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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended June 30, 2002.
[ ] Transition report under section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from to _______________ to ______________.
Commission file number 000-27941
IMERGENT, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 87-0591719
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
754 East Technology Avenue,
Orem, Utah 84097
(Address of principal executive office) (Zip Code)
(801) 227-0004
(Issuer's telephone number)
NETGATEWAY, INC.
(Issuer's former name, if changed since last report)
Securities to be registered under Section 12(b) of the Act:
Title of Each Class Name of Each Exchange On Which Registered
None None
Securities to be registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001
Indicate by check mark whether the registrant (1) 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), Yes[X] No [ ], and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Based on the average of the bid and asked price for the registrant's
common stock on the Nasdaq OTC Bulletin Board on October 8, 2002, the aggregate
market value on such date of the registrant's common stock held by
non-affiliates of the registrant was $14,196,487. For the purposes of this
calculation, shares owned by officers, directors and 10% stockholders known to
the registrant have been deemed to be owned by affiliates.
The number of shares outstanding of the registrant's common stock, as
of October 8, 2002, was 11,000,774.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for its 2002 Annual Meeting of
Stockholders, which is expected to be filed within 120 days after the end of the
registrant's fiscal year, are incorporated by reference in Part III (Items 10,
11, 12 and 13) of this Report.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS...................................................... 3
ITEM 2. PROPERTIES.................................................... 19
ITEM 3. LEGAL PROCEEDINGS............................................. 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................... 21
ITEM 6. SELECTED FINANCIAL DATA....................................... 23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................... 24
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................... 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 40
ITEM 11. EXECUTIVE COMPENSATION........................................ 41
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.....................................................41
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K................................................... 41
SIGNATURES .............................................................. 78
PART I
Throughout this report, we refer to Imergent, Inc., together with its
subsidiaries, as "we," "us," or "our company."
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS.
THESE STATEMENTS RELATE TO FUTURE EVENTS OR OUR FUTURE FINANCIAL PERFORMANCE. IN
SOME CASES, YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS
MAY, WILL, SHOULD, EXPECT, PLAN, INTEND, ANTICIPATE, BELIEVE, ESTIMATE, PREDICT,
POTENTIAL OR CONTINUE, THE NEGATIVE OF SUCH TERMS OR OTHER COMPARABLE
TERMINOLOGY. THESE STATEMENTS ARE ONLY PREDICTIONS. ACTUAL EVENTS OR RESULTS MAY
DIFFER MATERIALLY. IN EVALUATING THESE STATEMENTS, YOU SHOULD SPECIFICALLY
CONSIDER VARIOUS FACTORS, INCLUDING THE RISKS OUTLINED BELOW. THESE FACTORS MAY
CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FORWARD-LOOKING
STATEMENT.
ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE
FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE RESULTS,
LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. MOREOVER, NEITHER WE NOR ANY
OTHER PERSON ASSUMES RESPONSIBILITY FOR THE ACCURACY AND COMPLETENESS OF THE
FORWARD-LOOKING STATEMENTS. WE ARE UNDER NO DUTY TO UPDATE ANY OF THE
FORWARD-LOOKING STATEMENTS AFTER THE DATE OF THIS ANNUAL REPORT TO CONFORM SUCH
STATEMENTS TO ACTUAL RESULTS OR TO CHANGES IN OUR EXPECTATIONS.
Item 1. Business.
General
We are an e-Services company that provides eCommerce technology, training
and a variety of web-based technology and resources to over 100,000 small
businesses and entrepreneurs annually. Our affordably priced e-Services
offerings leverage industry and client practices, and help increase the
predictability of success for Internet merchants. Our services also help
decrease the risks associated with e-commerce implementation by providing
low-cost, scalable solutions with minimal lead-time, ongoing industry updates
and support. Our strategic vision is to remain an eCommerce provider tightly
focused on our target market.
We are continuing to execute and build on a strategic plan that we adopted
in fiscal year 2001 which was designed to allow us to sustain revenue and
profitability at acceptable levels after we ceased, due to a change in our
product offerings, to recognize revenue from prior product offerings. We have
phased out our CableCommerce and Internet Commerce Center (ICC) activities and
have concentrated on our StoresOnline product through our Internet Training
Workshops. We will continue to seek to maximize this existing business model,
which is designed to increase our revenue by enhancing the range of products and
service offerings to our customer base, increasing sales to our existing
customer base, and by increasing the overall number of attendees at our Internet
Marketing Workshops. We will also continue to seek to reduce our cost of revenue
through continued enhancement of our StoresOnline software. Currently,
substantially all of our revenues are derived from our StoresOnline subsidiary.
We were incorporated under the laws of Nevada on April 13, 1995, under the
name Video Calling Card, Inc. In June 1998, we acquired all of the outstanding
capital stock of Netgateway, a Nevada corporation formerly known as
eClassroom.com, in exchange for 5,900,000 shares (590,000 shares as presently
constituted) of our common stock. At the same time, we acquired the assets of
Infobahn, LLC d/b/a Digital Genesis, an electronic commerce applications
developer, in exchange for 400,000 shares of our common stock.
In January 1999, StoresOnline.com, Ltd., a Canadian corporation and our
wholly owned subsidiary, acquired all of the outstanding capital stock of
Spartan Multimedia, Ltd., an Internet storefront developer and storefront
service provider, in exchange for 371,429 shares of Class B common stock of
StoresOnline.com. The Class B common stock is exchangeable on a one-to-one basis
for shares of our common stock. To date, a total of 276,713 shares have been
exchanged.
In November 1999, we reincorporated under the laws of Delaware.
In June 2000, we acquired all of the outstanding capital stock of Galaxy
Enterprises, Inc., a Nevada corporation, in exchange for approximately 3,900,000
shares (390,000 shares as presently constituted) of our common stock. Galaxy
Enterprises was organized as a Nevada corporation on March 3, 1994. Galaxy
Enterprises was originally formed under the name Cipher Voice, Inc., and was
incorporated for the purpose of developing, producing and marketing equipment
related to computer hardware security, known as a digital voice
encryption-decryption electronic device. Galaxy Enterprises was unsuccessful in
developing that technology and subsequently ceased operations.
In December 1996, Galaxy Enterprises acquired all of the issued and
outstanding common stock of GalaxyMall, Inc., a Wyoming corporation, in exchange
for 3,600,000 shares of Galaxy Enterprises common stock. As a result of this
stock acquisition, Galaxy Mall became a wholly owned subsidiary of Galaxy
Enterprises. On December 16, 1996, Galaxy Enterprises changed its name from
Cipher Voice, Inc. to Galaxy Enterprises, Inc.
Effective May 31, 1999, Galaxy Enterprises, through its wholly owned
subsidiary IMI, Inc., acquired substantially all of the assets of Impact Media,
L.L.C., a Utah limited liability company engaged in the design, manufacture and
marketing of multimedia brochure kits, shaped compact discs and similar products
and services intended to facilitate conducting business over the Internet. The
assets acquired included, among other things, equipment, inventory and finished
goods, intellectual property, computer programs and cash and accounts
receivable. The primary use of these assets relate to the design, manufacture
and marketing of Impact Media's products and services. In January 2001 we sold
our IMI subsidiary to Capistrano Partners LLC for $1,631,589, including
$1,331,589 owed to us by IMI at the time of the sale. We received a cash payment
of $300,000 and a promissory note for the balance of the purchase price which
note was subsequently converted into shares, which at that time represented 8.7%
of the outstanding capital stock of IMI. At the time of the original
transaction, Capistrano Partners LLC was an unrelated third party, but the sole
member of Capistrano is now an equity investor in us.
In August 2000, we announced that we would close our Long Beach
headquarters and consolidate it with our Orem, Utah operations. After the
relocation of our operations to Utah we dramatically slowed the development of
our Internet Commerce Center, or ICC, stopped substantially all sales and
marketing activity for business-to-business solutions based on the ICC and
terminated the employment of the ICC engineering, sales and marketing teams. We
are continuing to support our existing business-to-business customers served by
the ICC. Although early versions of the ICC are fully operational and being used
by current customers, we have suspended all ICC engineering and programming
activities with respect to new versions and features of the ICC pending receipt
of actual ICC customer orders. No such orders have been received to date and we
are not actively soliciting such orders; however, if an existing ICC customer
were to order services we would identify the actual customer needs and, if
further ICC development work was required and appropriate, do such work at that
time. After the relocation of our operations to Utah, we also restructured our
CableCommerce operations. Through July, 2001 we continued to work with our cable
operator partners in support of existing Internet cable malls and to increase
the number of merchants hosted on these malls, but our activity in this regard
was greatly reduced effective January 2001 as a result of reductions in the size
of the sales and marketing team. In July 2001, we transferred to a third party
the opportunity to market these product and service offerings to both our
existing cable operator business partners and others. Pursuant to this
arrangement we continued for a period of time to provide the underlying
technology, hosting and other services, but all of these services have now been
terminated and the existing Internet cable malls were shut down.
