U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
_____________
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended October 31, 2004
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____ to ____
Commission File No. 000-24996
INTERNET COMMERCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-3645702
(State of incorporation) (I.R.S. Employer
Identification Number)
805 Third Avenue, 9th Floor
New York, New York 10022
(Address of principal executive offices, including zip code)
(212) 271-7640
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of December 14, 2004, the registrant had outstanding 19,058,187 shares
of Class A Common Stock.
INTERNET COMMERCE CORPORATION
INDEX TO FORM 10-Q
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets as of October 31, 2004 (unaudited)
and July 31, 2004.................................................... 3
Consolidated statements of operations and comprehensive loss
for the three months ended October 31, 2004 (unaudited)
and October 31, 2003 (unaudited)..................................... 4
Consolidated statements of cash flows for the three months
ended October 31, 2004 (unaudited) and October 31, 2003
(unaudited).......................................................... 5
Notes to consolidated financial statements (unaudited)............... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 18
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................... 36
Item 4. Controls and Procedures......................................... 36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 37
Item 2. Unregistered Sales of Equity................................... 37
Item 3. Defaults Upon Senior Securities................................ 37
Item 4. Submission of Matters to a Vote of Security Holders............ 38
Item 5. Other Information.............................................. 38
Item 6. Exhibits ...................................................... 38
SIGNATURES
CERTIFICATIONS
2
INTERNET COMMERCE CORPORATION
Consolidated Balance Sheets
October 31, July 31,
2004 2004
------------- ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,645,535 $ 3,789,643
Accounts receivable, net of allowance
for doubtful accounts of $338,409 and $308,867,
respectively 2,475,352 2,154,463
Prepaid expenses and other current assets 213,600 244,900
------------ ------------
Total current assets 6,334,487 6,189,006
Restricted cash 107,992 107,658
Property and equipment, net 253,472 295,556
Capitalized software development costs, net 4,465 17,860
Goodwill 2,619,048 2,539,238
Other intangible assets, net 1,971,371 2,265,010
Other assets 14,237 14,237
------------ ------------
Total assets $ 11,305,072 $ 11,428,565
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 718,780 $ 523,703
Accrued expenses 978,952 1,004,461
Accrued dividends - preferred stock 333,333 232,787
Deferred revenue 136,273 133,063
Capital lease obligation 27,507 52,291
Other liabilities 22,085 45,111
------------ ------------
Total current liabilities 2,216,930 1,991,416
Capital lease obligation - less current portion 1,197 2,908
------------ ------------
Total liabilities 2,218,127 1,994,324
------------ ------------
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 $10,333,333) 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 19,058,187
shares issued and outstanding, respectively 190,582 190,582
Additional paid-in capital 95,197,670 95,143,356
Accumulated deficit (86,301,410) (85,899,800)
------------ ------------
Total stockholders' equity 9,086,945 9,434,241
------------ ------------
Total liabilities and stockholders' equity $ 11,305,072 $ 11,428,565
============ ============
See notes to consolidated financial statements.
3
Consolidated Statements of Operations and Comprehensive Loss (unaudited)
Three Months Ended
October 31,
-----------------------------
2004 2003
------------ ------------
Revenue:
Services $ 3,746,540 $ 3,103,352
------------ ------------
Expenses:
Cost of services (excluding non-cash compensation of $2,143
for the three months ended October 31, 2004) 1,417,426 1,860,309
Product development and enhancement (excluding non-cash
compensation of $7,552 for the three months ended
October 31, 2004) 222,711 225,214
Selling and marketing (excluding non-cash compensation of
$2,643 for the three months ended October 31, 2004) 838,118 825,681
General and administrative (excluding non-cash compensation
of $198,495 and $52,943 for the three months ended October 31,
2004 and 2003, respectively) 1,462,165 945,385
Non-cash charges for stock-based compensation and services 210,833 52,943
------------ ------------
Total expenses 4,151,253 3,909,532
------------ ------------
Operating loss (404,713) (806,180)
------------ ------------
Other income and (expense):
Interest and investment income 6,098 858
Interest expense (2,996) (12,425)
------------ ------------
3,102 (11,567)
------------ ------------
Net loss $ (401,611) $ (817,747)
Dividends on preferred stock (100,546) (100,561)
------------ ------------
Loss attributable to common stockholders $ (502,157) $ (918,308)
============ ============
Basic and diluted loss per common share $ (0.03) $ (0.07)
============ ============
Weighted average number of common shares outstanding -
basic and diluted 19,058,187 13,797,567
============ ============
COMPREHENSIVE LOSS:
Net loss $ (401,611) $ (817,747)
Other comprehensive income:
Unrealized gain - marketable securities -- 9,023
------------ ------------
Comprehensive loss $ (401,611) $ (808,724)
============ ============
See notes to consolidated financial statements.
4
Consolidated Statements of Cash Flows (unaudited)
Three Months Ended October 31,
-------------------------------
2004 2003
----------- -----------
Cash flows from operating activities:
Net loss $ (401,611) $ (817,747)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 381,260 385,804
Bad debt expense 29,542 15,517
Non-cash interest expense -- 8,605
Non-cash charges for equity instruments
issued for compensation and services 210,833 52,943
Changes in:
Accounts receivable (350,431) (213,365)
Prepaid expenses and other assets 3,883 42,717
Accounts payable 195,077 (264,772)
Accrued expenses (30,885) (245,909)
Deferred revenue 3,210 (27,351)
Other liabilities (23,026) (39,520)
----------- -----------
Net cash provided by (used in) operating activities 17,852 (1,103,078)
----------- -----------
Cash flows from investing activities:
Additional costs of previous acquisition (79,810) --
Purchases of property and equipment (32,142) (46,188)
Purchase of certificates of deposit -- (421)
----------- -----------
Net cash used in investing activities (111,952) (46,609)
----------- -----------
Cash flows from financing activities:
Net proceeds from the issuance of common
stock and warrants (23,512) --
Payments of capital lease obligations (26,496) (36,136)
----------- -----------
Net cash used in financing activities (50,008) (36,136)
----------- -----------
Net decrease in cash and cash equivalents (144,108) (1,185,823)
Cash and cash equivalents, beginning of period 3,789,643 2,283,339
----------- -----------
Cash and cash equivalents, end of period $ 3,645,535 $ 1,097,516
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest during the period $ 2,996 $ 3,820
See notes to consolidated financial statements.
5
INTERNET COMMERCE CORPORATION
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Internet
Commerce Corporation (the "Company" or "ICC") have been prepared in
accordance with accounting principles generally accepted in the United
States of America ("GAAP") for interim financial information. In the
opinion of management, such statements include all adjustments (consisting
only of normal recurring adjustments) necessary for the fair presentation
of the Company's financial position, results of operations and cash flows
at the dates and for the periods indicated. Pursuant to the requirements
of the Securities and Exchange Commission (the "SEC") applicable to
Quarterly Reports on Form 10-Q, the accompanying financial statements do
not include all the disclosures required by GAAP for annual financial
statements. While the Company believes that the disclosures presented are
adequate to make the information not misleading, these unaudited interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the
Company's Annual Report on Form 10-K for the year ended July 31, 2004.
Operating results for the three month period ended October 31, 2004 are
not necessarily indicative of the results that may be expected for the
fiscal year ending July 31, 2005.
2. ORGANIZATION AND NATURE OF BUSINESS
ICC provides Internet-based services for the e-commerce
business-to-business communication services market. ICC.NET, our global
Internet-based value added network, or VAN, provides supply chain
connectivity solutions for electronic data interchange, or EDI, and
e-commerce, and offers users a vehicle to securely send and receive files
of any format and size.
The ICC.NET system uses the Internet and proprietary technology to deliver
the Company's customers' documents and data files to members of their
trading communities, many of which have incompatible systems, by
translating the documents and data files into any format required by the
receiver. The system can be accessed using a standard Web browser or
virtually any other communications protocol.
The Company has the capability to facilitate the development and operation
of comprehensive business-to-business electronic commerce solutions. The
Company can provide professional service electronic commerce solutions
involving EDI and EAI (Enterprise Application Integration) by providing
mission critical electronic commerce consulting, electronic commerce
software, outsourced electronic commerce services and technical resource
management.
ICC's capabilities also include an EDI Service Bureau, which provides EDI
services to small and mid-sized companies. The Service Bureau's services
include the conversion of electronic forms into hard copies and the
conversion of hard copies to an EDI format. The Service Bureau also
provides Universal Product Code ("UPC") services and maintains UPC
catalogs for its customers.
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 are included in the Service
Bureau segment.
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.
6
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES
Principles of consolidation:
The consolidated financial statements include the accounts of the Company
and its wholly owned 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 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
service contracts. Under these contracts, the Company is required to
provide a specified number of maps for a fixed fee. Revenue from such
contracts 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 our EDI
education and training seminars were immaterial in all periods presented.
Revenue from fixed fee data mapping and professional service contracts are
recognized using the percentage-of-completion method of accounting, as
prescribed by SOP 81-1 "Accounting for Performance of Construction-Type
and Certain Production-Type Contracts."
