
39
Costs of transmitting documents and data could increase, which would harm
our business and operating results. The cost of transmitting documents and data
over the Internet could increase. We may not be able to increase our prices to
cover these rising costs. Also, foreign and state laws and regulations relating
to the provision of services over the Internet are still developing. If
individual states or foreign countries impose taxes or laws that negatively
impact services provided over the Internet, our cost of providing our ICC.NET
and other services may increase.
Risks Relating to our Class A Common Stock
Trading of our class A common stock is volatile. The market price of our
class A common stock has been very volatile in the past, ranging from a high of
$2.55 to a low of $0.80 between January 1, 2003 and October 26, 2004, and is
likely to fluctuate substantially in the future. If our class A common stock
fails to maintain a minimum bid price of $1.00 for 30 consecutive trading days,
it may no longer be eligible for trading in the Nasdaq SmallCap Market.
Shares eligible for future sale by our existing stockholders may adversely
affect our stock price and may render it difficult to sell class A common stock.
Between January 1, 2003 and October 2004, we registered on one or more
registration statements, an aggregate of 9,987,817 shares of our class A common
stock, which includes 3,016,917 shares of class A common stock issuable upon the
exercise of warrants to purchase shares of class A common stock and 192,307
shares of class A common stock issuable upon conversion of our series D
preferred stock, and of which a registration statement covering 1,941,409 shares
has not been declared effective by the Securities and Exchange Commission. The
market price of our class A common stock could be materially and adversely
affected by sales of even a small percentage of these shares or the perception
that these sales could occur.
The market for our class A common stock may be illiquid, which would
restrict the ability to sell shares of class A common stock. Our class A common
stock is trading on the Nasdaq SmallCap Market. It is possible that the trading
market for the class A common stock in the future will be thin and illiquid,
which could result in increased volatility in the trading prices for our class A
common stock. The price at which our class A common stock will trade in the
future cannot be predicted and will be determined by the market. The price may
be influenced by many factors, including investors' perceptions of our business,
our financial condition, operating results and prospects, the use of the
Internet for business purposes and general economic and market conditions.
Our board of directors can issue preferred stock with rights adverse to
the holders of class A common stock. Our board of directors is authorized,
without further stockholder approval, to determine the provisions of and to
issue up to 4,979,575 shares of preferred stock. Issuance of preferred shares
with rights to dividends and other distributions, voting rights or other rights
superior to the class A common stock could be adverse to the holders of class A
common stock. In addition, issuance of preferred shares could have the effect of
delaying, deterring or preventing an unsolicited change in control of our
company, or could impose various procedural and other requirements that could
make it more difficult for holders of our class A common stock to effect certain
corporate actions, including the replacement of incumbent directors and the
completion of transactions opposed by the incumbent Board of Directors. The
rights of the holders of our class A common stock would be subject to, and may
be adversely affected by, the rights of the holders of any preferred stock that
may be issued in the future. We are also subject to Section 203 of the Delaware
General Corporation Law, which prohibits us from engaging in a business
combination with any "interested" stockholder (as defined in Section 203) for a
period of three years from the date the person becomes an interested
stockholder, unless certain conditions are met.
We may have to use significant resources indemnifying our officers and
directors or paying for damages caused by their conduct. The Delaware General
Corporation Law provides for broad indemnification by corporations of their
officers and directors and permits a corporation to exculpate its directors from
liability for their actions. Our bylaws and certificate of incorporation
implement this indemnification and exculpation to the fullest extent permitted
under this law as it currently exists or as it may be amended in the future.
Consequently, subject to this law and to some limited exceptions in our
certificate of incorporation, none of our directors will be liable to us or to
our stockholders for monetary damages resulting from conduct as a director
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is primarily exposed to interest rate risk and credit risk.
40
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 8. Financial Statements and Supplementary Data
The response to this item is submitted in a separate section of this
annual report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
Our management, including our Chief Executive Officer and Acting Chief
Financial Officer, have carried out an evaluation of the effectiveness of our
disclosure controls and procedures as of July 31, 2004, pursuant to Exchange Act
Rules 13a-15(e) and 15(d)-15(e). Based upon that evaluation, our Chief Executive
Officer and Acting Chief Financial Officer have concluded that as of such date,
our disclosure controls and procedures in place are effective to ensure material
information and other information requiring disclosure is identified and
communicated on a timely basis. There were no significant changes in the
registrant's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation.
Item 9B. Other Information.
None.
41
PART III
The information required to be filed by Part III (Items 10, 11, 12, 13 and
14) is hereby incorporated by reference from the Company's definitive proxy
statement (to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A), which proxy statement will be filed no later than 120 days
after July 31, 2004.
42
PART IV
Item 15. Exhibits, Financial Statements Schedules and Signatures
(a) List of documents filed as part of the report:
1. Consolidated Financial Statements
See index to Consolidated Financial Statements and Schedule on page
F-1
2. Financial Statement Schedule
See index to Consolidated Financial Statements and Schedule on page
F-1
3. Exhibits
The following documents are filed as exhibits to this form 10-K, including
those exhibits incorporated in this form 10-K by reference to a prior filing of
ICC under the Securities Act or the Exchange Act as indicated in parenthesis:
Exhibit No. Description
2.1 Agreement and Plan of Merger among ICC, ICC Acquisition
Corporation, Inc., a wholly-owned subsidiary of ICC, Research
Triangle Commerce, Inc., or RTCI, and the selling shareholders of
RTCI (10)
2.2 Agreement and Plan of Merger among ICC, IDC, and the selling
shareholders of IDC (4)
2.3 Agreement and Plan of Merger among ICC, ICC Acquisition Corporation
Inc., a wholly-owned subsidiary of ICC, Electronics Commerce
Systems, Inc., or ECS, and certain shareholders of ECS (18)
3(i).1 Amended and Restated Certificate of Incorporation (1)
3(i).2 Certificate of Merger merging Infosafe Systems, Inc. and ICC (1)
3(i).3 Certificate of Amendment to the Amended and Restated Articles of
Incorporation (2)
3(i).4 Certificate of Designations--Series A Convertible Redeemable
Preferred Stock (1)
3(i).5 Certificate of Designations--Series C Preferred Stock (8)
3(i).6 Certificate of Designations--Series D Preferred Stock (8)
3(ii).1 Amended and Restated By-laws (6)
4.1 Specimen Certificate for Class A Common Stock (3)
4.2 Form of Class A Bridge Warrant issued in the 1998 bridge financing
(1)
4.3 Warrant Agreement dated January 12, 2000, by and among ICC and
Cable and Wireless USA, Inc. (8)
4.4 Form of Class A Common Stock Warrant issued in the October 29, 2001
private placement (13)
4.5 Form of Warrant Agreement issued in the April 30, 2003 and May 1,
2003 private placement (15)
4.6 Form of Registration Rights Agreement dated April 30, 2003, among
ICC and the purchasers of shares of class A common stock identified
therein (15)
4.7 Form of Registration Rights Agreement dated April 30, 2003, between
ICC and Blue Water Venture Fund II, L.L.C. (15)
43
4.8 Warrant Agreement dated May 30, 2003 by and between Silicon Valley
Bank, a California-chartered bank ("SVB") and the ICC (16)
4.9 Registration Rights Agreement dated as of May 30, 2003 by and
between SVB and the ICC (16)
4.10 Form of Warrant Agreement issued in the April 20, 2004 private
placement (17)
4.11 Form of Registration Rights Agreement dated as of April 20, 2004
between ICC and the purchasers of shares of class A common stock
identified therein (17)
4.12 Form of Registration Rights Undertaking dated June 22, 2004 by ICC
in favor of the shareholders of ECS (19)
10.1 1994 Stock Option Plan (3)
10.2 Lease Agreement between 805 Third Ave. Co. and ICC relating to the
rental of ICC's current principal executive office (4)
10.3 Lease Agreement, dated as of May 21, 1999, between JB Squared LLC
and ICC relating to the rental of approximately 4,000 square feet
at the Lakeview Executive Center, 45 Research Way, East Setauket,
New York, 11733 (5)
10.4 Master Agreement between Cable & Wireless PLC and ICC executed on
November 24, 1999 (7)
10.5 Amended and restated Stock Option Plan (9)
10.6 First Amendment to Lease Agreement, dated as of January, 2000, by
and between JB Squared LLC and ICC relating to the rental of an
additional approximately 4,800 square feet at the Lakeview
Executive Center, 45 Research Way, East Setauket, New York, 11733
(12)
10.7 First Amendment of Lease Agreement between Madison Third Building
Companies LLC and ICC relating to the rental of additional office
space at 805 Third Avenue, New York, New York 10022 (12)
10.8 Lease Agreement, dated as of August 2, 2000, by and between IDC
Realty, LLC as landlord and ICC as tenant relating to the rental of
an approximately 8,000 square feet facility used by ICC's Service
Bureau division (12)
10.9 Lease Agreement, dated as of November 1, 1999, by and between
Shannon Oaks Partnership as landlord and RTCI as tenant relating to
the rental of an approximately 8,000 square feet facility used by
ICC's Professional Services division (14)
10.10 License agreement with Triaton dated July 2002 (13)
10.11 Form of Subscription Agreement dated as of April 30, 2003, among
ICC and the purchasers of shares of class A common stock identified
therein (15)
10.12 Form of Subscription Agreement dated as of April 30, 2003, between
ICC and Blue Water Venture Fund II, L.L.C. for the purchase of
shares of Series D Preferred Stock (15)
10.13 Accounts Receivable Financing Agreement dated as of May 30, 2003 by
and between SVB and ICC (16)
10.14 First Loan Modification Agreement dated as of October 22, 2003 by
and between SVB and ICC (16)
10.15 Intellectual Property Security Agreement dated as of May 30, 2003
by and between SVB and ICC (16)
10.16 Form of Securities Purchase Agreement dated as of April 15, 2004 by
and among ICC and the purchasers listed on Schedule 1 thereto (17)
23 Consent of Deloitte & Touche LLP *
31.1 Certificate of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 *
44
31.2 Certificate of the Acting Chief Financial 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 Acting Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 *
- --------------------------
* Filed herewith
(1) Incorporated by reference to ICC's registration statement on Form S-3
(File no. 333-80043), as filed with the Securities and Exchange Commission
on June 4, 1999.
(2) Incorporated by reference to ICC's Annual Report on Form 10-KSB for the
year ended July 31, 1998, as filed with the Securities and Exchange
Commission on October 29, 1998.
(3) Incorporated by reference to ICC's registration statement on form SB-2
(File no. 33-83940).
(4) Incorporated by reference to ICC's Quarterly Report on Form 10-QSB for the
quarter ended October 31, 1997, as filed with the Securities and Exchange
Commission on December 12, 1997.
(5) Incorporated by reference to Amendment No. 3 to ICC's registration
statement on Form S-3 (File no. 333-80043), as filed with the Securities
and Exchange Commission on October 18, 1999.
(6) Incorporated by reference to ICC's Current Report on Form 8-K dated June
30, 1999, as filed with the Securities and Exchange Commission on July 1,
1999.
(7) Incorporated by reference to ICC's Current Report on Form 8-K dated
November 24, 1999, as filed with the Securities and Exchange Commission on
December 1, 1999.
(8) Incorporated by reference to Amendment No. 1 to ICC's registration
statement on Form S-3 (File no. 333-93301), as filed with the Securities
and Exchange Commission on February 8, 2000.