Effective July 2, 2002, we changed our corporate name to "Imergent, Inc."
to better reflect the scope and direction of our current business activities of
assisting and providing web-based technology solutions to small emerging
companies and entrepreneurs who are seeking to establish a viable e-commerce
presence on the Internet. Also effective July 2, 2002, we effected a 10:1
reverse split of our shares of common stock and reduced the authorized number of
shares of common stock from 250,000,000 to 100,000,000.
Industry Background
The Internet economy has transformed the way business is conducted. To
address this more competitive environment companies are now required to market
dynamically, compete globally and communicate with a network of consumers and
partners. Introducing a business to the Internet economy can unleash new
opportunities for that business that can drive revenue growth, services
opportunities, product innovation, and operational efficiencies. Companies must
be able to offer and/or deliver their services and products through the Internet
to capitalize on its potential.
In April 2002, Nielsen/NetRatings, Inc. estimated yet another increase in
USA Internet users to over 165 million, and the growth trend continues worldwide
as well as reported by Nua Ltd., to over 850 million Internet users worldwide.
The continued growth of business-to-consumer eCommerce and the growing
acceptance of eCommerce as a mainstream medium for commercial transactions,
presents a significant opportunity for companies, including small businesses and
entrepreneurs. To take advantage of this opportunity they must extend their
marketing and sales efforts to the Internet and often must transform their core
business and technologies in order to be able to successfully conduct commerce
by means of the Internet. The transformation challenges include systems
engineering, technical, commercial, strategic and creative design challenges and
developing an understanding of how the Internet transforms relationships between
businesses and their internal organizations, customers, and business partners. A
company seeking to effect such a transformation often needs outside technical
expertise to assist in identifying viable Internet tools, and to develop and
implement reasonable strategies all within the company's budget, especially if
the company believes that rapid transformation will lead to a competitive
advantage.
We believe this environment has created a significant and growing demand
for third-party Internet professional services and has resulted in a
proliferation of companies (e-Service companies) offering specialized solutions,
such as order processing, transaction reporting, helpdesk, training, consulting,
security, Website design and hosting. This specialization has resulted in a
fragmented market that often requires a company to combine solutions from
different providers that may be based on different, or even contradictory,
strategies, models and designs. We believe that there is a very large,
fragmented and under-served market for entrepreneurial companies searching for
professional services firms that offer turnkey business-to-consumer eCommerce
solutions coupled with training, consulting and continuing education.
We believe that few of the existing e-Services providers targeting small
businesses and entrepreneurs have the range of product and service offerings
that focus on the peculiar needs of this market. This market requires a broad
range of product and services offerings that are necessary to assist in a
coordinated transformation of their business to embrace the opportunities
presented by the Internet. Accordingly, we believe that these organizations are
increasingly searching for a services firm such as ours that offers turn-key
business-to-consumer eCommerce solutions focused on their e-Services
requirements, which include training, education, technology, creative design,
transaction processing, data warehousing/hosting, transaction reporting, help
desk support and consulting. Furthermore, we believe that organizations will
increasingly look to Internet solutions providers that leverage industry and
client practices, increase predictability of success for Internet solution
deployments and decrease implementation risks by providing low-cost, scalable
solutions with minimal lead-time.
Our Business
Offering services to Small Businesses
We offer a continuum of services and technology to the small business owner
and entrepreneur. Our services start with a complimentary 90-minute
informational Preview Training Session for those interested in extending their
business to the Internet. These Training Sessions have proven to increase
awareness of and excitement for the opportunities presented by the Internet. We
typically conducted 20-30 sessions each week across the United States. At these
Preview Training Sessions, our instructors preview the advantages of
establishing a website on the Internet, answer in general terms many of the most
common questions new or prospective Internet merchants have (including the
identification of the types of products, services, and information that are best
marketed and/or sold on the Internet), how to develop an effective marketing and
advertising strategy, and how to transform an existing "brick and mortar"
company into a successful e-commerce enabled company.
Approximately two weeks after each Preview Training Session, we return to
conduct an intensive eight hour Internet training workshop which provides
Internet eCommerce and website implementation training to a subset of
individuals and companies that attended the preview session. At the Internet
training workshop, attendees learn some of the detail, tips, and techniques
needed to transform an existing "brick and mortar" company into an eCommerce
success. They learn how to open and promote a successful Internet business,
including a plain English explanation of computer/Internet/technical
requirements and e-commerce tools, specific details and tips on how to promote
and drive traffic to a website and techniques to increase sales from traffic to
a website.
At the conclusion of the workshop, the attending individual or company,
typically a small business or individual entrepreneur, is presented an
opportunity to purchase a license to use our proprietary StoresOnline software
and website development platform and an integrated package of services and
thereby become an Internet merchant and client of the company.
The integrated package of services includes:
o The ability to create up to three different, fully eCommerce enabled
websites, with the option to host such on our servers
o Access to our detailed database of Internet marketing information
o Helpdesk technical support via on-line chat, email, and telephone
o Initial registration to over 300 different search engines, directories
and link pages
o Tracking software to monitor site traffic (hits, unique visitors, page
views, referring URL, search engine and keywords used, time of visit,
etc.)
o Internet classified advertisements
o Merchant accounts for real-time on-line credit card processing
o Testing and marketing tools (auto responders)
The license to our StoresOnline software and website development platform
permits the client to create up to three custom websites. If the client prefers,
the client can use our development team of employees and contractors to design
and program the website for an additional charge or the client can create their
own website, which can either be a static, standalone site hosted by a third
party, or it can be hosted by us for an additional fee. If we host the site, the
client will be able to take advantage of the dynamic website updating
capabilities of the StoresOnline platform, along with other benefits provided by
the hosting service.
Following the initial sale to a client, we seek to provide additional
technology and services to our clients. On the services side, we offer custom
programming to create distinctive web page graphics and banners and advanced
programming to enhance websites with things such as streaming audio and video
media, Macromedia(TM) Flash and Director programming techniques, commitments to
deliver page view traffic to the website and a ten week coaching and mentoring
program. The coaching and mentoring program is provided by a third-party and
involves a series of telephone training sessions with a tutor who provides
specific assistance in a variety of areas, including Internet marketing. We
continue to explore ideas, products and services to enhance ongoing customer
training and assistance.
We also continue to seek to increase sales to our existing client base by
more aggressively imposing and collecting set-up and hosting fees, selling
programming services to update existing client websites and an outsourced
outbound telemarketing program through which we periodically contact persons who
attended our Internet training workshops. In particular we are focusing on
selling Internet training workshop attendees who did not purchase at the
workshop our basic package and on selling additional product and service
offerings (both ours and third parties) to persons who purchased at the
workshop. Through this telemarketing program we also seek to increase the
website activation rate of customers who purchase at our Internet training
workshops but have not yet designed or activated their website and thereby
establish a stronger relationship with these persons and offer them additional
products and services. We may also, for a fee, allow third parties to market to
our clients and Preview Training Session and Internet training workshop
attendees, products and services that are complimentary with our product and
service offerings. In some situations this could result in the client purchasing
additional products and services.
In addition to seeking to grow by increasing the number of Preview Training
Sessions and Workshops in the United States, we intend to continue an
international expansion of our business, initially into selected
English-speaking countries in the Asia Pacific region, South Africa, and Canada,
and possibly thereafter to additional countries in Asia and Europe. Our research
indicated that we should experience lower customer acquisition costs in these
regions than we currently experience in the United States and that our turnkey
product and service offering for small businesses and entrepreneurs may enjoy a
first mover advantage in some of these markets. We have been encouraged by our
initial experiences in some of these markets, which have validated our research
and indicated that, in time, we could experience results that are comparable to
those we have historically experienced in the United States market. We are
continuing to refine our international market strategies based on these initial
experiences and have initiated the establishment of strategic alliances with
other companies with experience in certain of these countries to assist in this
effort.
Seasonality. Revenues during the year for our workshop business can be
subject to seasonal fluctuations. The first and second calendar quarters are
generally stronger than the third and fourth calendar quarters. Customers seem
less interested in attending our workshops during the period between July 15th
through Labor day, and again during the holiday season from Thanksgiving Day
through the first week of the following January.
Our Technology
We believe that a key component of our success will be a number of new
technologies we have developed. These technologies distinguish our services and
products from those of our competitors and help substantially to reduce our
operating costs and expenses. The most important of these are the continued
enhancements to our StoresOnline software and hosting platform and our Dynamic
Image Server technology.
The StoresOnline platform is a web-based turnkey eCommerce development
platform, which has been continuously improved over the past decade. The current
version of the StoresOnline platform represents the culmination of over ten
years of development effort on a platform that has hosted over 20,000
eCommerce-enabled websites and, in the past, has received broad acceptance in
the fast growing market of small businesses and in the entrepreneurial
community. The current StoresOnline platform version represents a continued
stage of evolution towards an easier to use and more scalable application. The
most recent additions and enhancements to the software include several new
features, including the support of additional credit card processing companies,
a tracking package which allows both numerical and graphical display of site
traffic statistics, new target market/entry page functions, and an expanded
library of design templates, in addition to enhancements to existing features.