The percentage of completion for each contract is determined based on the
ratio of direct labor hours incurred to total estimated direct labor hours
required to complete the contract. The Company may periodically encounter
changes in estimated costs and other factors that may lead to a change in
the estimated profitability of a fixed-price contract. In such
circumstances, adjustments to cost and profitability estimates are made in
the period in which the underlying factors requiring such revisions become
known. If such revisions indicate a loss on a contract, the entire loss is
recorded at such time. Amounts billed in advance of services being
performed are recorded as deferred revenue. Certain fixed-fee contracts
may have substantive customer acceptance provisions. The acceptance terms
generally include a single review and revision cycle for each deliverable
to incorporate the customer's suggested or required modifications.
Deliverables are considered accepted upon completion of the review and
revision cycle and revenue is recognized upon that acceptance.
The Company also derives revenue from its Service Bureau. Service Bureau
revenue is comprised of EDI services, including data translation services,
purchase order and invoice processing from EDI-to-print and print-to-EDI,
UPC services, including UPC number generation, UPC catalog maintenance and
UPC label printing. The Service Bureau also derives revenue from software
licensing and provides software maintenance and support. Revenue from the
EDI services and UPC services is recognized when the services are
provided. The Company accounts for its EDI software license sales in
accordance with the American Institute of Certified Public Accountants'
Statement of Position 97-2, "Software Revenue Recognition," as amended
("SOP 97-2"). Revenue from software licenses is recognized when all of the
following conditions are met: (1) a non-cancelable, non-contingent license
agreement has been signed; (2) the software product has been delivered;
(3) there are no material uncertainties regarding customer acceptance; and
(4) collection of the resulting receivable is probable. Revenue from
software maintenance
7
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONTINUED)
and support contracts is recognized ratably over the life of the contract.
The Service Bureau's software license revenue was not significant in any
of the periods presented.
In addition, SOP 97-2 generally requires that revenue from software
arrangements involving multiple elements be allocated among each element
of the arrangement based on the relative fair values of the elements, such
as software licenses, post contract customer support, installation or
training. Furthermore, SOP 97-2 requires that revenue be recognized as
each element is delivered and the Company has no significant performance
obligations remaining. The Company's multiple element arrangements
generally consist of a software license and post contract support. The
Company allocates the aggregate revenue from multiple element arrangements
to each element based on vendor specific objective evidence. The Company
has established vendor specific objective evidence for each of the
elements as it sells both the software and post contract customer support
independent of multiple element agreements. Customers are charged standard
prices for the software and post contract customer support and these
prices do not vary from customer to customer.
If the Company enters into a multiple element agreement where vendor
specific objective evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred
until all elements of the arrangement are delivered.
Service revenue from post contract customer support is recognized ratably
over the term of the support contract, on a straight-line basis. Other
service revenue is recognized at the time the service is performed.
Deferred revenue:
Deferred revenue is comprised of deferrals for subscription fees,
professional services, license fees and maintenance associated with
contracts for which amounts have been received in advance of services to
be performed or prior to the shipment of software.
Stock-based Compensation:
In January 2004, the Company adopted the fair value provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). SFAS 123 established a
fair-value-based method of accounting for stock-based compensation plans.
Pursuant to the transition provisions of SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" (SFAS 148), the
Company has elected the prospective method and will apply the fair value
method of accounting to all equity instruments issued to employees on or
after August 1, 2003. The fair value method is not applied to stock option
awards granted in fiscal years prior to 2004. Such awards will continue to
be accounted for under the intrinsic value method pursuant to Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), except to the extent that prior years' awards are
modified subsequent to August 1, 2003. Option awards granted prior to
August 1, 2003 that have not been modified or settled continue to be
accounted for under the intrinsic value method of APB 25. Therefore, the
cost related to stock-based employee compensation included in the
determination of the net loss for 2004 is less than that which would have
been recognized if the fair value based method had been applied to all
awards since their date of grant. The following table illustrates the
effect on net loss and net loss per common share if the fair value based
method had been applied to all outstanding and unvested awards in each
period.
8
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONTINUED)
Three Months Ended
October 31,
--------------------------
2004 2003
----------- -----------
Net loss, as reported $ (401,611) $ (817,747)
Add: Stock-based employee compensation
expense included in reported
net loss 178,373 --
Deduct: Total stock-based employee
compensation expense determined
under fair value based method
for all awards (178,373) (189,820)
----------- -----------
Pro forma net loss $ (401,611) $(1,007,567)
=========== ===========
Basic and diluted loss per
common share:
As reported $ (0.03) $ (0.07)
Pro forma $ (0.03) $ (0.08)
Use of estimates:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts of
assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and reported amounts of revenue
and expense during the reporting period. Actual results could differ from
those estimates. Significant accounting estimates used in the preparation
of the Company's consolidated financial statements include the fair value
of equity securities underlying stock based compensation, the
realizability of deferred tax assets, the carrying value of goodwill,
intangible assets and long-lived assets, and depreciation and
amortization.
Recent Accounting Pronouncements:
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 supersedes
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS 146 requires
that costs associated with an exit or disposal plan be recognized when
incurred rather than at the date of a commitment to an exit or disposal
plan. SFAS 146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company adopted SFAS 146
on January 1, 2003. The adoption of this standard did not have a
significant impact on the Company's consolidated financial position or
results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others" which elaborates on the disclosures
to be made by a guarantor in its interim and annual financial statements
about its obligations under certain guarantees that it has issued. It also
clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provisions
of Interpretation No. 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosure
requirements in this Interpretation are effective for financial statements
of interim or annual periods ending after December 15, 2002. The Company
has provided information regarding commitments and contingencies relating
to guarantees in Note 10. The adoption of this standard did not have a
significant impact on the Company's consolidated financial position or
results of operations.
9
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONTINUED)
In November 2002, the Emerging Issues Task Force of the FASB ("EITF")
reached a consensus on Issue No. 00-21, "Revenue Arrangements with
Multiple Deliverables." EITF 00-21 addresses certain aspects of the
accounting by a vendor for arrangements under which the vendor will
perform multiple revenue generating activities. The EITF was effective for
revenue arrangements entered into in fiscal years and interim periods
beginning after June 15, 2003. The adoption of this consensus, effective
August 1, 2003, did not have a significant impact on the Company's
consolidated financial position or results of operations.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of FASB Statement No.
123" ("SFAS 148"). SFAS 148 amends SFAS 123, "Accounting for Stock-Based
Compensation" to provide alternative methods to account for the transition
from the intrinsic value method of recognition of stock-based employee
compensation in accordance with APB Opinion No. 25, "Accounting for Stock
Issued to Employees" to the fair value recognition provisions under SFAS
123. SFAS 148 provides two additional methods of transition and will no
longer permit the SFAS 123 prospective method to be used for fiscal years
beginning after December 15, 2003. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosure in
both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the pro-forma effects
had the fair value recognition provisions of SFAS 123 been used for all
periods presented. The adoption of SFAS 148 did not have a significant
impact on the Company's consolidated financial position and results of
operations. The Company adopted the fair-value recognition provisions of
SFAS 123 in January 2004.
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. The Company adopted FIN 46 in its entirety as of January 31, 2003.
Since the Company does not have any VIE's, the adoption of FIN 46 did not
have an impact on the Company's 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. SFAS 149 is generally effective for
contracts entered into or modified after June 30, 2003 and did not have a
significant impact on the Company's consolidated financial position or
results of operations.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS
150"). SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. This Statement is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. For
financial instruments created before the issuance date of this SFAS 150
and still existing at the beginning of the
10
INTERNET COMMERCE CORPORATION
3. SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES (CONTINUED)
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 SFAS 150, effective
August 1, 2003, did not have a material impact on the Company's
consolidated financial position or results of operations.
4. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk primarily consist of accounts receivable.
The Company believes that any credit risk associated with receivables is
minimal due to the number and credit worthiness of its customers.
Receivables are stated at estimated net realizable value, which
approximates fair value. For the three-month period ended October 31, 2004
and 2003, no single customer accounted for more than 10% of revenue. No
single customer accounted for more than 10% of accounts receivable at July
31, 2004 or October 31, 2004.
5. PRO FORMA DISCLOSURES RELATED TO RECENT ACQUISITIONS
In June 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 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, 2003. The pro forma results
are shown for illustrative purposes only and do not purport to be
indicative of the results of the Company that would have been reported had
the acquisition of ECS occurred on August 1 or indicative of results that
may occur in the future.
Three months ended
October 31,
2004 2003
---------------------------
Revenues $ 3,747,000 $ 3,596,000
Net loss $ (402,000) $ (792,000)
Basic and diluted loss per common share $ (0.03) $ (0.06)
6. BUSINESS SEGMENT INFORMATION
The Company's two operating segments are:
11
INTERNET COMMERCE CORPORATION
6. BUSINESS SEGMENT INFORMATION (CONTINUED)
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 at the end of 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.
The tables below summarize information about operations and long-lived
assets as of and for the three months ended October 31, 2004 and 2003.