(9) Incorporated by reference to ICC's proxy statement for the annual meeting
of stockholders for the year ended July 31, 1999, as filed with the
Securities and Exchange Commission on May 23, 2000.
(10) Incorporated by reference to ICC's Current Report on Form 8-K dated June
14, 2000, as filed with the Securities and Exchange Commission on June 15,
2000.
(11) Incorporated by reference to ICC's Current Report on Form 8-K dated August
2, 2000, as filed with the Securities and Exchange Commission on August
11, 2000.
(12) Incorporated by reference to ICC's Annual Report on Form 10-KSB for the
year ended July 31, 2000, as filed with the Securities and Exchange
Commission on October 13, 2000.
(13) Incorporated by reference to ICC's registration statement on Form S-3
(file No. 333-99059), as filed with the Securities and Exchange Commission
on August 30, 2002.
(14) Incorporated by reference to ICC's Annual Report on Form 10-K for the year
ended July 31, 2002, as filed with the Securities and Exchange Commission
on October 31, 2002.
(15) Incorporated by reference to ICC's Current Report on Form 8-K dated April
30, 2003, as filed with the Securities and Exchange Commission on May 2,
2003.
(16) Incorporated by reference to ICC's Annual Report on Form 10-K for the year
ended July 31, 2003,as filed with the Securities and Exchange Commission
on October 31, 2003.
(17) Incorporated by reference to ICC's Current Report on Form 8-K dated April
20, 2004, as filed with the Securities and Exchange Commission on April
20, 2004.
(18) Incorporated by reference to ICC's Current Report on Form 8-K dated May
25, 2004, as filed with the Securities and Exchange Commission on May 26,
2004.
45
(19) Incorporated by reference to ICC's Current Report on Form 8-K dated June
22, 2004, as filed with the Securities and Exchange Commission on June 22,
2004.
(b) Exhibits
See index to exhibits on page 44.
(c) Financial Statement Schedule
See index to Consolidated Financial Statements and Schedule on page F-1.
46
INTERNET COMMERCE CORPORATION
Index to Consolidated Financial Statements and Schedule
Page
----
Report of Independent Registered Public Accounting Firm F-2
Consolidated balance sheets F-3
Consolidated statements of operations F-4
Consolidated statements of changes in stockholders'
equity and other comprehensive income F-5
Consolidated statements of cash flows F-8
Notes to consolidated financial statements F-9
Schedule II. Valuation and Qualifying Accounts F-37
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Internet Commerce Corporation
New York, New York
We have audited the accompanying consolidated balance sheets of Internet
Commerce Corporation (the "Company") as of July 31, 2004 and 2003, and the
related consolidated statements of operations, changes in stockholders' equity
and other comprehensive income, and cash flows for each of the three years in
the period ended July 31, 2004. Our audits also included the financial statement
schedule listed at Item 15. These financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Internet Commerce Corporation as of
July 31, 2004, and 2003, and the results of its operations and its cash flows
for each of the three years in the period ended July 31, 2004, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the Consolidated Financial Statements, the Company
adopted the provisions of Statement of Financial Accounting Standards ("SFAS")
No. 141, "Business Combinations," and SFAS 142, "Goodwill and Other Intangible
Assets," effective August 1, 2001.
/s/ Deloitte & Touche LLP
New York, New York
October 28, 2004
F-2
INTERNET COMMERCE CORPORATION
Consolidated Balance Sheets
July 31,
---------------------------------
2004 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 3,789,643 $ 2,283,339
Marketable securities -- 91,941
Accounts receivable, net of allowance for
doubtful accounts of $308,867 and $220,281,
respectively 2,154,463 1,732,890
Prepaid expenses and other current assets 244,900 295,474
------------ ------------
Total current assets 6,189,006 4,403,644
Restricted cash 107,658 128,607
Property and equipment, net 295,556 556,812
Software development costs, net 17,860 127,841
Goodwill 2,539,238 1,211,925
Other intangible assets, net 2,265,010 2,151,000
Other assets 14,237 18,507
------------ ------------
Total assets $ 11,428,565 $ 8,598,336
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 523,703 $ 918,337
Accrued expenses 1,004,461 1,178,880
Accrued dividends - preferred stock 232,787 231,726
Deferred revenue 133,063 96,952
Capital lease obligation 52,291 148,189
Other current liabilities 45,111 129,985
------------ ------------
Total current liabilities 1,991,416 2,704,069
Capital lease obligation - less current portion 2,908 46,120
Other non-current liabilities -- 8,011
------------ ------------
Total liabilities 1,994,324 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 $10,232,787) 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; 19,058,187
and 13,797,566 shares issued and outstanding, respectively 190,582 137,976
Class B - par value $.01 per share, 2,000,000 shares
authorized, six votes per share; none issued and
outstanding -- --
Additional paid-in capital 95,143,356 87,489,583
Accumulated deficit (85,899,800) (81,813,191)
Accumulated other comprehensive income -- 25,665
------------ ------------
Total stockholders' equity 9,434,241 5,840,136
------------ ------------
Total liabilities and stockholders' equity $ 11,428,565 $ 8,598,336
============ ============
See notes to consolidated financial statements.
F-3
INTERNET COMMERCE CORPORATION
Consolidated Statements of Operations
Year Ended July 31,
--------------------------------------------------
2004 2003 2002
------------ ------------ ------------
Revenues:
Services $ 11,704,803 $ 12,083,314 $ 11,221,796
Technology license -- -- 3,000,000
------------ ------------ ------------
Total revenues 11,704,803 12,083,314 14,221,796
------------ ------------ ------------
Expenses:
Cost of services (excluding non-cash compensation of $38,877
in 2004, and $118,762 in 2002) 6,736,490 7,621,823 8,775,553
Impairment of software inventory -- 248,077 --
Impairment of capitalized software development costs 44,983 148,479 --
Product development and enhancement (excluding non-cash
compensation of $125,829 in 2004) 953,013 1,110,941 976,903
Selling and marketing (excluding non-cash compensation of
$94,119 in 2004 and $29,690 in 2002) 3,070,431 3,034,726 3,499,500
General and administrative (excluding non-cash compensation of
$542,014, $139,415 and $101,556 in 2004, 2003 and 2002,
respectively) 4,205,315 4,438,630 5,849,312
Non-cash charges for stock-based compensation, services and
legal settlements 800,839 139,415 250,008
Impairment of goodwill and acquired intangibles -- 982,142 1,710,617
------------ ------------ ------------
15,811,071 17,724,233 21,061,893
------------ ------------ ------------
Operating loss (4,106,268) (5,640,919) (6,840,097)
------------ ------------ ------------
Other income and (expense):
Interest and investment income 2,683 12,923 27,154
Investment gain (loss) 67,834 (19,072) 121,022
Interest expense (50,712) (39,326) (69,385)
Impairment of marketable securities -- (317,924) --
Other income (loss) (146) -- 213,753
------------ ------------ ------------
19,659 (363,399) 292,544
------------ ------------ ------------
Loss before income taxes (4,086,609) (6,004,318) (6,547,553)
Provision for income taxes -- -- --
------------ ------------ ------------
Net loss (4,086,609) (6,004,318) (6,547,553)
Dividends on preferred stock (401,061) (400,031) (364,987)
Beneficial conversation feature relating to series D preferred stock -- (106,730) --
Beneficial conversion feature for repricing and issuance of warrants
in warrant exchange offer -- -- (461,084)
------------ ------------ ------------
Loss attributable to common stockholders $ (4,487,670) $ (6,511,079) $ (7,373,624)
============ ============ ============
Basic and diluted loss per common share $ (0.30) $ (0.53) $ (0.68)
============ ============ ============
Weighted average number of common shares outstanding -
basic and diluted $ 15,025,524 $ 12,303,367 $ 10,867,447
============ ============ ============
See notes to consolidated financial statements.
F-4
INTERNET COMMERCE CORPORATION
Consolidated Statements of Changes in Stockholders' Equity and Other
Comprehensive Income
Preferred Stock Common Stock
------------------------------------------------------------------------------------------------
Series A Series C Series D Class A Class B
------------------------------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount
------------------------------------------------------------------------------------------------
Balance - August 1, 2001 225 $2 10,000 $100 - $- 9,770,180 $97,702 1,930 $19
Conversion of series
A preferred stock (225) (2) 73,688 737
Proceeds from exercise
of employee stock options 69,452 695
Forfeiture of cash related
to options issued in
acquisition
Conversion of Class B
common stock 1,930 19 (1,930) (19)
Proceeds from exercise
of warrants 23,910 239
Proceeds from warrant
exchange offer 263,715 2,638
Proceeds from private
placement of common
stock and warrants 1,159,716 11,597
Common stock issued to
directors 22,218 222
Forfeiture and cancellation
of a former officer's
restricted common stock (23,684) (237)
Common stock issued to
investment advisors 200,000 2,000
Common stock issued to
consultants 20,000 200
Common stock issued as
payment for dividends
on preferred stock 98,839 989
Accrued dividends on
preferred stock
Amortization of deferred
compensation for restricted
stock
Net loss
Unrealized loss -
marketable securities
Total comprehensive loss
-------------------------------------------------------------------------------------------------
Balance - July 31, 2002 - $ - 10,000 $ 100 - $ - 11,679,964 $116,801 - $ -
(Continued on next page)
F-5
INTERNET COMMERCE CORPORATION
Consolidated Statements of Changes in Stockholders' Equity and Other
Comprehensive Income (CONT'D)
Accumulated Deferred
------------------------------------
Additional Other Compensation Total
Paid-In Comprehensive Restricted Stockholders'
Capital Deficit Loss Stock Equity
-----------------------------------------------------------------------------------
Balance - August 1, 2001 $80,750,153 $(69,261,320) $(209,728) $(190,019) $11,186,909
Conversion of series
A preferred stock (735) -
Proceeds from exercise
of employee stock options 223,187 223,882
Forfeiture of cash related
to options issued in
acquisition 106,979 106,979
Conversion of Class B
common stock -
Proceeds from exercise
of warrants 59,536 59,775
Proceeds from warrant
exchange offer 636,936 639,574
Proceeds from private
placement of common
stock and warrants 3,095,671 3,107,268
Common stock issued to
directors 59,766 59,988
Forfeiture and cancellation
of a former officer's
restricted common stock (144,000) (144,237)
Common stock issued to
investment advisors 502,560 504,560
Common stock issued to
consultants 77,200 77,400
Common stock issued as payment
for dividends on
preferred stock 399,011 400,000
Accrued dividends on
preferred stock (364,987) (364,987)
Amortization of deferred
compensation for restricted
stock 190,019 190,019
Net loss (6,547,553) (6,547,553)
Unrealized loss -
marketable securities (118,347) (118,347)
----------
Total comprehensive loss (6,665,900)
-----------------------------------------------------------------------------------------
Balance - July 31, 2002 $85,401,277 $(75,808,873) $ (328,075) $ - $9,381,230
See notes to consolidated financial statements.