We have made significant progress in integrating the StoresOnline platform
as our primary tool for custom website design and development by our internal
production group. We believe that these changes, together with extensive
training of our internal production group and the upgrade of our data center to
include redundant power, bandwidth and servers, has allowed us to become more
self-reliant, effective for our customers and efficient in the programming of
customer sites. In addition, our customers are now able to create and maintain
their own sites quickly and easily without having to learn HTML programming or
use other software tools.
A unique technology innovation, our DynamicImage Server, allows images to
be created dynamically rather than by uploading images or using stock photos or
clip art. A user can create images dynamically through the manipulation of
multiple image variables (such as background color, text, borders, sizing,
dropshadows, etc.) in a simple "point and click" environment. This feature
allows the automatic generation of image permutations, allowing a customer, for
example, to view all of the different possible combinations of shirts, tie,
sport coats, and slacks before purchase. The DynamicImage Server allows for
quick and easy creation of graphical and professional looking storefronts.
Other Product and Service Offerings
We deliver business-to-business eCommerce solutions to a limited number
of existing clients for whom we maintain custom eCommerce applications. We are
no longer actively promoting this line of business and are not spending
significant resources to further develop or expand this business or its core
technology - the Internet Commerce Center (ICC). This activity is no longer part
of our core business, but the existing contracts provide for positive cash flow.
Our CableCommerce division originally partnered directly with several cable
operators to create and launch cable-branded electronic malls with leading cable
operators. The concept of Internet malls supported by advertising on cable
television was originally thought to be very promising, but we were unable to
find a cost effective means of attracting merchants to establish storefronts on
such malls and the margins on existing malls were insufficient to absorb the
associated sales and marketing costs. Accordingly, we elected not to pursue this
market or renew our contracts with our cable operator partners and are now no
longer engaged in the cable mall business.
Transaction Processing
We offer solutions that capture and transact customer orders according
to the business rules and specific "back office" needs of the particular client.
Our eCommerce system solution acts as a gateway, so our clients can receive and
process orders and payments, provide order confirmation and reporting and
organize order fulfillment in conjunction with payment processes. We can provide
support for eCommerce transactions using checks, credit cards, electronic funds
transfers, purchase orders and other forms of payment. We currently provide this
capability in conjunction with several third-party vendors.
Sales and Marketing
Because most of our products are sold at the end of our workshop sessions,
a significant investment must be made before any sales are made. Therefore, the
cost of customer acquisition and sell-through percentages are critical
components to the success of our business. We are continuously testing and
implementing changes to our business model which are intended to further reduce
the level of investment necessary to get a customer to attend our events and to
increase our value proposition to that customer, thereby increasing overall
sales.
We advertise our preview sessions in direct mail and e-mail solicitations
targeted to potential customers meeting established demographic criteria. The
direct mail and e-mail pieces are sent several weeks prior to the date of the
preview session. Mailing lists are obtained from list brokers. Announcements of
upcoming preview sessions also appear occasionally in newspaper advertisements
and radio spots in scheduled cities. Finally, we promote our preview and
workshop sessions through other third-party training companies.
We also use outsourced telemarketing programs to sell products and services
to preview and workshop attendees and to our existing client database.
Research and Development
Since June 1999, we have conducted considerable research and development
with respect to our technology, particularly in regard to development of our
StoresOnline product. During the years ended June 30, 2002, and June 30, 2001,
respectively, we invested, on a consolidated basis, approximately $52,000 and
$1,805,000, respectively, in the research and development of our technology.
Product development expenses in fiscal year 2001 related primarily to the
Internet Commerce Center (ICC) and were largely incurred during the first two
fiscal quarters of that year. The reduction in our research and development
costs in fiscal 2002 was also a function of substantial development and release
of the 4.0 version of the StoresOnline software in fiscal year 2001, whereas
development in fiscal year 2002 focused on refinement and enhancement of this
product. Our specific accomplishments during fiscal year 2002 were the addition
of new features to our StoresOnline platform, including the support of
additional credit card processing gateways, a tracking package which allows both
numerical and graphical display of site traffic statistics, new target
market/entry page functions, and an expanded library of design templates. In
general, our research and development efforts during fiscal years 2001 and 2002
have:
o focused on the enhancement and refinement of existing services in
response to rapidly changing client specifications and industry needs
o introduced support for evolving communications methodologies and
protocols, software methodologies and protocols and computer hardware
technologies
o improved functionality, flexibility and ease of use
o enhanced the quality of documentation, training materials and
technical support tools
o developed an internal database that replaced existing incompatible,
standalone systems used in marketing and sales, and that is intended,
with further development, to incorporate storefront production,
customer service and accounting
o completed a new merchant login system providing enhanced security and
management of password access to the Merchant Services section of the
mall,
o reconfigured our computer networks, including hardware and software
upgrades, firewall protection; and
o established a new company-wide data center with redundant power,
bandwidth and servers.
Competition
Our markets are becoming increasingly competitive. Our competitors include
a few companies like ours, that have historically had varying rates of success
and longevity, application service providers, software vendors, systems
integrators and information technology consulting service providers who offer
some or all of the same products as us to the small business and entrepreneur
markets.
Most of these competitors do not yet offer a full range of Internet
professional services. Many are currently offering some of these services or
have announced their intention to do so. These competitors at any time could
elect to focus additional resources in our target markets, which could
materially adversely affect our business, prospects, financial condition and
results of operations. Many of our current and potential competitors have longer
operating histories, larger customer bases, longer relationships with clients
and significantly greater financial, technical, marketing and public relations
resources than we do.
Additionally, should we determine to pursue acquisition opportunities, we
may compete with other companies with similar growth strategies. Some of these
competitors may be larger and have greater financial and other resources than we
do. Competition for these acquisition targets could also result in increased
prices of acquisition targets and a diminished pool of companies available for
acquisition.
There are relatively low barriers to entry into our business. Our
proprietary technology would not preclude or inhibit competitors from entering
our markets. In particular, we anticipate that new entrants will try to develop
competing products and services or new forums for conducting eCommerce that
could be deemed competitors. We believe, however, that we presently have a
competitive advantage due to our proven marketing strategies and the flexibility
we have obtained through enhancements to our StoresOnline software. In 1995,
certain of our principals were instrumental in creating an Internet marketing
workshop industry. We believe that this experience with marketing workshops
gives us an important competitive advantage.
Anticipated and expected technology advances associated with the Internet,
increasing use of the Internet and new software products are welcome
advancements and are expected to attract more interest in the Internet and
broaden its potential as a viable marketplace and industry. We anticipate that
we can continue to compete successfully by relying on our infrastructure and
existing marketing strategies and techniques, systems and procedures, by adding
additional products and services in the future, by periodic revision of our
methods of doing business and by continuing our expansion into international
markets where we believe there is an overall lower level of competition.
Intellectual Property
Our success depends in part upon our proprietary technology and other
intellectual property and on our ability to protect our proprietary technology
and other intellectual property rights. In addition, we must conduct our
operations without infringing on the proprietary rights of third parties. We
also rely upon un-patented trade secrets and the know-how and expertise of our
employees. To protect our proprietary technology and other intellectual
property, we rely primarily on a combination of the protections provided by
applicable copyright, trademark and trade secret laws as well as on
confidentiality procedures and licensing arrangements.
Although we believe that we have taken appropriate steps to protect our
intellectual property rights, including requiring that employees and third
parties who are granted access to our intellectual property enter into
confidentiality agreements, these measures may not be sufficient to protect our
rights against third parties. Others may independently develop or otherwise
acquire un-patented technologies or products similar or superior to ours.
We license from third parties certain software and Internet tools that we
include in our services and products. If any of these licenses were to be
terminated, we could be required to seek licenses for similar software and
Internet tools from other third parties or develop these tools internally. We
may not be able to obtain such licenses or develop such tools in a timely
fashion, on acceptable terms, or at all.
Companies participating in the software and Internet technology industries
are frequently involved in disputes relating to intellectual property. We may in
the future be required to defend our intellectual property rights against
infringement, duplication, discovery and misappropriation by third parties or to
defend against third-party claims of infringement. Likewise, disputes may arise
in the future with respect to ownership of technology developed by employees who
were previously employed by other companies. Any such litigation or disputes
could result in substantial costs to, and a diversion of effort by, us. An
adverse determination could subject us to significant liabilities to third
parties, require us to seek licenses from, or pay royalties to, third parties,
or require us to develop appropriate alternative technology. Some or all of
these licenses may not be available to us on acceptable terms or at all. In
addition, we may be unable to develop alternate technology at an acceptable
price, or at all. Any of these events could have a material adverse effect on
our business, prospects, financial condition and results of operations.