Such information has been recast for each period presented, to reflect
this reorganization as if it had occurred on August 1, 2003.
Service
ICC.NET Bureau Total
----------- ----------- -----------
Three Months - October 31, 2004
Revenues from external customers $ 2,825,242 $ 921,298 $ 3,746,540
=========== =========== ===========
Operating income (loss) $ (477,713) $ 73,000 $ (404,713)
Other income, net 3,102 -- 3,102
----------- ----------- -----------
Net income (loss) (1) $ (474,611) $ 73,000 $ (401,611)
=========== =========== ===========
Supplemental segment information:
Amortization and depreciation $ 308,711 $ 72,549 $ 381,260
Non-cash charges for stock-based
compensation and services $ 210,833 $ -- $ 210,833
As of October 31, 2004
Property and Equipment, net $ 189,202 $ 64,270 $ 253,472
Capitalized software development costs, net 4,465 -- 4,465
Goodwill 1,211,925 1,407,123 2,619,048
Other intangibles assets, net 956,000 1,015,371 1,971,371
----------- ----------- -----------
Long lived assets, net $ 2,361,592 $ 2,486,764 $ 4,848,356
=========== =========== ===========
(1) Commencing in the first quarter of fiscal 2005, certain costs for
selling and marketing functions were allocated to the Service Bureau
from ICC.NET based on the level of service performed. ICC.NET
allocated $24,000 of selling and marketing costs to the Service
Bureau during the three months ended October 31, 2004. Also
commencing in the first quarter of fiscal 2005, certain costs for
executive management, MIS, human resources and accounting and
finance functions were allocated to the Service Bureau from ICC.NET
based on the level of service performed. ICC.NET allocated $135,000
of general and administrative costs for these services to the
Service Bureau for the three months ended October 31, 2004.
12
INTERNET COMMERCE CORPORATION
6. BUSINESS SEGMENT INFORMATION (CONTINUED)
Service
ICC.NET Bureau Total
----------- ----------- -----------
(As recasted)
Three Months - October 31, 2003
Revenues from external customers $ 2,795,701 $ 307,651 $ 3,103,352
=========== =========== ===========
Operating loss (1) $ (775,246) $ (30,934) $ (806,180)
Other expense, net (11,567) -- (11,567)
----------- ----------- -----------
Net loss $ (786,813) $ (30,934) $ (817,747)
=========== =========== ===========
Supplemental segment information:
Amortization and depreciation $ 372,516 $ 13,288 $ 385,804
Non-cash charges for stock-based
compensation and services $ 52,943 $ -- $ 52,943
As of October 31, 2003
Property and Equipment, net $ 440,079 $ 35,221 $ 475,300
Capitalized software, net -- 108,738 108,738
Acquired identified intangibles, net 1,912,000 -- 1,912,000
Goodwill 26,132 1,185,793 1,211,925
----------- ----------- -----------
Long lived assets, net $ 2,378,211 $ 1,329,752 $ 3,707,963
=========== =========== ===========
(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 performed by ICC.NET
personnel. ICC.NET allocated $45,000 to the Service Bureau during the
three month period ended October 31, 2003.
7. 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 $772,001, of which $423,274 was paid in cash at closing,
$122,822 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 was 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
13
INTERNET COMMERCE CORPORATION
7. STOCKHOLDERS' EQUITY (CONTINUED)
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.
No directors, officers or entities with which the Company's directors or
officers are affiliated participated in the 2004 Private Placement.
2003 Private Placement of Common Stock and Preferred Stock:
During April and May 2003, the company completed a private placement of
common stock, convertible preferred stock and warrants to purchase shares
of common stock (the "2003 Private Placement") for aggregate gross
proceeds of approximately $2,085,000.
In the 2003 Private Placement, the Company sold 1,682,683 shares of class
A common stock and warrants to purchase 1,346,140 of class A common stock
for gross proceeds of approximately $1,835,000 and 250 shares of series D
convertible redeemable preferred stock ("series D preferred") and warrants
to purchase 153,845 shares of class A common stock for $250,000. All
warrants are immediately exercisable and have an exercise price of $1.47
per share. The warrants are exercisable until the fifth anniversary of the
date of issuance. In addition, the warrants are redeemable at the
Company's option, if the closing bid price of the Company's class A common
stock exceeds 200% of the exercise price of the warrants for 30
consecutive trading days. The redemption price is $0.10 per share for each
share issuable under the warrants.
The 250 shares of series D preferred are convertible into 192,307 shares
of class A common stock. The allocation of the proceeds from the sale of
the series D preferred between the fair value of the series D and the fair
value of the detachable warrants resulted in a beneficial conversion
feature in the amount of $106,730. The discount was immediately accreted
and treated as a deemed dividend to the holder of the series D preferred,
as all of the series D preferred stock was immediately convertible upon
issuance.
In connection with the 2003 Private Placement, the Company incurred fees
of $325,750 of which $237,938 was payable in cash and $87,802 was paid by
issuing warrants to purchase 110,680 shares of class A common stock. These
warrants have substantially the same terms as the warrants issued in the
2004 Private Placement.
In connection with the 2003 Private Placement, the Company issued 48,076
shares of class A common stock and warrants to purchase 38,460 shares of
class A common stock in settlement of certain outstanding payables. The
common stock and warrants were valued at $50,000, the invoice amount of
the services provided to the Company.
Approximately 21%, or $432,000, of the gross proceeds from the 2003
Private Placement was received from directors and officers and entities
with which the Company's directors are affiliated. Subsequent to the
completion of the 2003 Private Placement, the Company determined that in
order to comply with NASD Marketplace Rule 4350(i)(1)(A), the purchase
price per share for the shares of class A common stock purchased by
directors and officers in the private placement should be increased to
market value, and on June 17, 2003 the directors and officers agreed to do
so. As a result, two directors and three officers agreed to pay an
additional $0.58 per share, or an aggregate of $85,502, for the shares of
class A common stock they purchased in the private placement. In August of
2003 the Company paid bonuses of $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.
14
INTERNET COMMERCE CORPORATION
7. STOCKHOLDERS' EQUITY (CONTINUED)
Stock Based Compensation:
On March 10, 2003, options and shares of class A common stock were awarded
to a non-employee director as compensation for consulting services. This
individual was awarded 20,000 shares of class A common stock, valued at
$18,000, which was recorded as a non-cash charge for stock-based
compensation in the quarter ended April 30, 2003. Also on March 10, 2003,
this individual was also granted options to purchase 100,000 shares of
class A common stock, of which options to purchase 60,000 shares have an
exercise price of $1.00 per share and vest six months from the date of
issuance, and options to purchase 40,000 shares have an exercise price of
$1.25 per share and vest one year from the date of issuance. The options
have a fair value of $67,000, of which $15,440 has been recorded as a
non-cash stock-based compensation charge for services during the three
months ended October 31, 2003. In November 2003, this individual
surrendered the 100,000 options noted above to the Company with no
additional compensation charge recorded.
Each non-employee member of the board of directors receives annual
compensation of $25,000 for his current term of office, payable quarterly,
in shares of class A common stock of the Company. The Company has recorded
a compensation charge of $32,460 and $37,503 for the three months ended
October 31, 2004 and 2003, respectively.
Stock Options Cancellation and Exchange:
In January 2004, the Company implemented a voluntary stock option exchange
program whereby the Company offered to exchange certain outstanding
options to purchase shares of the Company's class A 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 class A 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 a total of
823,500 shares of the Company's common stock and were granted options to
purchase 494,100 shares of the Company's class A 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 class A 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 the Company's class A common stock at an exercise price of $19.00 per
share.
Prior to August 1, 2003, the Company accounted for its employee stock
options under the intrinsic value method of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations
("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" (FASB No. 123"). The fair value method has been applied
prospectively to all employee awards granted, modified or settled after
August 1, 2003. Options granted prior to August 1, 2003 that have not been
modified or settled continue to be accounted for under the intrinsic value
method of APB 25. During the three months ended October 31, 2004 the
Company recorded non-cash charges for stock-based compensation of $178,373
and recorded no such charges during the three months ended October 31,
2003, as a result of the adoption of the fair value recognition provisions
of FASB No. 123.
15
INTERNET COMMERCE CORPORATION
8. IMPAIRMENT OF SOFTWARE DEVELOPMENT COSTS, INVESTMENTS AND SOFTWARE
INVENTORY
In January 2004, the Company recorded an impairment charge of
approximately $45,000 for previously capitalized software development
costs related to a completed development project of its Service Bureau.
The Company determined during the quarter ended January 31, 2004 that
projected sales of this software were not sufficient to support its
carrying value.
9. GOODWILL AND OTHER INTANGIBLE ASSETS
On August 1, 2001, the Company adopted the provisions of SFAS No. 141,
"Business Combinations" ("SFAS 141") and SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 142 requires that intangible assets
with indefinite useful lives no longer be amortized, but rather be tested
at least annually for impairment. The Company's reporting units utilized
for evaluating the recoverability of goodwill are the same as its
operating segments.