F-5
INTERNET COMMERCE CORPORATION
Consolidated Statements of Changes in Stockholders' Equity and Other
Comprehensive Income
Preferred Stock Common Stock
------------------------------------------------------------------------------------------------
Series A Series C Series D Class A Class B
------------------------------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount
------------------------------------------------------------------------------------------------
Balance - July 31, 2002 - $ - 10,000 $ 100 - $ - 11,679,964 $116,801 - $ -
Proceeds from private
placement of Series D
preferred stock, common
stock and warrants 250 3 1,682,683 16,827
Common stock and warrants
issued for services 48,076 480
Common stock issued
to directors 71,703 716
Proceeds from exercise
of employee stock options 12,797 128
Accrued dividends on
preferred stock
Common stock issued
as payment for dividends
on preferred stock 302,343 3,024
Forfeiture of cash
related to options
issued in acquisition
Stock options issued
for consulting services
Warrants issued in
connection with accounts
receivable financing
agreement
Net loss
Reclassification of net
unrealized loss on sale
Unrealized gain on
marketable securities
Impairment of marketable
securities
Total comprehensive loss
- ----------------------------------------------------------------------------------------------------------------------------------
Balance - July 31, 2003 - $ - 10,000 $ 100 250 $ 3 13,797,566 $137,976 - $ -
==================================================================================================================================
(Continued on next page)
F-6
INTERNET COMMERCE CORPORATION
Consolidated Statements of Changes in Stockholders' Equity and Other
Comprehensive Income (CONT'D)
Accumulated Deferred
------------------------------------
Additional Other Compensation Total
Paid-In Comprehensive Restricted Stockholders'
Capital Deficit Loss Stock Equity
----------------------------------------------------------------------------------
Balance - July 31, 2002 $85,401,277 $(75,808,873) $ (328,075) $ - $9,381,230
Proceeds from private
placement of Series D
preferred stock, common
stock and warrants 1,830,734 1,847,564
Common stock and warrants
issued for services 49,520 50,000
Common stock issued
to directors 83,950 84,666
Proceeds from exercise
of employee stock options 3,258 3,386
Accrued dividends on
preferred stock (400,031) (400,031)
Common stock issued
as payment for dividends
on preferred stock 396,977 400,001
Forfeiture of cash
related to options
issued in acquisition 47,511 47,511
Stock options issued
for consulting services 42,248 42,248
Warrants issued in
connection with accounts
receivable financing
agreement 34,139 34,139
Net loss (6,004,318) (6,004,318)
Reclassification of net
unrealized loss on sale 19,072 19,072
Unrealized gain on
marketable securities 16,744 16,744
Impairment of marketable
securities 317,924 317,924
---------
Total comprehensive loss (5,650,578)
- -----------------------------------------------------------------------------------------------------------------------------
Balance - July 31, 2003 $87,489,583 $(81,813,191) $ 25,665 $ - $5,840,136
=============================================================================================================================
See notes to consolidated financial statements.
F-6
INTERNET COMMERCE CORPORATION
Consolidated Statements of Changes in Stockholders' Equity and Other
Comprehensive Income
Preferred Stock Common Stock
-----------------------------------------------------------------------------------------------
Series A Series C Series D Class A Class B
-----------------------------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount
-----------------------------------------------------------------------------------------------
Balance - July 31, 2003 - $ - 10,000 $ 100 250 $ 3 13,797,566 $ 137,976 - $ -
Proceeds from 2004
private placement of
common stock and warrants 2,831,707 28,317
Expenses incurred from
2003 private placement
of series D preferred
stock, common stock and
warrants
Common stock issued
relating to the
acquisition of ECS 1,941,409 19,414
Proceeds from exercise
of warrants 28,846 288
Return of common stock in
compliance with NASD
Marketplace Rule 4350
(i) (1) (A) (11,091) (111)
Stock based compensation
expense
Common stock issued to
directors 104,382 1,044
Proceeds from exercise
of employee stock options 3,666 37
Accrued dividends
on preferred stock
Common stock issued as
payment for dividends
on preferred stock,
net of tax 361,702 3,617
Forfeiture of cash related
to options issued in
acquisition of RTCI
Net loss
Unrealized gain -
marketable securities
Reclassification of
unrealized gain on
marketable securities
Total comprehensive loss
- ---------------------------------------------------------------------------------------------------------------------------------
Balance - July 31, 2004 - $ - 10,000 $ 100 250 $ 3 19,058,187 $190,582 - $ -
- ---------------------------------------------------------------------------------------------------------------------------------
(Continued on next page)
F-7
INTERNET COMMERCE CORPORATION
Consolidated Statements of Changes in Stockholders' Equity and Other
Comprehensive Income (CONT'D)
Accumulated Deferred
------------------------------------
Additional Other Compensation Total
Paid-In Comprehensive Restricted Stockholders'
Capital Deficit Loss Stock Equity
-----------------------------------------------------------------------------------
Balance - July 31, 2003 $ 87,489,583 $(81,813,191) $ 25,665 $ - $5,840,136
Proceeds from 2004
private placement of
common stock and warrants 4,404,600 4,432,917
Expenses incurred from
2003 private placement
of series D preferred
stock, common stock and
warrants (23,385) (23,385)
Common stock issued
relating to the
acquisition of ECS 2,446,175 2,465,589
Proceeds from exercise
of warrants 42,115 42,403
Return of common stock in
compliance with NASD
Marketplace Rule 4350
(i) (1) (A) 111 -
Stock based compensation
expense 671,118 671,118
Common stock issued to
directors 130,762 131,806
Proceeds from exercise
of employee stock options 4,029 4,066
Accrued dividends
on preferred stock (401,061) (401,061)
Common stock issued as
payment for dividends
on preferred stock,
net of tax 336,383 340,000
Forfeiture of cash related
to options issued in
acquisition of RTCI 42,926 42,926
Net loss (4,086,609) (4,086,609)
Unrealized gain -
marketable securities
Reclassification of
unrealized gain on
marketable securities 42,169 42,169
(67,834) (67,834)
-----------
Total comprehensive loss
(4,112,274)
- -----------------------------------------------------------------------------------------------------------------------------
Balance - July 31, 2004 $95,143,356 $(85,899,800) $ - $ - $9,434,241
- -----------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
F-7
INTERNET COMMERCE CORPORATION
Consolidated Statements of Cash Flows
Year Ended July 31,
------------------------------------------------
2004 2003 2002
----------- ----------- ------------
Cash flows from operating activities:
Net loss $(4,086,609) $(6,004,318) $(6,547,553)
Adjustments to reconcile net loss to net cash used in operating
activities:
Impairment of goodwill and intangible assets -- 982,142 1,710,617
Impairment of software inventory -- 248,077 --
Impairment of capitalized software 44,983 148,479 --
Impairment of marketable securities -- 317,924 --
Depreciation and amortization 1,445,111 1,678,166 2,132,467
Bad debt expense 176,670 43,501 223,107
Non-cash interest expense 28,434 5,705 --
Loss on disposal of fixed assets -- -- 10,453
Realized loss (gain) on sale of marketable securities (67,834) 19,072 (121,020)
Non-cash charges for equity instruments issued for compensation,
services, change of control and legal settlement 800,839 139,415 250,008
Changes in:
Accounts receivable (309,449) 1,200,081 (1,611,337)
Prepaid expenses and other assets 48,731 (40,388) (35,664)
Accounts payable (476,448) 45,413 148,420
Accrued expenses (337,420) (350,961) (285,000)
Deferred revenue (49,753) (67,499) (142,314)
Other liabilities (92,884) (65,458) (24,735)
----------- ----------- -----------
Net cash used in operating activities (2,875,629) (1,700,649) (4,292,551)
----------- ----------- -----------
Cash flows from investing activities:
Payment for purchase of acquisitions, net of cash acquired 69,316 -- --
Capitalization of software development costs -- (16,333) (175,034)
Purchases of property and equipment (63,266) (60,513) (49,535)
Proceeds from sales of property and equipment -- -- 31,252
Proceeds from sales of marketable securities 134,110 55,494 537,535
Proceeds from maturity of certificate of deposits -- 28,496 119,532
----------- ----------- -----------
Net cash provided by investing activities 140,160 7,144 463,750
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of preferred stock and warrants, net -- 250,000 --
Proceeds from issuance of common stock and warrants, net 4,409,531 1,815,402 3,107,269
Proceeds from exercise of warrants 42,403 -- 699,348
Proceeds from exercise of employee stock options 4,066 3,386 223,882
Payment of preferred stock dividends -- -- (6,583)
Payment of withholding taxes on preferred stock dividends (60,000) -- --
Payments of capital lease obligations (154,227) (179,859) (330,687)
----------- ----------- -----------
Net cash provided by financing activities 4,241,773 1,888,929 3,693,229
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 1,506,304 195,424 (135,572)
Cash and cash equivalents, beginning of period 2,283,339 2,087,915 2,223,487
----------- ----------- -----------
Cash and cash equivalents, end of period 3,789,643 2,283,339 2,087,915
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest during the period $ 22,278 $ 33,621 $ 69,385
See notes to consolidated financial statements.
F-8
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
1. ORGANIZATION AND NATURE OF BUSINESS
Internet Commerce Corporation ("ICC" or the "Company") 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.
On June 22 2004, the Company acquired Electronic Commerce Systems, Inc.
("ECS"). ECS offers ongoing EDI compliance within e-business solutions to
suppliers. ECS provides Internet-based services, software, and service bureau
services for the e-commerce business-to-business communication service
market. The operating results of ECS will be included in the Service Bureau
segment.
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES
Principles of consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. 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
F-9
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONT'D)
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).
Until 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 February 2004. Revenues from 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
revisions 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 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
F-10
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONT'D)
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.
Depreciation and amortization:
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the related assets,
generally three to seven years. Leasehold improvements are amortized using
the straight-line method over the shorter of the term of the lease or the
estimated useful life of the asset.
Loss per share of common stock:
The Company calculates its loss per share under the provisions of Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128").
SFAS 128 requires dual presentation of "basic" and "diluted" loss per share
on the face of the statement of operations. In accordance with SFAS 128,
basic loss per common share is computed by dividing the net loss attributable
to common stockholders by the weighted average number of shares of common
stock outstanding during each period. Diluted loss per share is calculated by
dividing net loss attributable to common stockholders by the weighted average
number of shares of common stock outstanding and all dilutive potential
common shares that were outstanding during the period. The per share effects
of potential common shares such as warrants, options and convertible
preferred stock have been excluded from the calculation of diluted loss per
share, as their effect would be antidilutive in all periods presented.
Software development costs:
The Company capitalizes software development costs under the provisions of
either Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1") or Statement of
Financial Accounting Standards No. 86, "Computer Software to be Sold, Leased,
or Otherwise Marketed" ("SFAS 86"), based on the intended use of the
software.
The Company capitalizes the costs of acquiring, developing and testing
software to meet the Company's internal needs. Under the provisions of SOP
98-1, the Company capitalizes costs associated with software developed or
obtained for internal use when both the preliminary project stage is
completed and management has authorized further funding for the project which
it deems probable will be completed and used to perform the function
intended. Capitalized costs include only (1) external direct costs of
materials and services consumed in developing or obtaining internal-use
software, (2) payroll and payroll-related costs for employees who are
directly associated with and devote time to the internal-use software project
and (3) interest costs incurred while developing internal-use software.
Capitalization of such costs ceases
F-11
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONT'D)
no later than the point at which the project is substantially complete and
ready for its intended use. Software development costs are amortized using a
straight-line method over a three-year period. Accumulated amortization of
software development costs for internal use software was $380,179, $326,598
and $273,017 for the years ended July 31, 2004, 2003 and 2002, respectively.