Employees
As of September 28, 2002, we had 89 full-time employees, including 5
executive personnel, 43 in sales and marketing, 4 in the development of our
e-Business solutions, 25 in web site production and customer support and 12 in
general administration and finance. We also use some independent contractors who
speak at our preview and/or workshop training sessions, and others who provide
some programming services.
Governmental Regulation
We are subject to regulations applicable to businesses generally, including
a customer's three-day right, in some states, to rescind the purchase of our
StoresOnline product at one of our Internet workshops. We are also subject to an
increasing number of laws and regulations directly applicable to access to, and
commerce on, the Internet. In addition, due to the increasing popularity and use
of the Internet, it is probable that additional laws and regulations will be
adopted with respect to the Internet in the future, including with respect to
issues such as user privacy, pricing and characteristics and quality of products
and services. The adoption of any such additional laws or regulations may
decrease the growth of the Internet, which could in turn decrease the demand for
our products or services, our cost of doing business or otherwise have an
adverse effect on our business, prospects, financial condition or results of
operations. Moreover, the applicability to the Internet of existing laws
governing issues such as property ownership, libel and personal privacy is
uncertain. Future federal or state legislation or regulation could have a
material adverse effect on our business, prospects, financial condition and
results of operations.
Risk Factors
You should carefully consider the following risks before making an
investment in our Company. In addition, you should keep in mind that the risks
described below are not the only risks that we face. The risks described below
are all the risks that we currently believe are material to our business.
However, additional risks not presently know to us, or risks that we currently
believe are not material, may also impair our business operations. You should
also refer to the other information set forth in this Annual Report on Form
10-K, including the discussions set forth in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business," as
well as our financial statements and the related notes.
Our business, financial condition, or results of operations could be
adversely affected by any of the following risks. If we are adversely affected
by such risks, then the trading of our common stock could decline, and you could
lose all or part of your investment.
We may not maintain profitability at the levels achieved during our
past fiscal year, or achieve profitability in future years.
We achieved profitability for the first time in fiscal 2002. During the
last two quarters of fiscal 2001 and the first two quarters of fiscal 2002, our
profitability was based in large part on the benefit of deferred revenue, which
did not contribute to our cash flow. We do not expect this benefit to reoccur.
Successfully achieving our strategic plan and achieving profitability for future
fiscal years depends on our ability to:
o increase the number of workshops held without experiencing a reduction
in the portion of attendees who purchase our products and services at
the workshops
o successfully develop and sell additional products to our existing
customers
o generate revenues through sales of third party products and services,
and
o continue to identify, attract, retain and motivate qualified
personnel.
Furthermore, the growth of our business depends on factors outside our
control, including:
o adoption by the market of the Internet, and more specifically, our
Internet based solutions
o continued acceptance by our target customers of a "clicks and mortar"
strategy, and
o acceptance of our basic outsourcing business model by our target
customers.
We have had a capital deficit, we have a history of losses and we may
in the future experience losses.
We have incurred substantial losses in the past and may in the future incur
additional losses. At June 30, 2002 and 2001, we had working capital of $289,438
and a working capital deficit of $11,352,351, respectively. Our shareholders
equity was $2,468,574 at June 30, 2002 compared to a capital deficit of
$9,306,829 at June 30, 2001. We generated revenues from continuing operations of
$37,350,850 for the year ended June 30, 2002 and $43,000,533 for the year ended
June 30, 2001. For the year ended June 30, 2002 we realized net income of
$2,198,769 and for the year ended June 30, 2001 we incurred a net loss of
$3,638,736. For the year ended June 30, 2002 and the year ended June 30, 2001,
we recorded negative cash flows from continuing operations of $3,548,931 and
$7,347,123, respectively.
We have historically invested heavily in sales and marketing, technology
infrastructure and research and development and must continue to invest heavily
in sales and marketing in connection with our workshop business. As a result, we
must generate significant revenues to achieve and maintain profitability. If we
are able to increase revenue, then we expect our sales and marketing expenses,
research and development expenses and general and administrative expenses will
increase in absolute dollars and may increase as a percentage of revenues. In
addition, our results for fiscal 2002 were materially affected by a benefit of
deferred revenue, which did not contribute to cash flow, during the first two
fiscal quarters, which benefit we do not expect to reoccur. As a result, we may
not be able to achieve and maintain profitability for a complete fiscal year in
the future.
Our auditor's report on our financial statements includes an
explanatory paragraph with respect to substantial doubt existing about our
ability to continue as a going concern
To date, we have been unable to fund operations from cash generated by our
business and have funded operations primarily by selling our equity and debt
securities. While we have substantially reduced our level of operating expenses,
we continue to consume cash in our operations, and cash resources available to
us are insufficient to fund our operations until we reach positive cash flow. As
a result, our financial statements include a note that indicates that we had
losses from operations and a net capital deficit and that, accordingly, these
matters raise substantial doubt about our ability to continue as a going
concern. Our financial statements do not include any adjustments that might
result from this uncertainty.
We are subject to compliance with securities law, which expose us to
potential liabilities, including potential rescission rights.
We have periodically offered and sold our common stock to investors
pursuant to certain exemptions from the registration requirements of the
Securities Act of 1933, as well as those of various state securities laws. The
basis for relying on such exemptions is factual; that is, the applicability of
such exemptions depends upon our conduct and that of those persons contacting
prospective investors and making the offering. We have not received a legal
opinion to the effect that any of our prior offerings were exempt from
registration under any federal or state law. Instead, we have relied upon the
operative facts as the basis for such exemptions, including information provided
by investors themselves.
If any prior offering did not qualify for such exemption, an investor would
have the right to rescind its purchase of the securities if it so desired. It is
possible that if an investor should seek rescission, such investor would
succeed. A similar situation prevails under state law in those states where the
securities may be offered without registration in reliance on the partial
preemption from the registration or qualification provisions of such state
statutes under the National Securities Markets Improvement Act of 1996. If
investors were successful in seeking rescission, we would face severe financial
demands that could adversely affect our business and operations. Additionally,
if we did not in fact qualify for the exemptions upon which we have relied, we
may become subject to significant fines and penalties imposed by the SEC and
state securities agencies.
In particular, our private placement conducted January-April 2001 to a
group of our then long-time stockholders who were accredited investors occurred
in part while a dormant, i.e., not effective, registration statement was on file
with the SEC with respect to a public offering of our common stock by a third
party deemed by current SEC interpretations to be an offering by us. Although we
believe that these unregistered securities were issued pursuant to an available
exemption under applicable securities laws, we are aware of current
interpretations of securities regulators that are inconsistent with our view. If
our interpretation is proven incorrect then, among other consequences, the
purchasers of such securities would be entitled to exercise rescission rights
with respect to their investment in us. If such rights were exercised by these
investors, we would be liable to them in an amount equal to the total proceeds
of such offering, $2,076,500, plus interest at rates determined by state
statutes from the date of such offering to the date of payment. We believe that,
if such an offer of rescission was made to these investors at this time, it
would not be accepted. If we were required to make such an offer and it was
accepted, then the required payments would exceed our cash resources and would
require us to seek additional financing, most likely in the form of additional
issuances of common stock, to make such payments and would materially and
adversely effect our financial condition.
Our ability to use our net operating loss carryforwards has been
reduced. This could adversely affect our net income and cash flow.
As of June 30, 2002, we had net operating loss carryforwards of
approximately $40 million that expire through 2022, which can be used to reduce
our future U.S. federal income tax liabilities. However, approximately $20
million of these loss carryforwards is subject to the limitation proscribed by
Section 382 of the Internal Revenue Code. In addition, future changes in
ownership of more than 50% may further limit the use of these carryforwards. Our
earnings and cash resources will be materially and adversely affected by this
limitation if future earnings exceed the benefit of the limited net operating
loss carryforwards. A stock ownership change could occur as a result of
circumstances that are not within our control. In addition to the Section 382
limitations, uncertainties exist as to the future utilization of the operating
loss carryforwards under the criteria set forth under FASB Statement No. 109.
Therefore, we have fully reserved the deferred tax asset at June 30, 2002.
We depend on our senior management, and their loss or unavailability
could put us at a serious disadvantage.
We depend on the continued services of our key personnel, including our
president, chief executive officer, chief financial officer, chief technical
officer and vice-president of operations, as well as the speakers at our
previews and workshops and other key personnel. Each of these individuals has
acquired specialized knowledge and skills with respect to our operations. As a
result of the recent changes and financial difficulties we have experienced, we
could face substantial difficulty in retaining and hiring qualified members of
our senior executive staff. Our executive officers have been working at reduced
salaries for approximately 18 months. Historically, companies such as ours have
premised executive compensation on participation in corporate growth and
earnings. However, recent trends have emphasized cash-based compensation, which
we have not historically done. If we were to increase executive compensation,
this could negatively impact our short-term financial performance. However,
failure to address this issue of executive compensation could result in members
of our senior management leaving the Company. The loss of one or more of these
executives could negatively impact our performance. In addition, we expect that
we will need to hire additional personnel in all areas if we are able to
successfully execute our strategic plan, particularly if we are successful in
expanding our operations internationally. Competition for the limited number of
qualified personnel in our industry is intense. At times, we have experienced
difficulties in hiring personnel with the necessary training or experience.