Intangible assets and related accumulated amortization consisted of the
following at October 31, 2004 and July 31, 2004.
October 31, 2004
(Unaudited) July 31, 2004
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Value Amortization Value Value Amortization Value
-------------------------------------------------------------------------------------
Data mapping technology (a)(c) $4,780,000 $3,824,000 $ 956,000 $4,780,000 $3,585,000 $1,195,000
Other technology (a) (d) 877,000 62,000 815,000 877,000 18,000 859,000
Customer relationships (b) (d) 216,000 16,000 200,000 216,000 5,000 211,000
-------------------------------------------------------------------------------------
$5,873,000 $3,902,000 $1,971,000 $5,873,000 $3,608,000 $2,265,000
=====================================================================================
(a) Amortized over five years on a straight-line basis.
Amortization expense recorded in cost of services.
(b) Amortized over five years on a straight-line basis.
Amortization expense recorded in selling and marketing.
(c) Acquired in the acquisition of Research Triangle Commerce,
Inc.
(d) Acquired in the acquisition of Electronic Commerce Systems,
Inc.
The Company did not have any indefinite lived intangible assets that were
not subject to amortization as of October 31, 2004 and July 31, 2004. The
aggregate amortization expense for other intangible assets were $294,000
and $239,000 during each of the three months ended October 31, 2004 and
2003, respectively.
At October 31, 2004, estimated amortization expense for other intangible
assets over the remaining life of those assets is as follows:
Fiscal
Year Estimated Remaining Amortization Expense
---- ----------------------------------------
2005 $880,000
2006 $458,000
2007 $219,000
2008 $219,000
2009 $195,000
16
INTERNET COMMERCE CORPORATION
9. GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
During the fourth quarter of fiscal 2003, the goodwill of the Service
Bureau was tested for impairment due to a significant decline in revenue
and operating income resulting primarily from the bankruptcy of its
largest customer. An impairment loss of $982,142 was recognized as a
result of this evaluation. The fair value of the Service Bureau was
estimated using the net present value of expected future cash flows.
The Company recorded an additional $79,810 to goodwill in the quarter
ended October 31, 2004 relating to the ECS acquisition as a result of
additional professional fees incurred after July 31, 2004.
The change in carrying amount of goodwill for the three months ended
October 31, 2004 is shown below:
Service
ICC.NET Bureau Total
----------------------------------------
Balance at July 31, 2004 $ 26,132 $ 2,513,106 $ 2,539,238
Additional cost of previous
acquisition - 79,810 79,810
----------------------------------------
Balance at October 31, 2004 $ 26,132 $ 2,592,916 $ 2,619,048
As of August 1, 2004, the Company performed its annual test for impairment
on the carrying value of goodwill of its ICC.NET and Service Bureau
reporting segments. The Company concluded that no impairment existed at
that date.
10. GUARANTEES AND INDEMNIFICATIONS
As part of its standard license agreements, the Company agrees to
indemnify its customers against liability if the Company's products
infringe a third party's intellectual property rights. Historically, the
Company has not incurred any significant costs related to performance
under these indemnities. As of October 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.
17
INTERNET COMMERCE CORPORATION
11. 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 was amortized to
interest expense over the term of the Financing Agreement. During the
fiscal year ended July 31, 2004, the Company recorded interest expense in
the amount of approximately $28,434 for the amortization of the fair value
of the warrants. No amortization expense was taken in the 2005 fiscal
year. 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 October 31, 2004 and July 31, 2004,
no amounts were outstanding under the Financing Agreement.
18
INTERNET COMMERCE CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains a number of "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), and Section 21E of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). Specifically, all statements other
than statements of historical facts included in this Quarterly Report regarding
our financial position, business strategy and plans and objectives of management
for future operations are forward-looking statements. These forward-looking
statements are based on the beliefs of management, as well as assumptions made
by and information currently available to management. When used in this
Quarterly Report, the words "anticipate," "believe," "estimate," "expect,"
"may," "will," "continue" and "intend," and words or phrases of similar import,
as they relate to our financial position, business strategy and plans, or
objectives of management, are intended to identify forward-looking statements.
These statements reflect our current view with respect to future events and are
subject to risks, uncertainties and assumptions related to various factors
including, without limitation, those described below the heading "Overview" and
in our registration statements and periodic reports filed with the SEC under the
Securities Act and the Exchange Act.
Although we believe that our expectations are reasonable, we cannot assure
you that our expectations will prove to be correct. Should any one or more of
these risks or uncertainties materialize, or should any underlying assumptions
prove incorrect, actual results may vary materially from those described in this
Quarterly Report as anticipated, believed, estimated, expected or intended.
In this Item 2, references to the "Company," "we," or "us" means Internet
Commerce Corporation and its wholly owned subsidiaries.
Overview
We are in the e-commerce ("EC") business-to-business communication
services market providing complete EC infrastructure solutions. Our business
operates in two segments: namely, ICC.NET and Service Bureau.
As the Company approaches cash flow break-even, we have strengthened the
executive management team by the addition of a new Chief Executive Officer,
Chief Operating Officer and Chief Financial Officer 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 the potential to increase our revenues
and profits.
ICC.NET includes the Company's global Internet-based value added network,
or VAN, which uses the Internet and our proprietary technology to deliver our
customers' documents and data files to members of their trading communities,
many of which may have incompatible systems, by translating the documents and
data files into any format required by the receiver. We believe that our ICC.NET
service has significant advantages over traditional VANs as well as email-based
and other Internet-based software systems because our service is provided at a
low cost, with greater transmission speed that is nearly real-time and offers
more features. In addition, ICC.NET facilitates the development and operation of
comprehensive business-to-business e-commerce solutions. Professional Services
assists its clients to conduct business electronically through a continuum of
services including eConsulting, data transformation mapping (EDI, EAI, XML) and
internetworking. Our Service Bureau manages and translates the data of small and
mid-sized companies that exchange EDI data with large companies that require
that data be transmitted to them electronically. The Service Bureau delivers
business-to-business EDI standards-based documents for companies that do not
have EDI departments.
The Value Added Network business has become significantly more price
competitive over the past year, with major networks restructuring to reduce
their overhead cost to be better positioned to compete on a price point basis
against Internet based networks such as ICC.NET. We have been successful in
maintaining, and in fact have improved, our margins, but we have experienced
some price erosion in competing for larger customers. Although we expect to
continue to add new customers and increase the volume of data transmitted
through our service, we do not expect our revenue from VAN services to continue
to grow as rapidly as in the past. This trend is expected to continue in the
short term until such time as a cost-based pricing floor is reached by our
larger
19
INTERNET COMMERCE CORPORATION
competitors. To counteract this negative impact on our revenue growth,
management has deployed a new dual pronged strategy. We expect to add revenue
through acquisition of Electronic Commerce Systems, Inc. ("ECS") and have
developed new product and service offerings (AS2 and Data Synchronization) to
improve our value proposition. AS2 capabilities has refocused the attention of
industry. AS2 is a service offering on the Internet, which handles primary XML
documents, which are an extension of traditional EDI. We have incorporated this
communication methodology into our standard network services and are achieving
success in stemming a migration of our customers network traffic to those who
could otherwise purchase an AS2 software offering.
Data synchronization has forced the industry to change its focus from cost
savings to compliance. Data synchronization is a methodology by which
descriptive data identifying an item or items is stored in a central depository
resulting in one common source of truth about the product description. We
believe this will be an industry focus for a year or so and thereafter be a
standard business practice. We have become a certified data synchronization
"on-boarder" and are currently offering training and consulting services to
capitalize on this emerging initiative.
During the fiscal quarter ended October 31, 2004, we further improved our
operational leverage by increasing our consolidated revenue by $643,000 and by
reducing our operating loss by $401,000 from the fiscal quarter ended October
31, 2003.
Consolidated revenue for the three months ended October 31, 2004 increased
from the three months ended October 31, 2003 by $643,000; however, our EDI
educational services and seminars unit that was discontinued in February 2004
due to continued operating losses produced revenue of $82,000 in the three
months ended October 31, 2003. VAN services revenue increased $266,000 or
approximately 11%. Service Bureau revenue in the quarter ended October 31, 2004
significantly increased $614,000, or 200%, over the three months period ended
October 31, 2003 due to the ECS acquisition. Professional services and mapping
revenues continue to be weak due to slow demand for these services. Commencing
in the third quarter of fiscal 2004 we combined the Professional Services
operating segment with ICC.NET to further minimize operating costs.
As a result, the Company, effective February 2004, no longer separately
reports the operating results for its professional services activities as a
separate segment and began including these results in the ICC.NET segment. These
activities were previously reported in the Professional Services segment.
We rely on many of our competitors to interconnect, at reasonable cost,
with our service and have interconnection arrangements with more than 65
business-to-business networks for the benefit of our customers. We believe that
these arrangements will satisfy the business requirements of our existing
customers.
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.
Critical Accounting Policies and Significant Use of Estimates in Financial
Statements
Critical accounting policies are those policies that require application
of management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain and may change in subsequent periods.