During the fiscal year ended July 31, 2002, $52,597 of costs associated with
the development of software for internal use have been capitalized. No
amounts were capitalized in the fiscal years ended July 31, 2004 and 2003.
The Company capitalizes the costs of computer software to be sold or
otherwise marketed in accordance with the provisions of SFAS 86. Costs
related to the conceptual formulation and design of software are expensed as
product development. Costs incurred subsequent to the establishment of
technological feasibility are capitalized. Capitalization of costs ceases
when the product is available for general release to customers. Capitalized
software costs are amortized over the shorter of three years or the expected
life of the product. Amortization of these software development costs
amounted to $11,417 and $13,020 for the fiscal years ended July 31, 2004 and
2003, respectively. The amounts amortized during the fiscal year ended July
31, 2002 were insignificant. Development costs in the amount of $16,333 and
$122,437 were capitalized under the provisions of SFAS 86 for the fiscal
years ended July 31, 2003 and 2002, respectively. No development costs were
capitalized during the fiscal year ended July 31, 2004. For the fiscal years
ended July 31, 2004 and 2003, the Company recorded impairment charges of
approximately $45,000 and $148,000, respectively, for previously capitalized
software development costs related to in-process software development
projects of its Service Bureau. The Company decided not to complete these
projects due to unfavorable market conditions.
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 applies 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 the fiscal
year ended July 31, 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 the fiscal year ended July 31, 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.
F-12
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONT'D)
-------------------------------------------------------------
2004 2003 2002
-------------------------------------------------------------
Net loss, as reported $ (4,086,609) $ (6,004,318) $ (6,547,553)
Add: Stock-based employee compensation expense
included in reported net loss 628,712 -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (633,104) (5,153,242) (9,755,547)
------------------------------------------------------------
Pro forma net loss $ (4,091,001) $(11,157,560) $(16,303,100)
============================================================
Basic and diluted loss per common share:
As reported $ (0.30) $ (0.53) $ (0.68)
Pro forma $ (0.27) $ (0.91) $ (1.58)
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.
Cash and cash equivalents:
The Company considers all highly liquid investments with a maturity of three
months or less at the time of purchase to be cash equivalents.
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.
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
F-13
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONT'D)
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 (See Note 4).
Goodwill:
Goodwill consists of the excess of the purchase price over the fair value of
identifiable net assets of businesses acquired. Effective August 1, 2001, the
Company adopted SFAS 141, "Business Combinations" ("SFAS 141") and SFAS 142,
"Goodwill and Other Intangible Assets" ("SFAS 142").
SFAS 141 requires that all business combinations subsequent to June 30, 2001,
be accounted for using the purchase method of accounting. SFAS 141 also
requires that the fair value of an assembled workforce acquired be included
in the amount initially recorded as goodwill. Upon adopting the provisions of
SFAS 141, the Company reclassified into goodwill $1,710,617 that was
initially recorded as other intangible assets related to the value of the
assembled workforce of Research Triangle Commerce, Inc., a wholly-owned
subsidiary of ICC acquired in November 2000 ("RTCI").
SFAS 142 requires that goodwill no longer be amortized; instead, goodwill is
to be 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
would be recognized by the Company in an amount equal to that excess (see
Note 4). The Company performs its annual goodwill impairment test on August
1st.
Marketable securities:
Marketable securities are classified as available for-sale securities.
Unrealized holding gains and losses are recorded as other comprehensive
income, net of any related tax effect (See Note 6).
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
F-14
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONT'D)
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 13. 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 is 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 or results of operations. The Company adopted
the fair-value recognition provisions of SFAS 123 in January 2004 (See Note
10).
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
F-15
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONT'D)
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 classifying and measuring 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. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. For financial instruments created before the issuance
date of SFAS 150 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 SFAS
150. The adoption of SFAS 150, effective August 1, 2003, did not have a
material impact on the Company's consolidated financial position or results
of operations.
3. ACQUISITION OF ECS
On June 22, 2004, the Company completed the acquisition of Electronic
Commerce Systems, Inc. ("ECS"). In accordance with the terms of the Agreement
and Plan of Merger, dated May 25, 2004 (the "Merger Agreement"), ICC
Acquisition Corporation, Inc., a wholly-owned subsidiary of ICC, merged with
and into ECS and ECS became a wholly-owned subsidiary of ICC. ICC issued a
total of 1,941,409 shares of its class A common stock, valued at $2,465,589,
in connection with the acquisition, of which 345,183 shares were issued in
exchange for approximately $471,000 of outstanding debt ECS owed to certain
of its shareholders and in payment of ECS's legal fees. In determining the
purchase price of the acquisition, the shares of ICC class A common stock
issued were valued at $1.28 per share, the average market price of ICC's
class A common stock over the 2-day period before and after the terms of the
acquisition were agreed to and announced.
The ECS merger was accounted for under the purchase method of accounting and,
accordingly, the acquired assets and liabilities of ECS were recorded based
on their fair values at the date of acquisition. The results of operations of
ECS are consolidated with the results of operations of the Company subsequent
to the acquisition date.
The following table sets forth the components of the purchase price as of
July 31, 2004:
Value of class A common stock issued $ 2,465,589
Estimated transaction costs 311,686
-----------
Total purchase price $ 2,777,275
===========
The following table provides the estimated fair value of assets acquired and
liabilities assumed:
Cash $ 174,875
Accounts receivable 288,794
Fixed assets 61,707
Other assets 6,093
Identifiable intangibles 1,092,776
Liabilities (174,283)
------------
Fair value of net assets acquired 1,449,962
------------
Estimated goodwill $ 1,327,313
============
F-16
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
3. ACQUISITION OF ECS (CONT'D)
At the date of acquisition, the intangible assets of ECS consisted of its
internally developed systems, valued at $877,000 and its customer
relationships valued at $216,000.
None of the goodwill associated with the acquisition of ECS is expected to be
deductible for tax purposes.
Pro Forma Financial Information
The following unaudited pro forma summary financial information presents the
consolidated results of operations of the Company as if the acquisition of
ECS had occurred on August 1, 2002. The pro forma results are shown for
illustrative purposes only and do not purport to be indicative of the results
that would have been reported if the acquisition of ECS had occurred on the
date indicated or indicative of the results which may occur in the future.
July 31, 2004 July 31, 2003
------------- -------------
Revenues $13,522,000 $13,750,000
Net loss $ (4,031,000) $(6,714,000)
Basic and diluted loss per common share $ (0.24) $ (0.47)
4. GOODWILL AND ACQUIRED INTANGIBLE ASSETS
On August 1, 2001, the Company adopted the provisions of SFAS 141, "Business
Combinations" ("SFAS 141"), and SFAS 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"). SFAS 141 requires that the fair value of an assembled
workforce acquired be included in the amount initially recorded as goodwill.
Upon adoption of SFAS 141, the Company reclassified into goodwill $1,710,617
that was initially recorded as other intangible assets related to the value
of the assembled workforce of RTCI as required by this statement. 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
evaluated goodwill for impairment at August 1, 2001 and determined no
impairment existed at that date. The Company's reporting units utilized for
evaluating the recoverability of goodwill are the same as its operating
segments.
At July 31, 2004 and 2003, other intangible assets included the proprietary
data mapping technology acquired in the acquisition of RTCI. In addition, at
July 31, 2004 other intangible assets included internally developed systems
and customer relationships acquired in the acquisition of ECS. The gross
carrying value of the mapping technology was $4,780,000 as of July 31, 2004
and 2003, respectively. The gross carrying values of the internally developed
systems and customer relationships were $877,000 and $216,000, respectively,
as of July 31, 2004. Accumulated amortization relating to mapping technology
was $3,585,000 and $2,629,000 as of July 31, 2004 and 2003, respectively. The
mapping technology is being amortized over five years and amortization
expense has been recorded in cost of services. Accumulated amortization
relating to the internally developed systems and customer relationships were
$18,000 and $4,000, respectively, as of July 31, 2004. The acquired
internally developed systems and customer relationships are being amortized
over five years, and amortization expense has been recorded in cost of
services and selling and marketing.
The Company did not have any indefinite lived intangible assets that were not
subject to amortization as of July 31, 2004 and 2003. The aggregate
amortization expense for other intangible assets was $979,000 and $956,000
for the years ended July 31, 2004 and 2003, respectively.
F-17
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
4. GOODWILL AND ACQUIRED INTANGIBLE ASSETS (CONT'D)
As of July 31, 2004, estimated amortization expense for other intangible
assets for the remaining life of those assets are as follows:
Year Estimated Amortization Expense
---- ------------------------------
2005 $1,175,000
2006 $ 458,000
2007 $ 219,000
2008 $ 219,000
2009 $ 196,000
F-18
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
4. GOODWILL AND ACQUIRED INTANGIBLE ASSETS (CONT'D)
The changes in the carrying amount of goodwill for the years ended July 31,
2004 and 2003, are as follows:
ICC.NET Service Bureau Total
--------------------------------------
Balance at July 31, 2002 $ 26,132 $ 2,167,935 $ 2,194,067
Impairment loss - (982,142) (982,142)
--------------------------------------
Balance at July 31, 2003 $ 26,132 $ 1,185,793 $ 1,211,925
Acquired goodwill - 1,327,313 1,327,313
--------------------------------------
Balance at July 31, 2004 $ 26,132 $ 2,513,106 $ 2,539,238
The goodwill of all reporting units is tested annually for impairment as of
August 1.
During the quarter ended July 31, 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. An impairment loss of $982,142 was recognized as a result of this
evaluation. The fair value of the Service Bureau reporting unit was estimated
using the net present value of expected future cash flows.
Due to a continued decline in revenue throughout the fiscal year ended July
31, 2002, continued operating losses and a significant reduction in
forecasted future operating profits, the Professional Services reporting
unit, which was combined with ICC.NET in February 2004, was tested for
impairment during the fourth quarter ended July 31, 2002. An impairment loss
of $1,710,617 was recognized as a result of this evaluation. The fair value
of the Professional Services reporting unit was estimated using the net
present value of expected future cash flows.
Prior to the Company's adoption of SFAS 142 on August 1, 2001, it was
required to evaluate its long lived assets and identifiable intangibles for
impairment pursuant to FAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS 121
requires that long-lived assets and certain identifiable intangibles held and
used by an entity be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable based on expected undiscounted cash flows and other relevant
factors attributable to that asset.
5. IMPAIRMENT OF SOFTWARE INVENTORY
In January 2003, the Company recorded an impairment charge of approximately
$248,000 for software inventory held by the Professional Services reporting
unit, which was combined with ICC.NET in February 2004, based on historical
and projected sales, which indicated that its net carrying value was not
recoverable. The Company had previously recorded a write-down 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 such inventory as of July 31, 2003 and 2004 is not
significant.
6. MARKETABLE SECURITIES
The following is a summary of available for sale marketable securities:
Gross Unrealized
------------------
Cost Gains Losses Fair Value
------- ------- ------- ----------
Equity investments - July 31, 2003 $66,275 $26,874 $(1,209) $91,941
======= ======= ======= =======
F-19
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
6. MARKETABLE SECURITIES (CONT'D)
Equity investments which consist of investments in publicly traded companies
for which the Company does not have the ability to exercise significant
influence are classified as available-for-sale and stated at fair value based
on quoted market rates. Adjustments to the fair value of available-for-sale
investments are recorded as a component of other comprehensive income, net of
any related tax effect.