Our cost reduction efforts may adversely impact our productivity and
service levels.
We implemented various cost-control measures affecting all areas of our
business operations during the past year, including reductions in our workforce,
from 121 at June 30, 2001 to 92 at June 30, 2002. These recent workforce
reductions have had an affect on the morale of our employees. Additionally, as
discussed above, the reduction of executive salaries and some employee fringe
benefits may reduce incentives for our employees to remain with us. Continued
cost reduction measures may be necessary to align our expenses with revenues and
improve our overall cash position. These expense reductions may include
additional headcount reductions and there is no assurance that these actions
will not adversely impact our employees' morale and productivity, the
competitiveness of our products and business, and the results of our operations.
We may enter into business combinations or pursue acquisitions of
complementary service or product lines, technologies or business that may
involve financial, integration and transaction completion risks that could
adversely affect our operations.
From time to time, we have evaluated and in the future may evaluate
potential acquisitions of businesses, services, products or technologies. These
acquisitions may result in a potentially dilutive issuance of equity securities,
the incurrence of debt and contingent liabilities, and amortization of expenses
related to intangible assets. In addition, acquisitions involve numerous risks,
including difficulties in the assimilation of the operations, technologies,
services and products of the acquired companies, the diversion of management's
attention from other business concerns, risks of entering markets in which we
have no or limited direct prior experience and the potential loss of key
employees of the acquired company. We have no present commitment or agreement
with respect to any material acquisition of other businesses, services, products
or technologies.
We have experienced difficulty monetizing the customer receivables
generated by our workshop business which may require us to raise additional
working capital.
We offer our customers a choice of payment options at our Internet training
workshops, including an installment payment plan. These installment contracts
are delivered to one of several third parties for servicing and thereafter we
seek to sell these contracts to the servicer and other third parties. We have in
the past experienced difficulties selling these installment contracts at
historical levels. During the first six months of fiscal 2002, there were no
finance companies willing to purchase our contracts, so we carried them
ourselves. In January 2002, we were once again able to sell contracts to a
finance company, but on terms that were less favorable than experienced in the
past. Although we are not currently experiencing difficulties selling our
installment contracts, a recurrence of those conditions would likely require us
to raise additional working capital to allow us to carry these assets on our
balance sheet. All of these installment contract arrangements are subject to
termination at any time by notice to us. The arrangements for the sale of the
installment contracts include a reserve account held by the purchaser of the
contracts as security against defaults by the customer. As a result of financial
difficulties experienced by one of these third party purchasers there is a
substantial risk that this third party may not be able to pay the amount due to
us with respect to the reserve account as it becomes payable. We have therefore
stopped selling receivables to this third party and have reserved against this
item and may have to raise additional working capital to cover such a loss,
should it materialize.
We are dependent on credit card issuers who provide us with merchant
accounts that are used to receive payments from our customers.
For the fiscal year ended June 30, 2002 approximately $15,600,000, or 42%,
of our total revenue was received from customers through credit card payments.
Each financial institution that issues merchant accounts establishes limits on
the amount of payments which may be received through the account and requires
that we keep reserves on deposit with it to protect the financial institution
against losses it may incur with respect to the account. We have in the past
experienced difficulty in maintaining these merchant accounts in good standing
due to changes in the reserve requirements imposed by the issuing banks with
whom we have worked, changes in the transaction amount permitted and rate of
charge-backs. If we were to experience a significant reduction in or loss of
these accounts our business would be severely and negatively impacted.
We are dependent on arrangements that allow us to sell to our customers
the ability to accept credit card payments for products and services sold
on their websites.
During the fiscal year ended June 30, 2002 we derived approximately
$5,100,000, or 14%, of our total revenues, from the sale to our customers of a
product which allows the customer to accept credit card payments for goods and
services sold by them through their website. In the past, we have experienced
difficulty in maintaining the arrangements that allow us to offer this product
to our customers and have experienced difficulty in establishing such a product
for resale at our workshops held outside the United States. In addition, from
time to time, credit card issuing organizations make changes that affect this
product which could negatively impact, or preclude, our offering this product
for sale in the United States in its present form. We presently obtain this
product for resale from Electronic Commerce International, Inc. ("ECI"), the
sole shareholder of which was John J. Poelman, our chief executive officer who,
effective October 1, 2002, sold his interest in ECI to an unrelated third party.
Were we to lose our access to this product or if its cost increases our business
would be severely and negatively impacted and were we not to be able to obtain a
comparable product for resale outside the United States our ability to
successfully execute our international expansion would be compromised.
It is probable that we will require additional capital in order to
sustain our business and execute our growth plan, and such capital may not
be available to us.
Our workshop business model requires significant outlays of money in
advance for directed sales and marketing expenses to obtain each new sale. This
requires us to continue to make significant ongoing expenditures to cover these
customer acquisition costs. Our experience over the past five years validates
this business model and we have generally experienced an immediate positive
financial return on these expenditures under current conditions. If these
conditions change then our operations and financial prospects will be adversely
effected. Our plan to grow our business includes increasing sales to our
existing customers, something with which we have had little success in the past.
Based on these factors and our current strategic plan to increase revenues,
we believe that we will in the future likely need to raise additional capital,
in addition to that already raised in our recent private placements of
unregistered common stock. Our success in raising this capital will depend upon
our ability to access equity capital markets and obtain working capital through
sales of our customer receivables. We may not be able to obtain additional funds
on acceptable terms. If we fail to obtain funds on acceptable terms, we might be
forced to reduce the number of preview and workshop sessions we hold, delay or
abandon some or all of our plans for growth, including the development of
products, the financing of acquisitions, or the pursuit of business
opportunities. If we issue securities for capital, the interests of investors
and shareholders could be diluted.
Our business could be materially and adversely affected as a result of
general economic and market conditions.
We are subject to the effects of general global economic and market
conditions. The U.S. economy is much weaker now than it has been in recent years
and may continue to be weak for the foreseeable future. These economic
conditions may cause businesses to curtail or eliminate spending on eCommerce
services or to reduce demand for our products and services.
Our operations could be hurt by terrorist attacks and other activity
that make air travel difficult or reduce the willingness of our target
customers to attend our group meetings.
We rely on frequent presentations of our preview training sessions and
Internet training workshops by a limited number of persons in various cities and
these persons generally travel by air. In addition, these preview training
sessions and Internet training workshops involve large groups of persons in
upscale and sometimes marquis hotel facilities. Our business would be materially
and adversely affected by air travel becoming less available due to significant
cut backs in the frequency of service or significant increases in processing
times at airports due to security or other factors or by air travel becoming
unavailable due to governmental or other action as was the case during a brief
period during September 2001. In addition, our business would be materially and
adversely affected if our target customers were to become fearful of attending
large public meetings in large hotels.
The market for our products and services is evolving and its growth is
uncertain.
The markets for our products and services are continuing to evolve and are
increasingly competitive. Demand and market acceptance for recently introduced
and proposed new products and services and sales of them through our proposed
international operations are subject to a high level of uncertainty and risk.
Our business may suffer if the market develops in an unexpected manner, develops
more slowly than in the past or becomes saturated with competitors, if any new
products and services do not sustain market acceptance or if our efforts to
expand internationally do not sustain market acceptance.
We may not have the resources to compete with other companies within
our industry.
Although most of our direct competitors have not to date offered a range of
Internet products and services comparable to those offered by us, many have
announced their intention to do so. These competitors at any time could elect to
focus additional resources in our target markets, which could materially and
adversely affect us. Many of our current and potential competitors have longer
operating histories, larger customer bases, longer relationships with clients
and significantly greater financial, technical, marketing and public relations
resources than we do. Competitors that have established relationships with large
companies, but have limited expertise in providing Internet solutions, may
nonetheless be able to successfully use their client relationships to enter our
target market or prevent our penetration into their client accounts. We believe
our competitors may be able to adapt more quickly to new technologies and
customer needs, devote greater resources to the promotion or sale of their
products and services, initiate or withstand substantial price competition, take
advantage of acquisition or other opportunities more readily or develop and
expand their product and service offerings more quickly.
Expansion into international markets and development of
country-specific eCommerce products and services may be difficult or
unprofitable.
In the past fiscal year, we expanded our current operations into selected
international markets and, based on the results of these operations, we plan to
continue to expand our international operations. Our failure to establish
successful operations and sales and marketing efforts in international markets
would likely seriously harm the financial results of our operations.
There are difficulties inherent in doing business in international markets
such as:
o cultural and other differences between the markets with which we
are familiar and these international markets that could result in
lower than anticipated attendance at our preview sessions and
Internet training workshops and/or lower than anticipated sales
o banking and payment mechanisms that differ from those in the
United States and make it more difficult for us to both accept
payments by credit card and offer to customers a product that
allows customers to accept credit card payments on their websites
o unproven markets for our services and products
o unexpected changes in regulatory requirements
o potentially adverse tax environment
o export restrictions and tariffs and other trade barriers
o burdens of complying with applicable foreign laws and exposures
to different legal standards, particularly with respect to
intellectual property, privacy and distribution of potentially
offensive or unlawful content over the Internet, and
o fluctuations in currency exchange rates.