The following list of critical accounting policies is not intended to be a
comprehensive list of all of our accounting policies. Our significant accounting
policies are more fully described in note 2 of the notes to the consolidated
financial statements included in our Annual Report on Form 10-K for the year
ended July 31, 2004. 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
20
INTERNET COMMERCE CORPORATION
management's judgment in selecting any available alternative would not produce a
materially different result. We have identified the following to be critical
accounting policies of the Company:
Revenue Recognition: The Company derives revenue from subscriptions to its
ICC.NET service, which includes transaction, mailbox and fax transmission fees.
The subscription fees are comprised of both fixed and usage-based fees. Fixed
subscription fees are recognized on a pro-rata basis over the subscription
period, generally three to six months. Usage fees are recognized in the period
the services are rendered. The Company also derives revenue through
implementation fees, interconnection fees and by providing data mapping services
to its customers. Implementation fees are recognized over the life of the
subscription period. Interconnection fees are fees charged to connect to another
VAN service and are recognized when the data is transmitted to the connected
service. Revenue from data mapping services is recognized when the map has been
completed and delivered to the customer. The Company has a limited number of
fixed fee data mapping services contracts. Under these arrangements the Company
is required to provide a specified number of maps for a fixed fee. Revenue from
such arrangements is recognized using the percentage-of-completion method of
accounting (see below).
The Company provides 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 are recognized when the services are provided. The Company
discontinued its EDI education and training seminars in February 2004. Revenues
from our EDI education and training seminars were immaterial in all periods
presented.
Revenue from fixed fee data mapping and professional service contracts is
recognized using the percentage-of-completion method of accounting, as
prescribed by SOP 81-1 "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts."
The percentage of completion for each contract is determined based on the
ratio of direct labor hours incurred to total estimated direct labor hours
required to complete the contract. The Company may periodically encounter
changes in estimated costs and other factors that may lead to a change in the
estimated profitability of a fixed-price contract. In such circumstances,
adjustments to cost and profitability estimates are made in the period in which
the underlying factors requiring such revisions become known. If such revisions
indicate a loss on a contract, the entire loss is recorded at such time. Amounts
billed in advance of services being performed are recorded as deferred revenue.
Certain fixed-fee contracts may have substantive customer acceptance provisions.
The acceptance terms generally include a single review and revision cycle for
each deliverable to incorporate the customer's suggested or required
modifications. Deliverables are considered accepted upon completion of the
review and revision and revenue cycle is recognized upon acceptance.
Service Bureau revenue is comprised of EDI services including data
translation services, EDI-to-print and print-to-EDI purchase order and invoice
processing, UPC services including UPC number generation, UPC catalog
maintenance and UPC label printing. The Service Bureau also derives revenue from
licensing software and providing software maintenance and support. Revenue from
EDI services and UPC services is recognized when the services are provided. The
Company accounts for its EDI software license sales in accordance with the
American Institute of Certified Public Accountants' Statement of Position 97-2,
"Software Revenue Recognition," as amended ("SOP 97-2"). Revenue from software
licenses is recognized when all of the following conditions are met: (1) a
non-cancelable non-contingent license agreement has been signed; (2) the
software product has been delivered; (3) there are no material uncertainties
regarding customer acceptance; and (4) collection of the resulting receivable is
probable. Revenue from software maintenance and support contracts is recognized
ratably over the life of the contract. The Service Bureau's software license
revenue was not significant in any of the periods presented.
In addition, SOP 97-2 generally requires that revenue from software
arrangements involving multiple elements be allocated among each element of the
arrangement based on the relative fair values of the elements, such as software
licenses, post contract customer support, installation or training. Furthermore,
SOP 97-2 requires that revenue be recognized as each element is delivered with
no significant performance obligation remaining on the part of the Company. The
Company's multiple element arrangements generally consist of a software license
and post contract support. The Company allocates the aggregate revenue from
multiple element arrangements to each element based on vendor specific objective
evidence. The Company has established vendor specific objective evidence for
each of the elements as it sells both the software and post contract customer
support independent of
21
INTERNET COMMERCE CORPORATION
multiple element agreements. Customers are charged standard prices for the
software and post contract customer support and these prices do not vary from
customer to customer.
If the Company enters into a multiple element agreement for which vendor
specific objective evidence of fair value for each element of the arrangement
does not exist, all revenue from the arrangement is deferred until all elements
of the arrangement are delivered.
Service revenue from post contract customer support is recognized ratably
over the term of the support contract, on a straight-line basis. Other service
revenue is recognized at the time the service is performed.
Goodwill: Goodwill consists of the excess purchase price over the fair
value of identifiable net assets of acquired businesses. The carrying value of
goodwill is evaluated for impairment on an annual basis. Management also reviews
goodwill for impairment whenever events or changes in circumstances indicate
that the carrying amount of goodwill may be impaired. If it is determined that
an impairment in value has occurred, goodwill is written down to its implied
fair value. The Company's reporting units utilized for evaluating the
recoverability of goodwill are the same as its operating segments.
Other Intangible Assets: Other intangible assets are carried at cost less
accumulated amortization. Other intangible assets are amortized on a
straight-line basis over their expected lives, which are estimated to be five
years. The Company did not have any indefinite lived intangible assets other
than goodwill that were not subject to amortization.
Impairment of long-lived assets: Long-lived assets of the Company,
including amortizable intangibles, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset may
not be recoverable. Management also reevaluates the periods of amortization of
long-lived assets to determine whether events and circumstances warrant revised
estimates of useful lives. When such events or changes in circumstances occur,
the Company tests for impairment by comparing the carrying value of the
long-lived asset to the estimated undiscounted future cash flows expected to
result from use of the asset and its eventual disposition. If the sum of the
expected undiscounted future cash flows is less than the carrying amount of the
asset, the Company would recognize an impairment loss. The amount of the
impairment loss will be determined by comparing the carrying value of the
long-lived asset to the present value of the net future operating cash flows to
be generated by the asset.
Stock-based compensation: In January 2004, the Company adopted the fair
value provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 established a
fair-value-based method of accounting for stock-based compensation plans.
Pursuant to the transition provisions of SFAS 148, "Accounting for Stock Based
Compensation - Transition and Disclosure" ("SFAS 148"), the Company has elected
the prospective method and will apply the fair value method of accounting to all
equity instruments issued to employees on or after August 1, 2003. The fair
value method is not applied to stock option awards granted in fiscal years prior
to 2004. Such awards will continue to be accounted for under the intrinsic value
method pursuant to Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), except to the extent that prior years'
awards are modified subsequent to August 1, 2003. Option grants issued prior to
August 1, 2003 that have not been modified or settled continue to be accounted
for under the intrinsic value method of APB 25. Therefore, the cost related to
stock-based employee compensation included in the determination of the net loss
for 2004 is less than that which would have been recognized if the fair value
based method had been applied to all awards since their date of grant.
Income Taxes: Deferred income taxes are determined by applying enacted
statutory rates in effect at the balance sheet date to the differences between
the tax bases of assets and liabilities and their reported amounts in the
consolidated financial statements. A valuation allowance is provided based on
the weight of available evidence, if it is considered more likely than not that
some portion, or all, of the deferred tax assets will not be realized.
Use of Estimates: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and reported amounts of revenue and expense
during the reporting period. Actual results could
22
INTERNET COMMERCE CORPORATION
differ from those estimates. The following discussion reviews items incorporated
in our financial statements during the three month periods ended October 31,
2004 and 2003 or as of October 31, 2004 and July 31, 2004 that required the use
of significant management estimates.
As discussed above, in January 2004, the Company adopted the fair value
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123"). During the three months ended
October 31, 2004 the Company recorded non-cash charges for stock-based
compensation of $178,373 and recorded no such amounts during the three months
ended October 31, 2003 as a result of the adoption of the fair value recognition
provisions of SFAS 123. The Black-Scholes option-pricing model was used to
determine the estimated fair value of stock options issued and modified. The use
of this model required management to make certain estimates for values of
variables used by the model. Management estimated the values for stock price
volatility, the expected life of the equity instruments and the risk free rate
based on information that was available to management at the time the
Black-Scholes option-pricing calculations were performed. Changes in such
estimates could have a significant impact on the estimated fair value of those
equity instruments.
The Company has entered into several transactions involving the issuance
of warrants and options to purchase shares of the Company's class A common stock
to consultants, lenders, warrant holders, placement agents and other business
associates and vendors. The issuance of these securities required management to
estimate their value using the Black-Scholes option-pricing model. The
Black-Scholes option-pricing model requires management to make certain estimates
for values of variables used by the model. Management estimated the values for
stock price volatility, the expected life of the equity instruments and the risk
free rate based on information that was available to management at the time the
Black-Scholes option-pricing calculations were performed. Changes in such
estimates could have a significant impact on the estimated fair value of those
equity instruments.
In connection with the Company's April 2004 private placement, the Company
incurred fees which were paid by issuing warrants to purchase 283,170 shares of
class A common stock at an exercise price of $2.22 per share. The fair value of
the warrants was determined by management to be $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 a total of
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.