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.
In January 2004, the Company disposed of all its available-for-sale
marketable securities and recorded a gain of $67,834.
7. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
Estimated July 31,
-----------------------------------------
Useful Lives
(Years) 2004 2003
------- ----------- -----------
Computers and office equipment 3 $ 2,988,220 $ 3,071,911
Furniture and fixtures 7 334,619 307,620
Purchased software 3 806,961 822,006
Leasehold improvements Various 189,688 189,688
----------- -----------
4,319,488 4,391,225
Less accumulated depreciation
and amortization (4,023,932) (3,834,413
----------- -----------
$ 295,556 $ 556,812
=========== ===========
Depreciation and amortization expense related to property and equipment,
including property and equipment acquired under capital leases, was
approximately $397,000, $589,000 and $898,000 for the years ended July 31,
2004, 2003 and 2002, respectively. As of July 31, 2004, property and
equipment acquired under capital leases had a cost basis of $419,921.
8. ACCRUED EXPENSES
Accrued expenses consist of the following:
July 31,
-----------------------------
2004 2003
---------- -----------
Employee compensation and severance $ 195,596 $ 230,696
Acquisition related liabilities 113,380 -
Vacation 310,100 342,886
Professional fees 148,870 287,004
Lease abandonment 33,117 165,536
Other 203,398 152,758
----------- -----------
$ 1,004,461 $ 1,178,880
=========== ===========
F-20
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
9. JOINT SERVICES AGREEMENT AND TECHNOLOGY LICENSE
In July 2002, the Company and Triaton GmbH ("Triaton") terminated a joint
services agreement between the parties that had been executed in July 2000
and amended in July 2001. The Company and Triaton entered into a new
agreement that provides Triaton a non-exclusive five-year license to use the
Company's electronic data interchange system in Europe. The agreement also
provides that Triaton may purchase sales support and customer support
services based on ICC's standard terms and conditions. Triaton may also
purchase software maintenance and support on an annual basis. The sale price
for the license was $3,000,000 which was recognized as revenue in the fiscal
year ended July 31, 2002. Under the terms of the agreement, Triaton paid
$1,500,000 in July 2002 and $1,500,000 in October 2002.
10. STOCKHOLDERS' EQUITY
2004 Private Placement of Common Stock:
On April 20, 2004, the Company completed a private placement of class A
common stock and warrants to purchase shares of class A common stock (the
"2004 Private Placement") for aggregate gross proceeds of approximately
$4,955,500. 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. 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 incurred fees and
expenses of $748,488, of which $423,274 was paid in cash at closing, $99,309
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.
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. The registration statement was declared
effective on August 20, 2004 and the Company is required to pay the holders
of shares issued in the 2004 Private Placement liquidated damages totaling
$3,300 because of a two-day delay in causing the registration statement to
become effective. If the effectiveness of the registration statement 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 effectiveness of the registration
statement is not maintained.
2003 Private Placement of Common Stock and Preferred Stock:
During April and May 2003, the Company completed a private placement of
class A 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.
F-21
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
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 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 stock 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 and which amount was immediately accreted
and treated as a deemed dividend to the holder of the series D preferred
stock as all of the series D preferred stock 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 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
Company's private placement described above, 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 approximately $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.
2001 Private Placement of Common Stock:
On October 29, 2001, the Company sold 1,159,716 shares of class A common
stock and warrants to purchase 347,915 shares of class A common stock for
gross proceeds of $3,189,219. The warrants are immediately exercisable and
have an exercise price of $3.58 per share. The warrants are exercisable for
a five-year period. The Company may redeem the warrants, at its option, if
the closing bid price of the class A common stock exceeds 200% of the
exercise price for a period of 30 consecutive trading days. The redemption
price is $0.10 for each share issuable under the warrants.
In connection with the private placement, the Company incurred fees of
$152,511, of which $35,000 was paid in cash and $117,511 was paid by issuing
warrants to purchase 50,000 shares of class A common stock. The warrants
have substantially the same terms and conditions as the warrants issued in
the private
F-22
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
placement. Approximately 20%, or $635,000, of the gross proceeds were
received from directors and officers and entities with which the Company's
directors are affiliated.
Warrant Exchange Offer:
On April 23, 2002, the Company commenced a warrant exchange offer. The offer
was made to investors who participated in the Company's private placement on
October 29, 2001 and to holders of warrants issued as fees in connection
with that private placement. The warrant exchange offer reduced the exercise
price of the warrants issued in the private placement from $3.58 per share
to $2.50 per share of class A common stock for investors that agreed to
exercise those warrants by the expiration date of the warrant exchange
offer.
In addition, for each share of class A common stock purchased pursuant to a
warrant exercise, a new warrant (the "New Warrants") to purchase an
equivalent number of shares of class A common stock was issued. The New
Warrants have an exercise price of $3.50 per share and are exercisable for
five years. The Company may redeem the warrants, at its option, if the
closing bid price of the class A common stock exceeds 200% of the exercise
price for a period of thirty consecutive days. The redemption price is ten
cents for each share issuable under the warrants. The warrant exchange offer
had an initial expiration date of April 30, 2002, but was extended until May
31, 2002. The Company received $659,288 in gross proceeds and issued a total
of 263,715 shares of class A common stock and warrants to purchase an
equivalent number of shares of class A common stock as a result of the
warrant exchange offer. The Company recorded a deemed dividend in the amount
of $461,084 during the third quarter of fiscal 2002 in connection with the
warrant exchange offer, representing the aggregate fair value of the
repriced warrants exercised in the warrant exchange offer and the fair value
of the New Warrants. In connection with the warrant exchange offer, the
Company incurred fees of approximately $19,000 which were paid in cash.
Class A Common Stock:
Holders of class A common stock are entitled to one vote per share on all
matters to be voted on by common stockholders. Subject to the preferences of
the preferred stock, the holders of class A common stock are entitled to a
proportional distribution of any dividends that may be declared by the board
of directors, provided that if any distributions are made to holders of
class A common stock, identical per-share distributions must be made to the
holders of class B common stock, even if the distributions are in class A
common stock. In the event of liquidation, dissolution or winding up of ICC,
the holders of class A common stock are entitled to share equally with
holders of class B common stock in all assets remaining after liabilities
and amounts due to holders of preferred stock have been paid in full or set
aside. Class A common stock has no preemptive, redemption or conversion
rights. The rights of holders of common stock are subject to, and may be
adversely affected by, the rights of the holders of series C preferred
stock, series D preferred stock or any other series of preferred stock the
Company may designate in the future.
Class B Common Stock:
Class B common stock is convertible into class A common stock on a
one-for-one basis both upon the request of the holder of the class B common
stock or automatically upon transfer of the class B common stock to a
stockholder that did not hold any class B common stock before the transfer.
Class B common stock is entitled to six votes per share, but in all other
respects each share of class B common stock is identical to a share of class
A common stock. There were no shares of class B common stock outstanding as
of July 31, 2004 or 2003.
F-23
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
Series A Preferred Stock:
Series A preferred stock is convertible, at the option of the holder, into
class A common stock. Each share of series A preferred stock is convertible
into a number of shares of class A common stock determined by dividing the
issuance price per share ($1,000) by 75% of the average market price of the
class A common stock for the ten trading days before the conversion date.
Each share of series A was convertible into a maximum of 333 shares and a
minimum of 200 shares of class A common stock. Series A preferred stock is
redeemable, in whole or in part, by the Company at the option of the
Company, commencing on the third anniversary of the date of issuance. The
redemption price for each share of series A preferred stock is $1,000, plus
unpaid dividends. Notice of redemption must be given 30 days prior to the
redemption date.
Subject to the rights of stockholders holding any series of the Company's
preferred stock that is senior to the series A preferred stock, upon a
liquidation, dissolution or winding up of the Company, the holders of series
A preferred stock are entitled to receive an amount equal to $1,000 per
share of series A preferred stock before any distribution is made to holders
of common stock.
The holders of the outstanding shares of series A preferred stock are
entitled to a 4% annual non-cumulative dividend payable, at the option of
the Company, in cash or in shares of class A common stock. Dividends are
payable on each July 1.
Series A preferred stock has no voting rights.
On July 1, 2002, the Company paid cash dividends of $6,583 to holders of
series A preferred stock. There were no accrued dividends as of July 31,
2004 or 2003.
There were no shares of series A preferred stock outstanding as of July 31,
2004 or 2003.
Series C Preferred Stock:
During the fiscal year ended July 31, 2000, the Company issued 10,000 shares
of series C preferred stock and warrants to purchase 400,000 shares of class
A common stock, at an exercise price of $22.21 per share, to Cable &
Wireless, PLC ("C&W") for total consideration of $10,000,000. A beneficial
conversion feature resulted from the allocation of the proceeds between the
fair value of the series C preferred stock and the fair value of the
warrants, which resulted in a discount on the preferred stock in the amount
of $4,549,535, which amount was immediately accreted and treated as a deemed
dividend to the holder of the shares of series C preferred stock as all of
the series C preferred stock was eligible for conversion upon issuance.
Series C preferred stock is convertible, at the option of the holder, into
447,628 shares of class A common stock, subject to certain customary
anti-dilution adjustments.
Series C preferred stock is redeemable, in whole or part, by the Company at
the option of the Company, at any time after January 1, 2005. The redemption
price for each share of series C preferred stock is $1,000 plus accrued and
unpaid dividends. Notice of redemption must be given 45 days prior to the
redemption date. Series C preferred shall be preferred as to assets over all
other classes or series of preferred stock of the Company in the event of
any liquidation, dissolution or winding up of the Company. In any
liquidation, dissolution or winding up, the holders of series C preferred
are entitled to receive an amount in cash equal to $1,000 per share plus any
accrued and unpaid dividends before any distribution is made to holders of
common stock.
F-24
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
The holders of the outstanding shares of series C preferred stock are
entitled to receive a 4% per share annual cumulative dividend payable in
cash or shares of common stock at the option of the Company. Each share of
series C preferred stock is deemed to have a value of $1,000 and each share
of common stock to be paid as a dividend shall be valued at the average of
the Market Price (as defined by the certificate of designation of the series
C convertible preferred stock) for ten consecutive trading days ending two
days prior to the payment date. Dividends are payable on January 1 of each
year. Dividends accrue and are cumulative on a daily basis, whether or not
earned or declared. In January 2004, 2003 and 2002, the Company issued
361,702, 302,343 and 98,839 shares of class A common stock in payment of the
dividends on series C preferred stock, respectively. The 2004 dividend was
reduced by fifteen percent due to mandatory IRS tax withholding which was
paid in March 2004 in the amount of $60,000. As of July 31, 2004, 2003 and
2002, the Company had accrued $232,787, $231,726 and $231,695 for dividends
payable, respectively.
On any matter presented to stockholders, series C preferred stock is
entitled to the number of votes per share equal to the number of whole
shares of class A common stock into which such share of series C preferred
stock is convertible on the record date for the determination of
stockholders that are entitled to vote on that matter.
The total liquidation value of series C preferred stock was $10,000,000 plus
accrued dividends of $232,787 as of July 31, 2004.