Management beneficially owns approximately 12% of our common stock and
their interests could conflict with other stockholders.
Our current directors and executive officers beneficially own approximately
12% of our outstanding common stock. As a result, the directors and executive
officers collectively may be able to substantially influence all matters
requiring stockholder approval, including the election of directors and approval
of significant corporate transactions. Such concentration of ownership may also
have the effect of delaying or preventing a change in control.
Our future success depends on continued growth in acceptance of the
Internet as a business medium.
In order for us to attain success, the Internet must continue to achieve
widespread acceptance as a business medium. In addition, the businesses and
merchants to whom we market our products and services must be convinced of the
need for an online eCommerce presence and must be willing to rely upon third
parties to develop and manage their eCommerce offerings and marketing efforts.
It remains uncertain whether a significant market for our products and services
will grow or whether our products and services will become generally adopted.
Our business model may not be successful and may need to be changed, and if we
are not successful in responding to the evolution of the Internet and in
tailoring our product and service offerings to respond to this evolution, our
business will be materially and adversely affected.
Evolving regulation of the Internet may harm our business.
As eCcommerce continues to evolve it is subject to increasing regulation by
federal, state, or foreign agencies. Areas subject to regulation include user
privacy, pricing, content, quality of products and services, taxation,
advertising, intellectual property rights, and information security. In
particular, laws and regulations applying to the solicitation, collection, or
processing of personal or consumer information could negatively affect our
activities. The perception of security and privacy concerns, whether or not
valid, may indirectly inhibit market acceptance of our products. In addition,
legislative or regulatory requirements may heighten these concerns if businesses
must notify Web site users that the data captured after visiting Web sites may
be used by marketing entities to unilaterally direct product promotion and
advertising to that user. Moreover, the applicability to the Internet of
existing laws governing issues such as intellectual property ownership and
infringement, copyright, trademark, trade secret, obscenity and libel is
uncertain and developing. Furthermore, any regulation imposing fees or assessing
taxes for Internet use could result in a decline in the use of the Internet and
the viability of e-commerce. Any new legislation or regulation, or the
application or interpretation of existing laws or regulations, may decrease the
growth in the use of the Internet, may impose additional burdens on e-commerce
or may require us to alter how we conduct our business. This could decrease the
demand for our products and services, increase our cost of doing business,
increase the costs of products sold through the Internet or otherwise have a
negative effect on our business, results of operations and financial condition.
Internet security issues pose risks to the development of eCommerce and
our business.
Security and privacy concerns may inhibit the growth of the Internet and
other online services generally, especially as a means of conducting commercial
transactions. Processing eCommerce transactions involves the transmission and
analysis of confidential and proprietary information of the consumer, the
merchant, or both, as well as our own confidential and proprietary information.
Anyone able to circumvent security measures could misappropriate proprietary
information or cause interruptions in our operations, as well as the operations
of the merchant. We may be required to expend significant capital and other
resources to protect against security breaches or to minimize problems caused by
security breaches. To the extent that we experience breaches in the security of
proprietary information which we store and transmit, our reputation could be
damaged and we could be exposed to a risk of loss or litigation and possible
liability.
We depend upon our proprietary intellectual property rights, none of
which can be completely safeguarded against infringement.
We rely upon copyright law, trade secret protection and confidentiality or
license agreements with our employees, customers, business partners and others
to protect our proprietary rights, but we cannot guarantee that the steps we
have taken to protect our proprietary rights will be adequate. We do not have
any patents or significant trademarks, and effective trademark, copyright and
trade secret protection may not be available in every country in which our
products are distributed or made available through the Internet. In addition,
while we attempt to ensure that our licensees maintain the quality of our brand,
these licensees may take actions that could materially and adversely affect the
value of our proprietary rights or the reputation of our products and media
properties.
We may incur substantial expenses in defending against third-party
patent and trademark infringement claims regardless of their merit.
From time to time, parties may assert patent infringement claims against us
in the form of letters, lawsuits and other forms of communications. Third
parties may also assert claims against us alleging infringement of copyrights,
trademark rights, trade secret rights or other proprietary rights or alleging
unfair competition. If there is a determination that we have infringed
third-party proprietary rights, we could incur substantial monetary liability
and be prevented from using the rights in the future.
We are aware of lawsuits filed against certain of our competitors regarding
the presentment of advertisements in response to search requests on "keywords"
that may be trademarks of third parties. It is not clear what, if any, impact an
adverse ruling in these recently filed lawsuits would have on us. Many parties
are actively developing search, indexing, eCommerce and other Web-related
technologies. We believe that these parties will continue to take steps to
protect these technologies, including seeking patent protection. As a result, we
believe that disputes regarding the ownership of these technologies are likely
to arise in the future.
There are low barriers to entry into the eCommerce services market and,
as a result, we face significant competition in a rapidly evolving
industry.
We have no patented, and only a limited amount of other proprietary,
technology that would preclude or inhibit competitors from entering our
business. In addition, the costs to develop and provide eCommerce services are
relatively low. Therefore, we expect that we will continually face additional
competition from new entrants into the market in the future. There is also the
risk that our employees may leave and start competing businesses. The emergence
of these enterprises could have a material adverse effect on us. Existing or
future competitors may better address new developments or react more favorably
to changes within our industry and may develop or offer e-commerce services
providing significant technological, creative, performance, price or other
advantages over the services that we offer.
Our operations, based in Utah, could be hurt by a natural disaster or other
catastrophic event.
Substantially all of our network infrastructure is located in Utah, an area
susceptible to earthquakes. We do not have multiple site capacity if any
catastrophic event occurs and, although we do have a redundant network system,
this system does not guarantee continued reliability if a catastrophic event
occurs. Despite implementation of network security measures, our servers may be
vulnerable to computer viruses, break-ins and similar disruptions from
unauthorized tampering with our computer systems. In addition, if there is a
breach or alleged breach of security or privacy involving our services, or if
any third party undertakes illegal or harmful actions using our community,
communications or eCommerce services, our business and reputation could suffer
substantial adverse publicity and impairment. We do not carry sufficient
business interruption or other insurance at this time to compensate for losses
that may occur as a result of any of these events.
Fluctuations in our operating results may affect our stock price and
ability to raise capital.
Our operating results for any given quarter should not be relied upon as an
indication of future performance. Quarter to quarter comparisons of our results
of operations may not be meaningful as a result of (i) our limited operating
history; (ii) the emerging nature of the markets in which we compete, and (iii)
during the second two fiscal quarters of our fiscal year ended June 30, 2001 and
the first two fiscal quarters of our fiscal year ended June 30, 2002, we enjoyed
a benefit resulting from the recognition of deferred revenue, which benefit we
do not expect to reoccur. In addition, future results may fluctuate, causing our
results of operations to fall below the expectations of investors and
potentially causing the trading price of our common stock to fall, impairing our
ability to raise capital. Our quarterly results may fluctuate due to the
following factors, among others:
o our ability to attract and retain clients
o one time events that negatively impact attendance and sales at
our preview sessions and Internet training workshops
o intense competition
o Internet and online services usage levels and the rate of market
acceptance of these services for transacting commerce
o our ability to timely and effectively upgrade and develop our
systems and infrastructure
o our ability to attract, train and retain skilled management,
strategic, technical and creative professionals
o technical, legal and regulatory difficulties with respect to our
workshop distribution channel and Internet use generally
o the availability of working capital and the amount and timing of
costs relating to our expansion, and
o general economic conditions and economic conditions specific to
Internet technology usage and eCommerce.
Investors will incur immediate and substantial dilution.
Significant additional dilution will result if outstanding options and
warrants are exercised. As of June 30, 2002, we had outstanding stock options to
purchase approximately 313,000 shares of common stock and warrants and
convertible securities to purchase approximately 502,000 shares of common stock.
To the extent that such options, warrants and convertible securities are
exercised, there will be further dilution. In addition, in the event future
financings should be in the form of, be convertible into, or exchangeable for
our equity securities, investors may experience additional dilution.
Some provisions of our certificate of incorporation and bylaws may
deter takeover attempts that may limit the opportunity of our stockholders
to sell their shares at a favorable price.
Some of the provisions of our certificate of incorporation and bylaws could
make it more difficult for a third party to acquire us, even if doing so might
be beneficial to our stockholders by providing them with the opportunity to sell
their shares at a premium to the then market price. Our bylaws contain
provisions regulating the introduction of business at annual stockholders'
meetings by anyone other than the board of directors. These provisions may have
the effect of making it more difficult, delaying, discouraging, preventing or
rendering more costly an acquisition or a change in control of our company.