23
INTERNET COMMERCE CORPORATION
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 was amortized to
interest expense over the term of the Financing Agreement. During the fiscal
year ended July 31, 2004, the Company recorded interest expense in the amount of
approximately $28,434 for the amortization of the fair value of the warrants. No
amortization expense was taken in the 2005 fiscal year. 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 and October 31, 2004, no amounts were outstanding under the
Financing Agreement.
On March 10, 2003, the Company issued options to purchase 100,000 shares
of class A common stock to a non-employee member of the board of directors as
compensation for consulting services. The estimated fair value of the options
was determined by management to be $42,000. In November 2003, this individual
surrendered his 100,000 options noted above to the Company with no additional
compensation charge recorded.
The allocation of the proceeds from the sale of the series D preferred
stock and warrants issued in the Company's April 30, 2003 private placement
between the fair value of the series D preferred stock and the fair value of the
detachable warrants required management to estimate the fair value of the
warrants. Management's estimate resulted in a beneficial conversion feature in
the amount of $106,730. The discount was immediately accreted and treated as a
deemed dividend to the holder of the series D preferred as all of the series D
preferred stock was eligible for conversion upon issuance.
In connection with the private placement that closed during April and May
of 2003, the Company incurred fees which were paid by issuing warrants to
purchase 110,680 shares of class A common stock at an exercise price of $1.47
per share. The fair value of the warrants was determined by management to be
$87,800.
In connection with the acquisition of RTCI on November 6, 2000, issued and
outstanding options and warrants to purchase RTCI common stock were exchanged
for options and warrants of ICC, providing the holders the right to receive,
upon exercise, an aggregate of 394,905 shares of ICC class A common stock and
$343,456 of cash. The options and warrants were valued using the Black-Scholes
option-pricing model. The fair value of the vested portion of the options was
included in the purchase price for RTCI.
Goodwill is evaluated for impairment at least annually and whenever events
or circumstances indicate impairment may have occurred. The assessment requires
the comparison of the fair value of each of the Company's reporting units to the
carrying value of its respective net assets, including allocated goodwill. If
the carrying value of the reporting unit exceeds its fair value, the Company
must perform a second test to measure the amount of impairment. The second step
of the goodwill impairment test compares the implied fair value of reporting
unit goodwill with the carrying amount of that goodwill. The Company allocates
the fair value of a reporting unit to all of the assets and liabilities of that
unit as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the price paid to acquire the reporting
unit. The excess of the fair value of a reporting unit over the amounts assigned
to its assets and liabilities is the implied fair value of goodwill. If the
carrying amount of reporting unit goodwill exceeds the implied fair value of
that goodwill, an impairment loss is recognized by the Company in an amount
equal to that excess.
The Company estimates the fair value of its reporting units based on the
net present value of expected future cash flows. The use of this method requires
management to make estimates of the expected future cash flows of the reporting
unit and the Company's weighted average cost of capital. Estimating the
Company's weighted average cost of capital requires management to make estimates
for long-term interest rates, risk premiums, and beta coefficients. Management
estimated these items based on information that was available to management at
the time
24
INTERNET COMMERCE CORPORATION
the Company prepared its estimate of the fair value of the reporting unit.
Changes in either the expected cash flows or the weighted average cost of
capital could have a significant impact on the estimated fair value of the
Company's reporting units.
During the fourth quarter of fiscal 2003, the goodwill of the Service
Bureau was tested for impairment due to a significant decline in revenues and
operating income resulting primarily from the bankruptcy of its largest
customer. The fair value of the Service Bureau reporting unit was estimated
using the net present value of expected future cash flows. An impairment of
goodwill in the amount of approximately $982,000 was recorded during the year
ended July 31, 2003. As of August 1, 2004, the Company performed its annual test
for impairment on the carrying value of goodwill of its ICC.NET and Service
Bureau reporting units. The Company concluded that no impairment existed at that
date.
25
INTERNET COMMERCE CORPORATION
Three Months Ended October 31, 2004 Compared with Three Months Ended October 31,
2003.
Results of Operations - Consolidated
The following table reflects consolidated operating data by reported
segments. All significant intersegment activity has been eliminated.
Accordingly, the segment results below exclude the effect of transactions with
our subsidiaries.
Three Months Ended
October 31,
---------------------------
Consolidated net loss: 2004 2003 (1)
----------- -----------
ICC.NET $ (474,611) $ (786,813)
Service Bureau 73,000 (30,934)
----------- -----------
Consolidated loss $ (401,611) $ (817,747)
=========== ===========
(1) Recasted to reflect the inclusion of Professional Services within the
ICC.NET segment.
Results of Operations - ICC.NET
Our ICC.NET service, the Company's global Internet-based value added
network, or VAN, uses the Internet and our proprietary technology to deliver our
customers' documents and data files to members of their trading communities,
many of which may have incompatible systems, by translating the documents and
data files into any format required by the receiver. In addition, ICC.NET
facilitates the development and operation of comprehensive business-to-business
e-commerce solutions. These professional services assist our clients to conduct
business electronically through a continuum of services including eConsulting,
data transformation mapping (EDI, EAI, XML) and internetworking. The following
table summarizes operating results for our ICC.NET service for the three months
ended October 31, 2004 and 2003:
Three Months Ended
October 31, Variance
-----------------------------------------------------------
2004 2003 (1) $ %
----------- ----------- ----------------------
Revenue:
VAN services $ 2,621,838 $ 2,355,730 $ 266,108 11
Professional services 138,775 355,162 (216,387) (61)
Mapping services 64,629 84,808 (20,179) (24)
----------- ----------- -----------
2,825,242 2,795,700 29,542 1
Expenses:
Cost of services 1,200,157 1,656,407 (456,250) (28)
Product development and enhancement 134,077 190,965 (56,888) (30)
Selling and marketing 688,312 807,231 (118,919) (15)
General and administrative 1,069,576 863,401 206,175 24
Non-cash charges for stock-based compensation 210,833 52,942 157,891 298
----------- ----------- -----------
3,302,955 3,570,946 (267,991) (8)
----------- ----------- -----------
Operating loss (477,713) (775,246) 297,533 (38)
Other expense, net 3,102 (11,567) 14,669 (127)
----------- ----------- -----------
Net loss $ (474,611) $ (786,813) $ 312,202 (40)
=========== =========== ===========
(1) Recasted to reflect the inclusion of Professional Services within the
ICC.NET segment.
26
INTERNET COMMERCE CORPORATION
Revenue - ICC.NET - Revenue related to our ICC.NET service was 75% of
consolidated revenue for the quarter ended October 31, 2004 (the "2005 Quarter")
and 90% of consolidated revenue for the quarter ended October 31, 2003 (the
"2004 Quarter"). Total ICC.NET revenue increased $30,000 in the 2005 Quarter
from the 2004 Quarter, or approximately 1%. VAN services revenue increased
$266,000, or approximately 11%, in the 2005 Quarter from the 2004 Quarter. The
increase in VAN services revenue is primarily attributable to an increase in the
monthly mailbox fee during the 2005 Quarter. Professional services revenue
decreased $216,000, or approximately 61%, in the 2005 Quarter from the 2004
Quarter, partially due to a decrease of $82,000 in revenue from EDI educational
services and seminars. We discontinued our EDI educational services and seminars
in January 2004. In addition, revenue from our professional services decreased
$107,000, or approximately 39%, in the 2005 Quarter from the 2004 Quarter due to
a continued slowing in demand for these services. Mapping revenue decreased
$20,000, or approximately 24%, in the 2005 Quarter from the 2004 Quarter,
primarily due to a decrease in the number of customers and smaller mapping
projects resulting from the continued slowing in demand for these services.
Cost of services - ICC.NET - Cost of services relating to our ICC.NET
service was 43% of revenue derived from the ICC.NET service in the 2005 Quarter,
compared to 59% of such revenue in the 2004 Quarter. Cost of services relating
to our ICC.NET service consists primarily of salaries and employee benefits,
connectivity fees, amortization and rent. Total cost of services decreased
$456,000 in the 2005 Quarter from the 2004 Quarter. Salaries and benefits and
fees paid to consultants decreased $297,000 in the 2005 Quarter from the 2004
Quarter, primarily due to a decrease in headcount to 16 in October 2004 from 34
in October 2003 and a decrease in the use of consultants. Allocation of salaries
from product and development decreased $46,000 in the 2005 Quarter from the 2004
Quarter, due to less developer time spent on costs of services projects. In
addition, travel and entertainment decreased $35,000 in the 2005 Quarter from
the 2004 Quarter due to the completion of professional service projects
requiring travel and the discontinuance of our educational services and seminars
in January 2004. Depreciation expense decreased $20,000 in the 2005 from the
2004 Quarter due to assets reaching the end of their useful lives subsequent to
the 2004 Quarter.