Series D Preferred Stock:
Series D preferred stock is convertible at the option of the holder into
192,307 shares of class A common stock subject to certain customary
anti-dilution adjustments.
Series D preferred stock is redeemable, in whole or in part, by the Company
at the option of the Company at any time after April 30, 2005 if the price
of class A common stock is greater than or equal to $2.60 per share for
thirty consecutive trading days. The redemption price for each share of
series D preferred stock is $1,000 plus any accrued and unpaid dividends.
Series D preferred shall have preference as to assets over all other classes
or series of common and preferred stock of the Company, except for series C
preferred, in the event of any liquidation, dissolution, or winding up of
the Company. In any liquidation, dissolution or winding up, The holders of
series D preferred are entitled to receive an amount in cash equal to $1,000
per share plus any accrued and unpaid dividends before any distribution is
made to holders of common and preferred stock, except for series C preferred
stock.
The holders of the outstanding shares of series D preferred stock are
entitled to receive dividends at the discretion of the Board of Directors.
On any matter presented to stockholders, series D preferred stock is
entitled to the number of votes per share equal to the number of whole
shares of class A common stock into which such share of series D preferred
stock is convertible on the record date for the determination of
stockholders that are entitled to vote on that matter.
F-25
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
Warrants:
As of July 31, 2004, the following warrants to purchase class A common stock
were outstanding:
Exercise
Number of Shares Price Expiration Date
---------------- --------- ---------------
C & W Warrants 400,000 (a) $ 22.21 January 12, 2005
2001 Private Placement Warrants 109,091 (b) $ 3.58 October 28, 2006
2001 Private Placement Commission Warrants 25,000 (b) (c) $ 3.50 October 28, 2006
2002 Warrant Exchange Offer Warrants 263,715 (b) $ 3.50 April 24, 2007
ING Warrants 60,000 (b) $ 3.50 July 11, 2007
2003 Private Placement Warrants 1,278,825 (b) $ 1.47 April 30, 2008
2003 Private Placement Warrants 230,774 (b) $ 1.47 May 1, 2008
2003 Private Placement Commission Warrants 89,810 (b) (d) $ 1.47 April 30, 2008
2003 Private Placement Commission Warrants 20,870 (b) (d) $ 1.47 May 1, 2008
Silicon Valley Bank Warrants 40,000 (e) $ 1.39 May 30, 2010
2004 Private Placement Warrants 849,507 $ 2.22 October 20, 2009
2004 Private Placement Commission Warrants 283,170 (f) $ 2.22 October 20, 2009
a) Issued to C&W in a private placement. Upon exercise, holder is entitled
to one share of class A common stock.
b) Redeemable by the Company at $0.10 per warrant under certain conditions.
c) Issued to solicitation agents for their role in the October 2001 private
placement.
d) Issued to solicitation agents for their role in the April and May 2003
private placement.
e) Issued in connection with the Company's Accounts Receivable Financing
Agreement (Note 12).
f) Issued to the private placement agent in the 2004 private placement.
The fair market value of warrants issued for compensation and services has
been recognized as an expense in the period in which the respective services
were performed.
On March 31, 2004, certain warrants exercisable for an aggregate of 18,000
shares of the Company's class A common stock expired.
F-26
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
Stock options:
The Company's Amended and Restated Stock Option Plan (the "Plan") provides
for the grant of options to purchase up to an aggregate of 7,000,000 shares
of class A common stock to employees, officers, directors and consultants or
advisors. The options granted may be either incentive stock options or
nonqualified options.
Incentive stock options granted to employees have an exercise price equal to
the fair market value of the underlying shares at the date of grant. The
Board of Directors determines the exercise price of nonqualified options
granted to employees and consultants. The term of all options granted may
not exceed 10 years. Options vest as determined by the Board, but generally
vesting occurs over a period of two to three years. Generally, vested
options must be exercised within 90 days of termination of the optionee's
employment or other relationship with the Company. If termination of
employment is for cause, the option will expire immediately.
In May 2002, the Company granted options to purchase an aggregate of 845,000
shares of class A common stock to certain executive officers. The options
all have an exercise price of $2.70 per share, which was the fair value of
the class A common stock at the date of grant. One-third of these options
vested upon issuance. An additional one-third vested on August 1, 2002,
since the Company's net revenue exceeded $2,000,000 in the month of July
2002. The remaining one-third will vest on the earlier of November 10, 2007
and the day the closing price of the Company's class A common stock equals
or exceeds $10.00 per share. All of these options will vest immediately upon
a change in control of the Company as defined in the option agreements.
In January 2004, the Company implemented a voluntary stock option exchange
program whereby the Company offered to exchange 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 two 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
with 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" ("APB 25"), and related interpretations.
Under APB 25, 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 fiscal year ended
July 31, 2004, the Company recorded non-cash charges for stock-based
compensation of $628,712 as a result of the adoption of the fair value
recognition provisions of FASB Statement No. 123.
F-27
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
The weighted-average fair value at the date of grant for options granted
during the fiscal years ended July 31, 2004, 2003 and 2002 was $0.68, $1.04
and $2.37 per share, respectively. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model
using the following weighted-average assumptions:
Year ended July 31,
------------------------------------
2004 2003 2002
-------- -------- ---------
Risk-free interest rate 2.43% 2.09% 3.77%
Expected lives 3 3 3
Expected volatility 94% 136% 140%
Expected dividend yield 0% 0% 0%
The following table summarizes the Company's stock options outstanding as of
July 31, 2004, 2003 and 2002, as well as changes during the years then
ended:
Year ended July 31,
---------------------------------------------------------------------------------
(Shares in thousands) 2004 2003 2002
-------------------------- ------------------------ -------------------------
Weighted-Average Weighted-Average Weighted-Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------- ------------------------- -------------------------
Options outstanding at beginning of year 5,262.0 $ 8.92 5,422.3 $ 9.62 4,517.7 $ 12.93
Granted 1,679.9 $ 1.63 342.0 $ 1.35 1,672.1 $ 3.08
Forfeited (1,701.6) $ 15.31 (489.5) $ 11.58 (698.0) $ 16.03
Exercised (3.7) $ 1.11 (12.8) $ 0.26 (69.5) $ 3.22
-------- -------- --------
Options outstanding at end of year 5,236.6 $ 4.51 5,262.0 $ 8.92 5,422.3 $ 9.62
======== ======== ========
Options exercisable at end of year 3,800.3 $ 4.95 4,406.2 $ 9.69 4,048.4 $ 7.53
======== ======== ========
F-28
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
The following table presents information relating to stock options
outstanding as of July 31, 2004: (Shares in thousands)
Options Outstanding Options Exercisable
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Contractual Exercise Exercise
Range of Exercise Prices Shares Life Price Shares Price
--------------------------------------------------------------------------------------------------
0.26 - 0.96 699.4 6.0 $ 0.63 469.4 $ 0.46
1.20 - 1.40 730.1 6.7 $ 1.27 631.1 $ 1.26
1.41 - 2.13 484.0 7.8 $ 1.74 108.3 $ 1.63
2.26 - 2.57 1,187.7 5.7 $ 2.47 946.0 $ 2.51
2.65 - 2.71 1,008.5 7.7 $ 2.70 726.9 $ 2.70
3.15 - 4.22 396.3 7.4 $ 3.72 393.0 $ 3.72
5.13 - 6.29 250.3 6.5 $ 5.16 250.3 $ 5.16
12.00 - 12.54 315.3 5.0 $ 12.03 115.3 $ 12.07
13.25 - 13.25 15.0 6.1 $ 13.25 10.0 $ 13.25
40.00 - 40.00 50.0 4.9 $ 40.00 50.0 $ 40.00
60.00 - 60.00 50.0 4.9 $ 60.00 50.0 $ 60.00
80.00 - 80.00 50.0 4.9 $ 80.00 50.0 $ 80.00
------------- ------------
5,236.6 6.6 $ 4.51 3,800.3 $ 4.95
============= ============
The Company had 941,259 options-shares available for grant under the Plan as
of July 31, 2004.
Restricted stock:
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 for the year ended July 31, 2003. At the same time, this
individual was also granted 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 $15,000 has been recorded as a non-cash stock-based compensation
charge for services for the year ended July 31, 2004. In November 2003, this
individual surrendered the 100,000 options described 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
shares of class A common stock of the Company. The Company recorded a
non-cash compensation charge of $129,722 and $79,167 for the fiscal years
ended July 31, 2004 and 2003, respectively, and issued 104,382 and 51,703
shares of class A common stock for the fiscal years ended July 31, 2004 and
2003, respectively, which were fully vested. No shares of common stock were
issued to directors for compensation in the fiscal year ended July 31, 2001.
The Company issued 172,907 shares of class A common stock to employees of
RTCI in exchange for outstanding shares of restricted stock of RTCI at the
consummation of the Company's acquisition of RTCI. Deferred stock-based
compensation related to the restricted stock of $730,957 was recorded at the
time of the acquisition. The Company recognized non-cash compensation
expense related to the restricted stock of $0, $0 and $190,019 for the
fiscal years ended July 31, 2004, 2003 and 2002, respectively. All
outstanding shares of restricted stock vested on January 1, 2002.
F-29
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
10. STOCKHOLDERS' EQUITY (CONT'D)
On July 11, 2002, the Company entered into a Settlement Agreement with ING
Merger, LLC and ING Capital, LLC, a wholly-owned subsidiary of ING Merger
(collectively "ING"), pursuant to which the Company issued 200,000 shares of
class A common stock and warrants to purchase 60,000 shares of class A
common stock to ING Capital.
The warrants are exercisable for five years at an exercise price per share
of $3.50. ING had provided certain investment banking services to ICC in
connection with its acquisition of RTCI. The Company had accrued $650,000
for such services at the time of the acquisition. The aggregate fair value
of the class A common stock and warrants issued pursuant to the settlement
was approximately $540,500. The Company recorded the difference of $109,500
as other income for the fiscal year ended July 31, 2002.
In connection with the acquisition of RTCI, the Company paid $300,000 of
investment banking fees on behalf of a former officer of the Company. During
2002, the former officer forfeited 23,689 shares of class A common stock
issued in the merger in repayment of these investment banking fees. The
number of shares forfeited were valued at the market price of ICC common
stock as defined in the Agreement and Plan of Merger among ICC and RTCI.
11. INCOME TAXES
The Company's effective tax rate varied from the statutory federal income
tax rate as follows:
For the year ended July 31,
-------------------------------------
2004 2003 2002
-------------------------------------
Expected tax rate (benefit) (35.0) % (35.0) % (35.0) %
Increase (decrease) in taxes resulting from:
Non-deductible amortization and write-off of
intangibles -- 5.7 9.1
Other permanent differences 0.3 1.1 1.5
State and local income tax (benefit), net of
federal effect (5.0) (4.0) 25.9
Other 1.7 (4.3) (6.7)
Increase in valuation allowance 38.0 36.5 5.2
-------- -------- -------
Effective tax rate -- % -- % -- %
======== ======== =======
F-30
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
11. INCOME TAXES (CONT'D)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets, liabilities and the
valuation allowance at July 31, 2004 and 2003 are as follows:
July 31,
----------------------------
2004 2003
------------ -----------
Deferred tax assets:
Accrued expenses $ 252,208 267,915
Deferred revenues 52,863 30,682
Deferred rent 6,175 29,389
Property and equipment 104,209 83,767
Marketable securities -- 116,903
Non-cash compensation associated with
options 268,447 --
Credit for increasing research
activity carryforwards 148,414 85,275
Capital loss carryforwards 100,036 --
Federal, state and local net
operating loss carryforwards 31,417,352 30,077,973
------------ -----------
32,349,704 30,691,904
Deferred tax liabilities:
Purchased intangibles (906,004) (860,400)
Capitalized software development costs (7,144) (56,944)
------------ -----------
(913,148) (917,344)
Net deferred tax asset before
valuation allowance 31,436,556 29,774,560
Valuation allowance (31,436,556) (29,774,560)
------------ -----------
Net deferred tax asset $ -- $ --
------------ -----------
The Company has provided a valuation allowance of 100% of its net deferred
tax asset due to the uncertainty of generating future profits that would
allow for the realization of such deferred tax asset. The net increase in
the total valuation allowance for the year ended July 31, 2004 was
$1,661,996.