In addition, our corporate charter provides for a staggered board of
directors divided into two classes. Provided that we have at least four
directors, it will take at least two annual meetings to effectuate a change in
control of the board of directors because a majority of the directors cannot be
elected at a single meeting. This extends the time required to effect a change
in control of the board of directors and may discourage hostile takeover bids.
We currently have three directors.
Further, our certificate of incorporation authorizes the board of directors
to issue up to 5,000,000 shares of preferred stock, which may be issued in one
or more series, the terms of which may be determined at the time of issuance by
the board of directors without further action by stockholders. Such terms may
include voting rights, including the right to vote as a series on particular
matters, preferences as to dividends and liquidation, conversion and redemption
rights and sinking fund provisions. No shares of preferred stock are currently
outstanding and we have no present plans for the issuance of any preferred
stock. However, the issuance of any preferred stock could materially adversely
affect the rights of holders of our common stock, and therefore could reduce its
value. In addition, specific rights granted to future holders of preferred stock
could be used to restrict our ability to merge with, or sell assets to, a third
party. The ability of the board of directors to issue preferred stock could make
it more difficult, delay, discourage, prevent or make it more costly to acquire
or effect a change in control, thereby preserving the current stockholders'
control.
Our stock price and its volatility and our listing may make it more
difficult to resell shares when desired or at attractive prices.
Our common stock now trades on The Nasdaq Over the Counter Bulletin Board.
A proposal has been made to phase out the Over the Counter Bulletin Board and
replace it with the Bulletin Board Exchange. If this proposal is implemented we
will have to apply to become listed on the Bulletin Board Exchange which will
require us to comply with that exchanges listing standards. Although it is
currently our intention to apply to become so listed we currently do not meet
all of the requirements for eligibility and there can be no assurance that even
if we did comply that our application would be accepted.
Some investors view low-priced stocks as unduly speculative and therefore
not appropriate candidates for investment. Many institutional investors have
internal policies prohibiting the purchase or maintenance of positions in
low-priced stocks. This has the effect of limiting the pool of potential
purchasers of our common stock at present price levels. Stockholders may find
greater percentage spreads between bid and asked prices, and more difficulty in
completing transactions and higher transaction costs when buying or selling our
common stock than they would if our stock were listed on the Nasdaq National
Market and if we do not qualify for listing on the Bulletin Board Exchange prior
to the phase out of the Over the Counter Bulletin Board prices for our shares
would be available only through the "pink sheets" and accordingly these spreads
would likely increase and liquidity in the market for our shares decrease. In
addition, the market for our common stock may not be an active market.
Our stock price may fluctuate in response to a number of events and
factors, such as quarterly variations in operating results, announcements of
technological innovations or new products and services by us or our competitors,
changes in financial estimates and recommendations by financial analysts
covering other companies, the operating and stock price performance of other
companies that investors may deem comparable, and news reports relating to
trends in our markets. In addition, the stock market in general, and the market
prices for Internet-related companies in particular, have experienced extreme
volatility that often has been unrelated to the operating performance of such
companies. These broad market and industry fluctuations may adversely affect the
price of our stock, regardless of our operating performance.
Future sales of common stock by our existing stockholders and by
holders of warrants and stock options granted by us could adversely affect
our stock price.
The market price of our common stock could decline as a result of sales of
a large number of shares of our common stock in the market or the perception
that these sales could occur, including as a result of our contractual
obligation to register for public resale certain of our outstanding shares.
These sales also might make it more difficult for us to sell equity securities
in the future at a time and at a price that we deem appropriate. As of October
8, 2002, we had outstanding 11,000,774 shares of common stock, of which
approximately 2,285,759 were freely tradable. Approximately 815,000 shares were
reserved for issuance pursuant to exercise of warrants and options. Shares
issued upon the exercise of stock options granted under our stock option plans
will be eligible for resale in the public market from time to time subject to
vesting and, in the case of some options, the expiration of the lock-up
agreements.
Item 2. Properties.
In October 2000, we completed the consolidation of our then existing
operations in southern California with those acquired through our merger with
Galaxy Enterprises by moving our headquarters from Long Beach, California to
Orem, Utah. Restructuring charges were approximately $275,000, which consisted
of severance packages, relocation expenses and equipment moving costs.
Our principal office is located at 754 East Technology Avenue, Orem, Utah
84097. The property consists of approximately 12,500 square feet leased from an
unaffiliated third party with a period of three years remaining on the lease
with an annual rental of $263,676. We maintain tenant fire and casualty
insurance on our properties located in these buildings in an amount that we deem
adequate. We also rent on a daily basis hotel conference rooms and facilities
from time to time in various cities throughout the United States, Canada and
other countries throughout the world at which we host our preview sessions and
Internet training workshops. We are under no long-term obligations to such
hotels.
Item 3. Legal Proceedings.
Other than as indicated below, we are not a party to any material legal
proceedings.
From time to time, we receive inquiries from attorney general offices and
other regulators about civil and criminal compliance matters with various city,
county, state and federal regulations. These inquiries sometimes rise to the
level of threatened or actual investigations and litigation. In the past, we
have received letters of inquiry from and/or have been made aware of
investigations by government officials in the states of Hawaii, Illinois,
Kentucky, Nebraska, North Carolina, Vermont, Utah, Texas, California and others,
as well as from a regional office of the Federal Trade Commission. We have
responded to these inquiries and have generally been successful in addressing
the concerns of these persons and entities, although there is often no formal
closing of the inquiry or investigation. There can be no assurance that these or
other inquiries and investigations will not have a material adverse effect on
business or operations. We also receive complaints and inquiries in the ordinary
course of our business from both customers and governmental and non-governmental
bodies on behalf of customers. To date we have been able to resolve these
matters on a mutually satisfactory basis.
Effective January 10, 2001, we entered into severance agreements with each
of Keith Freadhoff and Donald Corliss, former officers and directors of our
company. In consideration for the following, Messrs. Freadhoff and Corliss
agreed to release us from the provisions of their respective employment
agreements: engagement as a consultant and payment of consulting fees,
reimbursement of business expenses, continuation of health insurance benefits
for six months, the granting of a license to the code base of the ICC, an
interest in a server and a grant of options to purchase our common stock
proportionate to any options granted to Donald Danks. On August 30, 2001, Mr.
Freadhoff and Mr. Corliss issued a demand letter to us, claiming that the
payments stipulated in the severance agreements had not been made and purporting
to reassert their rights under their respective employment agreements. These
demands were subsequently resolved and withdrawn.
David Bassett-Parkins our former chief financial officer and chief
operating officer, and Hahn Ngo, our former executive vice president operations,
each delivered notice of intent to terminate their respective employment
agreements for "good reason," as that term is defined in his or her employment
agreement. Each of them has claimed that, under his or her employment agreement,
he or she was entitled to a lump sum severance payment as a result of
terminating his or her employment for "good reason." We entered into
negotiations with Mr. Bassett-Parkins and Ms. Ngo regarding their claims and
other matters and now believe, due to their failure to pursue their claims or
further negotiations concerning such claims, that the parties have abandoned
their claims, though no agreement was entered into or payments made by us to
these parties.
On October 23, 2001, we signed an Agreement and Plan of Merger with
Category 5 Technologies, Inc. ("C5T"), pursuant to which, subject to stockholder
approval, we would be acquired through a merger of a subsidiary of C5T into us.
On January 15, 2002, we and C5T issued a joint press release to announce
execution on January 14, 2002 of a Termination and Release Agreement to
terminate the Agreement and Plan of Merger and to abandon the merger
contemplated by such agreement. Pursuant to and upon the terms and conditions
contained in the Termination and Release Agreement, we agreed to pay a
reimbursement fee of $260,630 in various monthly installments of at least
$20,000 to C5T in connection with the termination of the merger. We did not pay
our first monthly installment under the Termination and Release Agreement due on
February 1, 2002. On February 8, 2002, we received notice from C5T that we were
in default under the Termination and Release Agreement, and on February 12,
2002, we received an acceleration notice whereby C5T demanded payment of the
entire reimbursement fee plus interest by February 18, 2002. The February 18,
2002 payment was not made. On April 8, 2002 C5T caused us to be served with a
Summons and Complaint in the Third Judicial District Court in and for Salt Lake
County, State of Utah, Case No. 020902991, whereby C5T seeks judgment against us
for breach of the Agreement and damages for the full amount of the Expense
Reimbursement Fee. On April 11, 2002 we entered into a Waiver Agreement with C5T
whereby payments due under the Termination Agreement are postponed for one year.
Under the Waiver Agreement, the first payment will be due on February 1, 2003.
The lawsuit has not, however, been withdrawn and we have been given an extension
of time to respond. We do not believe we are obligated to pay the Expense
Reimbursement Fee; however, we are continuing to evaluate this situation and are
working to resolve it. Due to the uncertainty of the outcome, the entire
$260,630 fee has been accrued by us and is carried as a current liability.
Item 4. Submission of Matters to a Vote of Security Holders.