Product development and enhancement - ICC.NET - Product development and
enhancement costs relating to our ICC.NET service consist primarily of salaries
and employee benefits. Product development and enhancement costs decreased
$57,000 in the 2005 Quarter from the 2004 Quarter. Salaries and benefits
decreased $83,000 in the 2005 Quarter from the 2004 Quarter, primarily due to a
decrease in the number of employees to 7 at the end of the 2005 Quarter from 10
at the end of the 2004 Quarter. Depreciation expense decreased $11,000 in the
2005 from the 2004 Quarter due to assets reaching the end of their useful lives
subsequent to the 2004 Quarter. Offsetting these decreases, allocation of
product development salaries to other departments decreased $38,000 in the 2005
Quarter from the 2004 Quarter.
Selling and marketing - ICC.NET - Selling and marketing expenses relating
to our ICC.NET service consist primarily of salaries and employee benefits,
rent, travel-related costs, advertising and trade-show costs. Selling and
marketing expenses relating to our ICC.NET service decreased $119,000 in the
2005 Quarter from the 2004 Quarter. Salaries and benefits decreased $80,000 in
the 2005 Quarter from the 2004 Quarter primarily due to a decrease in the number
of employees to 14 at the end of the 2005 Quarter from 21 at the end of the 2004
Quarter. Commencing in the 2005 Quarter, ICC.NET began allocating a portion of
the cost of sales and marketing functions to the Service Bureau segment based on
the level of effort utilized in selling Service Bureau products. This corporate
allocation to the Service Bureau segment was $24,000 in the 2005 Quarter.
General and administrative - ICC.NET - General and administrative expenses
supporting our ICC.NET service consist primarily of salaries and employee
benefits, legal and professional fees, facility costs, travel meals and
entertainment and insurance. General and administrative costs supporting our
ICC.NET service increased $206,000 in the 2005 Quarter from the 2004 Quarter.
Salaries and benefits increased $253,000 in the 2005 Quarter from the 2004
Quarter due to retention bonuses of $118,000 for finance department employees in
the 2005 Quarter and due the strengthening of executive management by the
addition of a new chief executive officer and chief operating officer subsequent
to the 2004 Quarter. Legal and professional fees increased $64,000 in the 2005
Quarter from the 2004 Quarter due to an increase in the use of these services.
Commencing in the second fiscal quarter of 2003, ICC.NET began allocating a
portion of the cost of executive management, human resources, accounting and
finance functions to the Service Bureau segment based on the level of services
provided, and in the 2005 Quarter, the cost of
27
INTERNET COMMERCE CORPORATION
the MIS function was added to those being allocated. This corporate allocation
to the Service Bureau segment increased $90,000 in the 2005 Quarter from the
2004 Quarter, to $135,000 from $45,000.
Non-cash charges - ICC.NET - Non-cash charges of approximately $211,000 in
the 2005 Quarter consist of $178,000 for stock options issued to employees and
directors and of $33,000 for shares of class A common stock to be issued to
non-employee directors as compensation for 2004 directors' fees. Non-cash
charges of approximately $53,000 in the 2004 Quarter consisted of shares of
class A common stock issued to non-employee directors as compensation for
calendar year 2003 directors' fees in the amount of $38,000. In addition,
$15,000 of expense was recognized during the 2004 Quarter for stock options
issued to a non-employee director as compensation for consulting services.
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.
("ECS"), the operating results of which are reported in the Service Bureau
segment. The following table summarizes operating results for our Service
Bureau:
Three Months Ended
October 31, Variance
--------------------
2004 2003 $ %
----------------------------------------------------------
Revenue:
Services $ 921,298 $ 307,651 $ 613,647 199
--------- --------- --------- ---------
Expenses:
Cost of services 217,270 203,901 13,369 7
Product development
and enhancement 88,635 34,249 54,386 159
Selling and marketing 149,806 18,450 131,356 712
General and administrative 392,587 81,985 310,602 379
--------- --------- --------- ---------
848,298 338,585 509,713 151
--------- --------- --------- ---------
Operating income (loss) 73,000 (30,934) 103,934 (336)
Other income, net -- -- -- --
--------- --------- --------- ---------
Net income (loss) $ 73,000 $ (30,934) $ 103,934 $ (336)
========= ========= ========= =========
Revenue - Service Bureau - Revenue relating to our Service Bureau was 25%
of consolidated revenue in the 2005 Quarter and 10% of consolidated revenue in
the 2004 Quarter. The Service Bureau's revenue was primarily generated from
services performed, customer support and licensing fees. Revenue in the 2005
Quarter increased $614,000, or 200%, from the 2004 Quarter due to the
acquisition of ECS in June 2004.
Cost of services - Service Bureau - Cost of services relating to our
service bureau was 24% of revenue derived from the Service Bureau in the 2005
Quarter, compared to 66% of such revenue in the 2004 Quarter. Cost of services
relating to our Service Bureau consists primarily of salaries and employee
benefits, amortization, connectivity fees and rent. Cost of services relating to
our Service Bureau increased $13,000 in the 2005 Quarter from the 2004 Quarter.
Amortization was $44,000 in the 2005 Quarter with no amount in the 2004 Quarter
due to the amortization of technology obtained in the acquisition of ECS.
Connectivity fees increased $10,000 in the 2005 Quarter from the 2004 Quarter
due an increase in the level of business conducted. Offsetting these increases,
28
INTERNET COMMERCE CORPORATION
allocation of expense from the product development and enhancement department
decreased $28,000 in the 2005 Quarter from the 2004 Quarter.
Product development and enhancement - Service Bureau - Product development
and enhancement costs consist primarily of salaries and employee benefits.
Product development and enhancement costs incurred by our Service Bureau
increased $54,000 in the 2005 Quarter from the 2004 Quarter. Salaries and
benefits increased $23,000 in the 2005 Quarter from the 2004 Quarter due
primarily to an increase in the number of employees to 4 at the end of the 2004
Quarter from 3 at the end of the 2003 Quarter. Allocation of product development
salaries to other departments decreased $29,000 in the 2005 Quarter from the
2004 Quarter.
Selling and marketing - Service Bureau - Selling and marketing expenses
relating to our Service Bureau consist primarily of salaries and employee
benefits and amortization. Selling and marketing expenses incurred by our
Service Bureau increased $131,000 in the 2005 Quarter from the 2004 Quarter.
Salaries and benefits increased $82,000 in the 2005 Quarter from the 2004
Quarter due to an increase in the number of employees to 4 at the end of the
2005 Quarter from 1 at the end of the 2004 Quarter. Amortization was $11,000 in
the 2005 Quarter with no amount in the 2004 Quarter due to the amortization of
customer relationships obtained in the acquisition of ECS. Allocation of selling
and marketing expenses from ICC.NET increased $24,000 in the 2005 Quarter from
the 2004 Quarter. See "Selling and marketing - ICC.NET" above for a discussion
of the allocation of selling and marketing expenses between segments.
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 expenses incurred by our Service Bureau increased $311,000 in
the 2005 Quarter from the 2004 Quarter. Salaries and employee benefits increased
$143,000 in the 2005 Quarter from the 2004 Quarter due primarily to an increase
in the number of employees to 5 at the end of the 2005 Quarter from 1 at the end
of the 2004 Quarter. Rent, office expense, telephone expenses and depreciation
increased $23,000, $16,000, $14,000 and $10,000, respectively, in the 2005
Quarter from the 2004 Quarter as a result of the addition of new facilities
resulting from the acquisition of ECS. Allocation of general and administrative
expenses from ICC.NET increased $90,000 in the 2005 Quarter from the 2004
Quarter. See "General and administrative - ICC.NET" above for a discussion of
the allocation of general and administrative expenses between segments.
Liquidity and Capital Resources
Our principal sources of liquidity, which consist of unrestricted cash and
cash equivalents, decreased slightly to $3,646,000 as of October 31, 2004 from
$3,790,000 as of July 31, 2004. We believe these resources provide us with
sufficient liquidity to continue in operation at least through July 31, 2005.
On April 20, 2004, the Company completed a private placement of common
stock and warrants to purchase shares of common stock (the "2004 Private
Placement") that provided aggregate gross proceeds of approximately $4,955,000.
In the 2004 Private Placement, the Company sold 2,831,707 shares of its
class A common stock and warrants to purchase 849,507 shares of our class A
common stock. These warrants are exercisable for five years commencing on
October 20, 2004 at an exercise price of $2.22 per share.
In connection with the 2004 Private Placement, the Company incurred fees
and expenses of $772,001, of which $423,274 was paid in cash at closing,
$122,822 is payable in cash and $225,905 was paid by issuing warrants to
purchase 283,170 shares of class A common stock. The fair value of the warrants
was estimated by management using the Black Scholes option-pricing model. These
warrants have substantially the same terms as the warrants issued in the 2004
Private Placement. No directors, officers or entities with which the Company's
directors, or officers are affiliated participated in the 2004 Private
Placement.
In connection with the 2004 Private Placement, the Company entered into a
registration rights agreement with the investors, dated as of April 20, 2004,
and filed a registration statement with the SEC on April 30, 2004 pursuant to
this agreement. 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
29
INTERNET COMMERCE CORPORATION
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.