The Company has net operating loss carryforwards for tax purposes of
approximately $78.5 million as of July 31, 2004. These carryforwards expire
from 2007 to 2024.
The Internal Revenue Code and Income Tax Regulations 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 initial public offering in January 1995, the net
operating loss carryover of approximately $1.9 million incurred prior to the
initial public offering is subject to an annual limitation of approximately
$400,000 until that portion of the net operating loss is utilized or
expires. Due to the 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 and subsequent to the initial public offering
is subject to an annual limitation of approximately $1 million until that
portion of the net operating loss is utilized or expires. Due to a 100%
ownership change of RTCI in November 2000, the acquired 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. Also, due to a
100% ownership change of ECS in June 2004, the acquired net operating loss
of approximately $1.1 million incurred prior to the ownership change is
subject to an annual limitation of approximately $128,000 until that portion
of the net operating loss is utilized or expires.
F-31
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
12. ACCOUNTS RECEIVABLE FINANCING AGREEMENT
On May 30, 2003, the Company executed an Accounts Receivable Financing
Agreement ("Financing Agreement") with Silicon Valley Bank ("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 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
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 seven years. 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 fiscal year ended July 31, 2003, the
Company recorded interest expense in the amount of approximately $5,700 for
the amortization of the fair value of the warrants. On October 22, 2003 and
August 31, 2004, the Company and the Bank amended the Financing Agreement to
extend its term to August 31, 2004 and December 29, 2004, respectively. As
of July 31, 2004, no amounts were outstanding under the Financing Agreement.
13. COMMITMENTS AND CONTINGENCIES
Profit sharing plan:
The Company has a Profit Sharing Plan under which an amount equal to 3.5% of
the pretax profit of the Company for each fiscal year is set aside for the
benefit of such employees as are determined by the Board of Directors. No
funding has been provided under this plan through July 31, 2004 as the
Company has incurred losses since the inception of the plan.
Obligations under operating leases:
The Company has non-cancelable operating lease commitments for office space
expiring on various dates through July 2009. Rent expense under these leases
was approximately $967,000, $1,047,000 and $1,319,000 for the fiscal years
ended July 31, 2004, 2003 and 2002, respectively. Certain leases contain
escalation clauses for operating expenses.
As of July 31, 2004, minimum future rental payments due under non-cancelable
operating leases are as follows:
Year Amount
-----------------------
2005 $ 762,658
2006 411,788
2007 419,217
2008 349,266
2009 311,106
----------
$2,254,035
==========
On July 31, 2004, the Company ceased utilizing certain office space leased
under a non-cancelable operating lease. The future lease payments for this
space in the amount of $33,000 and $166,000 have been recorded as a
F-32
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
13. COMMITMENTS AND CONTINGENCIES (CONT'D)
liability at July 31, 2004 and 2003, respectively. The Company's Norcross
office lease is with a related party with monthly payments of $3,715. This
lease expires on July 31, 2005
Obligations under capital leases:
The Company has various non-cancelable capital leases for computer equipment
and software. As of July 31, 2004, minimum future lease payments under
non-cancelable capital leases were as follows:
Amount
-------
2005 $54,480
2006 3,883
-------
58,363
Amount representing interest 3,164
-------
Present value of future minimum
lease payments 55,199
Less current portion (52,291)
-------
Capital lease obligation - less
current portion $ 2,908
=======
Representations and Warranties:
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 July 31, 2004, the Company was not subject to any
litigation alleging that the Company's products infringe the intellectual
property rights of any third parties.
Letters of credit:
The Company has provided cash collateral for letters of credit in the
aggregate amount of $107,563 and $128,607 at July 31, 2004 and 2003,
respectively, which serve as security deposits for certain lease agreements.
These amounts have been recorded as restricted cash in the Company's
consolidated balance sheet.
Separation Agreements:
In March 2001, ICC entered into a Separation Agreement with its former
President and Chief Executive Officer which required the Company to pay
$437,500, payable in equal monthly installments of $29,167 commencing on May
1, 2001. The final payment under this agreement was made in August 2002. In
June 2004, ICC entered into a Separation Agreement with its former Chief
Financial Officer which required the Company to pay $95,000, payable in
semi-monthly installments of $7,917 commencing on June 30, 2004. As of July
31, 2004, $71,250 was unpaid under this agreement.
14. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations
of credit risk primarily consist of cash and accounts receivable. The
Company invests its excess cash in money-market instruments with
institutions of high credit-quality. All accounts receivable are unsecured.
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.
F-33
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
14. CONCENTRATION OF CREDIT RISK (CONT'D)
For the fiscal years ended July 31, 2004 and 2003, no single customer
accounted for more than 10% of revenue. The Company had one customer that
accounted for 22% of revenue for the year ended July 31, 2002.
No single customer accounted for more than 10% of accounts receivable at
July 31, 2004 and 2003.
Revenue by geographic region, based on customer location is as follows:
Year ended North
July 31, America Europe Other Total
------------------ -------------- ------------- ---------- --------------
2004 $ 11,669,502 $ 27,698 $ 7,603 $ 11,704,803
2003 $ 12,054,455 $ 22,947 $ 5,912 $ 12,083,314
2002 $ 11,171,976 $ 3,024,118 $ 25,702 $ 14,221,796
15. 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.
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.
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.
Effective in June 2004, the Company combined the activities of ECS in the
Service Bureau segment.
F-34
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
15. BUSINESS SEGMENT INFORMATION (CONT'D)
The table below summarizes information about operations and long-lived
assets as of and for the years ended July 31, 2004 and 2003:
ICC.NET Service Bureau Total
------- -------------- -----
Year Ended - July 31, 2004
Revenues from external customers $ 10,273,810 $ 1,430,993 $ 11,704,803
============ ============ ============
Operating loss (1) $ (3,995,103) $ (111,165) $ (4,106,268)
Other income, net 20,394 (735) 19,659
------------ ------------ ------------
Net loss $ (3,974,709) $ (111,900) $ (4,086,609)
============ ============ ============
Supplemental segment information:
Amortization and depreciation 1,377,968 67,143 1,445,111
Impairment of capitalized software -- 44,983 44,983
Non-cash charges for stock-based
compensation and services 799,718 1,121 800,839
As of July 31, 2004
Property and equipment, net $ 222,757 $ 72,799 $ 295,556
Capitalized software, net -- 17,860 17,860
Acquired identified intangibles, net 1,195,000 1,070,010 2,265,010
Goodwill 26,132 2,513,106 2,539,238
------------ ------------ ------------
Long lived assets, net $ 1,443,889 $ 3,673,775 $ 5,117,664
============ ============ ============
ICC.NET Service Bureau Total
------- -------------- -----
Year Ended - July 31, 2003
(recasted)
Revenues from external customers $ 10,595,368 $ 1,487,946 $ 12,083,314
============ ============ ============
Operating loss (1) $ (4,508,817) $ (1,132,102) $ (5,640,919)
Other loss (363,399) -- (363,399)
------------ ------------ ------------
Net loss $ (4,872,216) $ (1,132,102) $ (6,004,318)
============ ============ ============
Supplemental segment information:
Amortization and depreciation $ 1,591,391 $ 86,775 $ 1,678,166
Impairment of software inventory 248,077 -- 248,077
Impairment of capitalized software -- 148,479 148,479
Impairment of marketable securities 317,924 -- 317,924
Impairment of acquired intangibles -- 982,142 982,142
Non-cash charges for stock-based
compensation and services 139,415 -- 139,415
As of July 31, 2003
Property and equipment, net $ 514,011 $ 42,801 $ 556,812
Capitalized software, net -- 127,841 127,841
Acquired identified intangibles, net 2,151,000 -- 2,151,000
Goodwill 26,132 1,185,793 1,211,925
------------ ------------ ------------
Long lived assets, net $ 2,691,143 $ 1,356,435 $ 4,047,578
============ ============ ============
(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
$180,000 and $135,000 of these costs to the Service Bureau for the fiscal
years ended July 31, 2004 and 2003, respectively.
F-35
INTERNET COMMERCE CORPORATION
Notes to consolidated financial statements
16. SUPPLEMENTAL NON-CASH DISCLOSURES TO STATEMENT OF CASH FLOWS
The Company had the following non-cash investing and financing activities:
Year ended July 31,
2004 2003 2002
---------- ---------- ---------
Amounts related to business combinations:
Fair value of assets acquired, net of cash acquired $2,776,683 $ -- $ --
Less:
Liabilities assumed 174,283 -- --
Fair value of equity instruments issued 2,465,589 -- --
Transaction costs accrued 206,127 -- --
---------- ---------- ----------
2,845,999 -- --
---------- ---------- ----------
Payment for purchase of acquisitions, net of cash acquired $ 69,316 $ -- $ --
========== ========== ==========
Equipment acquired under capital leases $ 15,117 $ -- $ 121,367
Issuance of common stock for dividends on preferred stock 401,061 400,031 400,000
Private placement commissions 8,802 87,802 117,511
Common stock and warrants issued to investment advisors -- -- 504,560
- ------------------------------------------------------------------------------------------------------------------------
17. QUARTERLY INFORMATION (UNAUDITED)
The following unaudited quarterly financial information (in thousands,
except for per share data) includes, in the Company's opinion, all normal
and recurring adjustments necessary to fairly state its consolidated results
of operations and related information for the periods presented
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Year ended July 31, 2004
Revenues, net $ 3,103 $ 2,756 $ 2,892 $ 2,954
Total costs and expenses 3,909 4,313 3,534 4,055
------- ------- ------- -------
Operating loss (806) (1,557) (642) (1,101)
Interest and investment income, net (12) 54 (20) (3)
Net loss $ (818) $(1,503) $ (662) $(1,104)
======= ======= ======= =======
Basic and diluted loss per common share $ (0.07) $ (0.12) $ (0.05) $ (0.06)
======= ======= ======= =======
Year ended July 31, 2003
Revenues, net $ 3,050 $ 2,837 $ 3,094 $ 3,102
Total costs and expenses 4,013 4,400 4,162 5,149
------- ------- ------- -------
Operating loss (963) (1,563) (1,068) (2,047)
Interest and investment income, net (18) (324) (6) (15)
Net loss $ (981) $(1,887) $(1,074) $(2,062)
======= ======= ======= =======
Basic and diluted loss per common share $ (0.09) $ (0.17) $ (0.11) $ (0.16)
======= ======= ======= =======
18. SUBSEQUENT EVENT - HEADQUARTERS RELOCATION
On September 28, 2004, ICC announced that the Board of Directors approved
the relocation of the corporate headquarters to Atlanta, Georgia. This move,
which is targeted for completion by mid-January 2005, will consolidate
corporate operations in one city. The East Setauket, NY; Cary, GA; and
Carrollton, GA facilities and offices will be unaffected by this move. Since
the lease of the present corporate headquarters in New York, NY, expires on
January 31, 2005, the Company does not expect to incur any lease termination
expenses. The Company expects to incur expenses of approximately $200,000
for moving, new leasehold improvements and retention bonuses, which will be
recognized when incurred.