During April and May 2003, the Company completed a private placement of
shares of its class Acommon stock, convertible preferred stock and warrants to
purchase shares of common stock (the "2003 Private Placement") for aggregate
gross proceeds of approximately $2,085,000.
In the 2003 Private Placement, the Company sold 1,682,683 shares of class
A common stock and warrants to purchase 1,346,140 of class A common stock
providing gross proceeds of approximately $1,835,000 and 250 shares of series D
convertible redeemable preferred stock ("series D preferred") and warrants to
purchase 153,845 shares of class A common stock for $250,000. All warrants are
immediately exercisable and have an exercise price of $1.47 per share. The
warrants are exercisable until the fifth anniversary of the date of issuance. In
addition, the warrants are redeemable at the Company's option, if the closing
bid price of the Company's class A common exceeds 200% of the exercise price of
the warrants for 30 consecutive trading days. The redemption price is $0.10 per
share for each share issuable under the warrants.
The 250 shares of series D preferred are convertible into 192,307 shares
of class A common stock. The allocation of the proceeds from the sale of the
series D preferred between the fair value of the series D and the fair value of
the detachable warrants resulted in a beneficial conversion feature in the
amount of $106,730. The discount was immediately accreted and treated as a
deemed dividend to the holder of the series D preferred as all of the series D
preferred was eligible for conversion upon issuance.
In connection with the 2003 Private Placement, the Company incurred fees
of $325,750, of which $237,938 was payable in cash and $87,802 was paid by
issuing warrants to purchase 110,680 shares of class A common stock. These
warrants have substantially the same terms as the warrants issued in the 2003
Private Placement.
In connection with the 2003 Private Placement, the Company issued 48,076
shares of class A common stock and warrants to purchase 38,460 shares of class A
common stock in settlement of certain outstanding payables. The common stock and
warrants were valued at $50,000, the invoice amount of the services provided to
the Company.
Approximately 21%, or $432,000, of the gross proceeds from the 2003
Private Placement was received from directors and officers and entities with
which the Company's directors are affiliated.
On May 30, 2003, the Company executed an Accounts Receivable Financing
Agreement ("Financing Agreement") with Silicon Valley Bank ("the Bank") with a
term of one year. Under the Financing Agreement, the Company may borrow, subject
to certain conditions, up to 80% of its outstanding accounts receivable up to a
maximum of $2,000,000. The applicable interest rate is the prime rate plus .35%
plus a collateral handling fee equal to .20% on the average daily outstanding
receivable balance, and interest is payable monthly. The Financing Agreement
contains certain restrictive covenants that are customary for a commercial
transaction of this type, including, without limitation, restrictions on the
disposition or encumbrance of the collateral pledged to the Bank, restrictions
on incurring additional indebtedness and restrictions on the payment of
dividends and the redemption or repurchase of any capital stock. In addition,
the Company is required to maintain at all times a ratio of Quick Assets (i.e.,
consolidated, unrestricted cash, cash equivalents, net accounts receivable and
investments with maturities of fewer than 12 months determined according to
GAAP) to Current Liabilities (i.e., all obligations and liabilities of the
Company to Bank, plus, without duplication, the aggregate amount of the
Company's total liabilities which mature within one (1) year) minus Deferred
Revenue (i.e., all amounts received in advance of performance under contracts
and not yet recognized as revenue) of at least 1.10 to 1.0. The Bank has been
granted a security interest in substantially all of the Company's assets. In
connection with the Financing Agreement, the Company issued the Bank warrants to
purchase 40,000 shares of the Company's class A common stock. The warrants are
immediately exercisable at an exercise price of $1.39, equal to the fair market
value of the Company's class A common stock on the date of closing of the
Financing Agreement. The warrants are exercisable for a seven-year period. The
fair value of the warrants in the amount of approximately $34,000 will be
amortized to interest expense over the term of the
30
INTERNET COMMERCE CORPORATION
Financing Agreement. During the three-month period ended October 31, 2004 and
2003, the Company recorded interest expense in the amount of approximately $0
and $8,600, respectively, 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. At October 31, 2004 and July 31, 2004, there
were no amounts outstanding under the Financing Agreement.
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.
Consolidated Working Capital
Consolidated working capital decreased slightly to $4,118,000 at October
31, 2004 from $4,198,000 at July 31, 2004.
Analysis of Cash Flows
Cash provided by operating activities was $18,000 in the 2005 Quarter
compared to cash used in operating activities of $1,103,000 in the 2004 Quarter.
Cash provided by operating activities in the 2005 Quarter is primarily the
result of an increase in accounts payable of $195,000 and increase in non-cash
charges of $211,000 and a lower operating losses. The decrease in the 2004
Quarter is primarily the result of a decrease in accounts payable and accrued
expense of $511,000 coupled with an increase in accounts receivable of $213,000
and operating losses.
Cash used in investing activities was $135,000 in the 2005 Quarter from
$47,000 in the 2004 Quarter. Cash used in investing activities in the 2005
Quarter resulted from the professional fees relating to the acquisition of ECS
of $80,000, professional fees relating to the 2004 Private Placement of $24,000
and expenditures from the purchase of property and equipment of $32,000. Cash
used in investing activities in the 2004 Quarter was primarily the result of
purchases of property and equipment of $46,000.
Cash used in financing activities was $26,000 in the 2005 Quarter compared
to $36,000 in the 2004 Quarter. Cash used in financing activities in the both
the 2005 and 2004 Quarters represent payments of capital lease obligations.
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.
31
INTERNET COMMERCE CORPORATION
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others" which elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of Interpretation
No. 45 are applicable on a prospective basis to guarantees issued or modified
after December 31, 2002. The disclosure requirements in this Interpretation are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The Company has provided information regarding commitments
and contingencies relating to guarantees in Note 10. The adoption of this
standard did not have a significant impact on the Company's consolidated
financial position or results of operations.
In November 2002, the Emerging Issues Task Force of the FASB ("EITF")
reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple
Deliverables." EITF 00-21 addresses certain aspects of the accounting by a
vendor for arrangements under which the vendor will perform multiple revenue
generating activities. The EITF was effective for revenue arrangements entered
into in fiscal years and interim periods beginning after June 15, 2003. The
adoption of this consensus, effective August 1, 2003, did not have a significant
impact on the Company's consolidated financial position or results of
operations.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123"
("SFAS 148"). SFAS 148 amends SFAS 123, "Accounting for Stock-Based
Compensation" to provide alternative methods to account for the transition from
the intrinsic value method of recognition of stock-based employee compensation
in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees" to the fair value recognition provisions under SFAS 123. SFAS 148
provides two additional methods of transition and will no longer permit the SFAS
123 prospective method to be used for fiscal years beginning after December 15,
2003. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to
require prominent disclosure in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
pro-forma effects had the fair value recognition provisions of SFAS 123 been
used for all periods presented. The adoption of SFAS 148 did not have a
significant impact on the Company's consolidated financial position and results
of operations. The Company adopted the fair-value recognition provisions of SFAS
123 in January 2004 (Note 6).
In January 2003, the FASB issued 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 hawse 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 Company's
consolidated financial position or results of operations.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer
32
INTERNET COMMERCE CORPORATION
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise shall be effective at the beginning of the
first interim period beginning after June 15, 2003. For financial instruments
created before the issuance date of this Statement and still existing at the
beginning of the interim period of adoption, transition shall be achieved by
reporting the cumulative effect of a change in an accounting principle by
initially measuring the financial instruments at fair value or other measurement
attribute required by this Statement. The adoption of this Statement, effective
August 1, 2003, did not have a material impact on the Company's consolidated
financial position or results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is primarily exposed to interest rate risk and credit risk.
Interest Rate Risk - Interest rate risk refers to fluctuations in the
value of a security resulting from changes in the general level of interest
rates. Investments that are classified as cash and cash equivalents have
original maturities of three months or less. Changes in interest rates may
affect the value of these investments.
Credit Risk - Our accounts receivables are subject, in the normal course
of business, to collection risks. We regularly assess these risks and have
established policies and business practices to protect against the adverse
effects of collection risks. As a result we do not anticipate any material
losses in this area.
Item 4. Controls and Procedures
Our management, including our chief executive officer and our principal
accounting officer, have carried out an evaluation of the effectiveness of our
disclosure controls and procedures as of October 31, 2004, pursuant to Exchange
Act Rules 13a-15(e) and 15(d)-15(e). Based upon that evaluation, our chief
executive officer and our principal accounting officer have concluded that as of
such date, our disclosure controls and procedures in place are effective to
ensure material information and other information requiring disclosure is
identified and communicated on a timely basis.
33
PART II. OTHER INFORMATION
- -------- -----------------
Item 1. Legal Proceedings
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3: Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
Exhibits.
---------
31.1 Certificate of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certificate of the 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 Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: December 15, 2004
INTERNET COMMERCE CORPORATION
by: /s/ Thomas J. Stallings
----------------------------------
Thomas J. Stallings
Chief Executive Officer
by: /s/ Glen Shipley
----------------------------------
Glen Shipley
Chief Financial Officer
35