F-36
INTERNET COMMERCE CORPORATION
Schedule II. Valuation and Qualifying Accounts
Balance at Additions Balance at
Beginning Charted to Additions End of
of Period Expense Acquired Deductions period
----------- ----------- ----------- ------------ -----------
Year ended July 31, 2004
Allowance for doubtful accounts $ 220,281 $ 176,670 $ 11,116 $ (99,200) $ 308,867
Allowance on deferred tax asset $29,774,560 $ 1,661,996 $ -- $ -- $31,436,556
Year ended July 31, 2003
Allowance for doubtful accounts $ 241,684 $ 43,501 $ -- $ (64,904) $ 220,281
Allowance on deferred tax asset $27,774,150 $ 2,000,410 $ -- $ -- $29,774,560
Year ended July 31, 2002
Allowance for doubtful accounts $ 224,022 $ 223,107 $ -- $ (205,445) $ 241,684
Allowance on deferred tax asset $27,433,411 $ 340,739 $ -- $ -- $27,774,150
F-37
INTERNET COMMERCE CORPORATION
EXHIBIT INDEX
Exhibit No. Description
- ------------------------------------------------------------------------------
2.1 Agreement and Plan of Merger among ICC, ICC Acquisition
Corporation, Inc., a wholly-owned subsidiary of ICC, Research
Triangle Commerce, Inc., or RTCI, and the selling shareholders of
RTCI (10)
2.2 Agreement and Plan of Merger among ICC, IDC, and the selling
shareholders of IDC (4)
2.3 Agreement and Plan of Merger among ICC, ICC Acquisition Corporation
Inc., a wholly-owned subsidiary of ICC, Electronics Commerce
Systems, Inc., or ECS, and certain shareholders of ECS (18)
3(i).1 Amended and Restated Certificate of Incorporation (1)
3(i).2 Certificate of Merger merging Infosafe Systems, Inc. and ICC (1)
3(i).3 Certificate of Amendment to the Amended and Restated Articles of
Incorporation (2)
3(i).4 Certificate of Designations-- Series A Convertible Redeemable
Preferred Stock (1)
3(i).5 Certificate of Designations-- Series C Preferred Stock (8)
3(i).6 Certificate of Designations-- Series D Preferred Stock (8)
3(ii).1 Amended and Restated By-laws (6)
4.1 Specimen Certificate for Class A Common Stock (3)
4.2 Form of Class A Bridge Warrant issued in the 1998 bridge financing
(1)
4.3 Warrant Agreement dated January 12, 2000, by and among ICC and
Cable and Wireless USA, Inc. (8)
4.4 Format Class A Common Stock Warrant issued in the October 29, 2001
private placement (13)
4.5 Form of Warrant Agreement issued in the April 30, 2003 and May 1,
2003 private placement (15)
4.6 Form of Registration Rights Agreement dated April 30, 2003, among
ICC and the purchasers of shares of class A common stock identified
therein (15)
4.7 Form of Registration Rights Agreement dated April 30, 2003, between
ICC and Blue Water Venture Fund II, L.L.C. (15)
4.8 Warrant Agreement dated May 30, 2003 by and between Silicon Valley
Bank, a California-chartered bank ("SVB") and the ICC (16)
4.9 Registration Rights Agreement dated as of May 30, 2003 by and
between SVB and the ICC (16)
4.10 Form of Warrant Agreement issued in the April 20, 2004 private
placement (17)
4.11 Form of Registration Rights Agreement dated as of April 20, 2004
between ICC and the purchasers of shares of class A common stock
identified therein (17)
4.12 Form of Registration Rights Undertaking dated June 22, 2004 by ICC
in favor of the shareholders of ECS (19)
10.1 1994 Stock Option Plan (3)
10.2 Lease Agreement between 805 Third Ave. Co. and ICC relating to the
rental of ICC's current principal executive office (4)
10.3 Lease Agreement, dated as of May 21, 1999, between JB Squared LLC
and ICC relating to the rental of approximately 4,000 square feet
at the Lakeview Executive Center, 45 Research Way, East Setauket,
New York, 11733 (5)
F-38
INTERNET COMMERCE CORPORATION
10.4 Master Agreement between Cable & Wireless PLC and ICC executed on
November 24, 1999 (7)
10.5 Amended and restated Stock Option Plan (9)
10.6 First Amendment to Lease Agreement, dated as of January, 2000, by
and between JB Squared LLC and ICC relating to the rental of an
additional approximately 4,800 square feet at the Lakeview
Executive Center, 45 Research Way, East Setauket, New York, 11733
(12)
10.7 First Amendment of Lease Agreement between Madison Third Building
Companies LLC and ICC relating to the rental of additional office
space at 805 Third Avenue, New York, New York 10022 (12)
10.8 Lease Agreement, dated as of August 2, 2000, by and between IDC
Realty, LLC as landlord and ICC as tenant relating to the rental of
an approximately 8,000 square feet facility used by ICC's Service
Bureau division (12)
10.9 Lease Agreement, dated as of November 1, 1999, by and between
Shannon Oaks Partnership as landlord and RTCI as tenant relating to
the rental of an approximately 8,000 square feet facility used by
ICC's Professional Services division (14)
10.10 License agreement with Triaton dated July 2002 (13)
10.11 Form of Subscription Agreement dated as of April 30, 2003, among
ICC and the purchasers of shares of class A common stock identified
therein (15)
10.12 Form of Subscription Agreement dated as of April 30, 2003, between
ICC and Blue Water Venture Fund II, L.L.C. for the purchase of
shares of Series D Preferred Stock (15)
10.13 Accounts Receivable Financing Agreement dated as of May 30, 2003 by
and between SVB and ICC (16)
10.14 First Loan Modification Agreement dated as of October 22, 2003 by
and between SVB and ICC (16)
10.15 Intellectual Property Security Agreement dated as of May 30, 2003
by and between SVB and ICC (16)
10.16 Form of Securities Purchase Agreement dated as of April 15, 2004 by
and among ICC and the purchasers listed on Schedule 1 thereto (17)
23 Consent of Deloitte & Touche LLP *
31.1 Certificate of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 *
31.2 Certificate of the Acting Chief Financial 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 Acting Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 *
- -------------------------
* Filed herewith
(1) Incorporated by reference to ICC's registration statement on Form S-3 (File
no. 333-80043), as filed with the Securities and Exchange Commission on
June 4, 1999.
(2) Incorporated by reference to ICC's Annual Report on Form 10-KSB for the
year ended July 31, 1998, as filed with the Securities and Exchange
Commission on October 29, 1998.
(3) Incorporated by reference to ICC's registration statement on form SB-2
(File no. 33-83940).
F-39
INTERNET COMMERCE CORPORATION
(4) Incorporated by reference to ICC's Quarterly Report on Form 10-QSB for the
quarter ended October 31, 1997, as filed with the Securities and Exchange
Commission on December 12, 1997.
(5) Incorporated by reference to Amendment No. 3 to ICC's registration
statement on Form S-3 (File no. 333-80043), as filed with the Securities
and Exchange Commission on October 18, 1999.
(6) Incorporated by reference to ICC's Current Report on Form 8-K dated June
30, 1999, as filed with the Securities and Exchange Commission on July 1,
1999.
(7) Incorporated by reference to ICC's Current Report on Form 8-K dated
November 24, 1999, as filed with the Securities and Exchange Commission on
December 1, 1999.
(8) Incorporated by reference to Amendment No. 1 to ICC's registration
statement on Form S-3 (File no. 333-93301), as filed with the Securities
and Exchange Commission on February 8, 2000.
(9) Incorporated by reference to ICC's proxy statement for the annual meeting
of stockholders for the year ended July 31, 1999, as filed with the
Securities and Exchange Commission on May 23, 2000.
(10) Incorporated by reference to ICC's Current Report on Form 8-K dated June
14, 2000, as filed with the Securities and Exchange Commission on June 15,
2000.
(11) Incorporated by reference to ICC's Current Report on Form 8-K dated August
2, 2000, as filed with the Securities and Exchange Commission on August 11,
2000.
(12) Incorporated by reference to ICC's Annual Report on Form 10-KSB for the
year ended July 31, 2000, as filed with the Securities and Exchange
Commission on October 13, 2000.
(13) Incorporated by reference to ICC's registration statement on Form S-3 (file
No. 333-99059), as filed with the Securities and Exchange Commission on
August 30, 2002.
(14) Incorporated by reference to ICC's Annual Report on Form 10-K for the year
ended July 31, 2002, as filed with the Securities and Exchange Commission
on October 31, 2002.
(15) Incorporated by reference to ICC's Current Report on Form 8-K dated April
30, 2003, as filed with the Securities and Exchange Commission on May 2,
2003.
(16) Incorporated by reference to ICC's Annual Report on Form 10-K for the year
ended July 31, 2003, as filed with the Securities and Exchange Commission
on October 31, 2003.
(17) Incorporated by reference to ICC's Current Report on Form 8-K dated April
20, 2004, as filed with the Securities and Exchange Commission on April 20,
2004.
(18) Incorporated by reference to ICC's Current Report on Form 8-K dated May 25,
2004, as filed with the Securities and Exchange Commission on May 25, 2004.
(19) Incorporated by reference to ICC's Current Report on Form 8-K dated June
22, 2004, as filed with the Securities and Exchange Commission on June 22,
2004.
F-40
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: October 29, 2004
INTERNET COMMERCE CORPORATION
by: /s/ Thomas Stallings
----------------------------------
Thomas Stallings
Chief Executive Officer
by: /s/ Michael Piccininni
----------------------------------
Michael Piccininni
Acting Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
47
Signature Title Date
- --------- ----- ----
/s/ Thomas J. Stallings Chief Executive Officer October 29, 2004
- ------------------------- and Director (Principal
Thomas J. Stallings Executive Officer)
/s/ Michael Piccininni Corporate Controller October 29, 2004
- ------------------------- (Acting Chief Financial
Michael Piccininni Officer)
/s/ Richard J. Berman Director October 29, 2004
- ------------------------
Richard J. Berman
/s/ Spencer I. Browne Director October 29, 2004
- ------------------------
Spencer I. Browne
/s/ G. Michael Cassidy Director October 29, 2004
- ------------------------
G. Michael Cassidy
/s/ Kim D. Cooke Director October 29, 2004
- ------------------------
Kim D. Cooke
Director October 29, 2004
- ------------------------
Donald R. Harkleroad
/s/ Charles C. Johnston Director October 29, 2004
- ------------------------
Charles C. Johnston
/s/ Arthur R. Medici Director October 29, 2004
- ------------------------
Arthur R. Medici
Director October 29, 2004
- ------------------------
John S. Simon
48