On June 28, 2002, a special meeting of our stockholders was held to
consider two amendments to our Certificate of Incorporation: (i) to effect a
one-for-ten reverse split of the issued and outstanding shares of our common
stock and reduce the authorized number of shares of common stock from
250,000,000 to 100,000,000; and (ii) to change our name to "Imergent, Inc."
107,772,045 shares of our common stock were entitled to vote at the meeting, and
of this amount, 63,424,333 shares were present in person or were represented by
proxy at the special meeting. The first proposed amendment was approved, and the
following votes were cast in respect of this proposal: for: 62,457,425; against:
505,198; abstain: 461,710. The second proposed amendment was also approved, and
the following votes were cast in respect of this proposal: for: 63,248,098;
against: 110,801; abstain: 65,434.
The amendments to our Certificate of Incorporation became effective on July
2, 2002. As a result of the reverse stock split, every ten shares of our
existing common stock were converted into one share of our new common stock
under our new name, Imergent, Inc. Fractional shares resulting from the reverse
stock split were settled by cash payment. These amendments have been
retroactively reflected in this Annual Report on Form 10-K.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
Market Information
Our common stock has traded on the Nasdaq OTC Bulletin Board since July 3,
2002 under the symbol "IMGG." From January 10, 2001 to July 2, 2002, our common
stock traded on the OTC Bulletin Board under the symbol "NGWY." Between November
18, 1999 and January 9, 2001, our common stock traded on The Nasdaq National
Market under the symbol "NGWY." The following table sets forth the range of high
and low bid prices as reported on The Nasdaq National Market or the Nasdaq OTC
Bulletin Board, as applicable, for the periods indicated, all of which preceded
our reverse split.
High Low
Fiscal 2002
First Quarter........................................... $7.20 $2.60
Second Quarter.......................................... 5.50 2.70
Third Quarter........................................... 3.70 0.90
Fourth Quarter.......................................... 1.80 0.85
Fiscal 2001
First Quarter............................................. 24.40 7.80
Second Quarter............................................ 10.00 1.60
Third Quarter............................................. 6.90 1.60
Fourth Quarter............................................ 7.50 2.80
These bid prices indicate the prices that a market maker is willing to pay.
These quotations do not include retail markups, markdowns or other fees and
commissions and may not represent actual transactions.
Security Holders
There were approximately 720 holders of record of our shares of common
stock as of September 30, 2002
Dividends
We have never paid any cash dividends on our common stock and we anticipate
that we will retain future earnings, if any, to finance the growth and
development of our business. Therefor, we do not anticipate paying any cash
dividends on our shares for the foreseeable future.
Equity Compensation Plan Information
The following table and note provide information about shares of our common
stock that were issuable as of June 30, 2002 (prior to the effective date of our
reverse stock split) pursuant to exercise of options under all of our existing
equity compensation plans.
- --------------------------------------------- ------------------------- ----------------------- ----------------------
Number of securities
remaining available
for future issuance
Number of securities Weighted-average under equity
to be issued upon exercise price compensation plans
Plan Category exercise of outstanding of outstanding (excluding securities
options options reflected in column
(a))
- --------------------------------------------- ------------------------- ----------------------- ----------------------
(a) (b) (c)
- --------------------------------------------- ------------------------- ----------------------- ----------------------
Equity compensation plans approved 128,125 (1) $28.40 370,625
by security holders 8,432 (2) $33.20 65,613
106,001 (3) $33.50 385,530
- --------------------------------------------- ------------------------- ----------------------- ----------------------
Equity compensation plans not approved 70,707 (4) $15.60 -
by security holders
- --------------------------------------------- ------------------------- ----------------------- ----------------------
Total 313,265 $23.30 821,768
- --------------------------------------------- ------------------------- ----------------------- ----------------------
- --------------------
(1) To be issued under our 1998 Stock Option Plan for Senior Executives.
This plan provided for the grant of options to purchase up to 5,000,000
shares of common stock (500,000 shares after giving effect to the one
for ten reverse split) to our senior executives. Options may be either
incentive stock options or non-qualified stock options under Federal
tax laws.
(2) To be issued under our 1998 Stock Compensation Program. This program
provided for the grant of options to purchase up to 1,000,000 shares of
common stock (100,000 shares after giving effect to the one for ten
reverse split) to officers, employees, directors and independent
contractors and agents. Options may be either incentive stock options
or non-qualified stock options under Federal tax laws.
(3) To be issued under our 1999 Stock Option Plan for Non-Executives. The
number of shares of stock available for grant under this plan was set
at 5,000,000 (500,000 shares after giving effect to the one for ten
reverse split). Options granted under this plan generally become
exercisable in increments over a period of up to three years.
(4) To be issued under the 1997 Employee Stock Option Plan of Galaxy
Enterprises, Inc. This plan was assumed by us pursuant to the terms of
our merger with Galaxy Enterprises in June 2000.
Recent Sales of Unregistered Securities
During the quarter ended June 30, 2002, we sold by way of the private
placement commenced in the third quarter of fiscal 2002, a total of 6,092,868
(post-reverse split) additional shares of our common stock for aggregate
additional consideration of $2,437,147. Commissions of $107,857 were paid in
connection with these sales. In our opinion, the offer and sale of these shares
were exempt by virtue of Section 4(2) of the Securities Act and the rules
promulgated thereunder.
On June 12, 2002, we issued 112,500 (post-reverse split) shares of common
stock to SBI and its designees for services in connection with our private
placement that closed in May 2002. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Related Party Transactions." In
our opinion, the offer and sale of these shares were exempt by virtue of Section
4(2) of the Securities Act and the rules promulgated thereunder.
On June 20, 2002 we issued 20,000 (post-reverse split) shares of common
stock to Howard Effron for services rendered to us as a financial advisor. In
our opinion, the offer and sale of these shares were exempt by virtue of Section
4(2) of the Securities Act and the rules promulgated thereunder.
Item 6. Selected Financial Data
The following selected restated consolidated financial data should be read
in conjunction with our consolidated financial statements and related notes
thereto and Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and reflect the acquisitions of Infobahn
Technologies, LLC (d/b/a Digital Genesis) completed on June 2, 1998, Spartan
Multimedia, Ltd. completed on January 15, 1999 and Galaxy Enterprises, Inc.
completed on June 26, 2000. The acquisition of Galaxy Enterprises, Inc. was
accounted for as a pooling-of-interests. Accordingly, all periods prior to the
acquisition have been restated. The consolidated statement of operations data
for each of the years in the three-year period ended June 30, 2002, and the
consolidated balance sheet data at June 30, 2002 and 2001 are derived from our
consolidated financial statements and are included elsewhere in this document.
Prior to the combination, Galaxy Enterprises' fiscal years ended on December 31.
In recording the pooling-of-interests, Galaxy Enterprises' financial statements
for the years ended December 31, 2000 and 1999 have been restated to conform to
our fiscal years ended June 30, 2000 and 1999. The restatement of Galaxy
Enterprises' results include a duplication of operations for the period from
July 1, 1998 to December 31, 1998. As a result, we have eliminated the related
income of $1,733,441 from accumulated deficit for fiscal 1999, which includes
$3.7 million in revenue, and Galaxy Enterprises' financial statements for the
year ended December 31, 1998 have been combined with our financial statements
for the period from March 4, 1998 (inception) through June 30, 1998. Historical
results are not necessarily indicative of the results to be expected in the
future.
Year Ended
-----------------------------------------------------------------------
June 30, June 30, June 30, June 30, June 30,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Consolidated Statement of Operations Data: (in thousands except per share amounts)
Revenue $ 37,351 $ 43,001 $ 22,150 $ 10,280 $ 7,268
Income (loss) from continuing operations 2,199 (4,315) (42,790) (16,797) (8,521)
Income (loss) from discontinued operations --- (286) (1,319) 3 -
Extraordinary items --- 962 - 1,653 -
Net income (loss) 2,199 (3,639) (44,109) (15,141) (8,521)
Basic and diluted (loss) income per share:
Income (loss) from continuing operations 0.37 (1.94) (23.12) (13.40) (9.70)
Loss from discontinued operations --- (0.12) (0.71) - -
Extraordinary items --- 0.43 - 1.32 -
Net income (loss) per common share 0.37 (1.63) (23.83) (12.08) (9.70)
Weighted average common shares outstanding
Basic 5,874 2,228 1,851 1,254 879
Diluted 5,878 2,228 1,851 1,254 879
Consolidated Balance Sheet Data: As of June 30
-----------------------------------------------------------------------
2002 2001 2000 1999 1998
Cash 520 $ 149 $ 2,607 $ 968 $ 279
Working capital (deficit) 289 (11,352) (14,845) (9,292) (8,733)
Total assets 7,377 6,055 11,851 5,353 2,041
Short-term debt 242 3,759 409 1,535 2,152
Long-term debt 421 442 - - 383
Stockholders' equity (capital deficit) 2,469 (9,307) (10,776) (8,106) (7,692)
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This management's discussion and analysis of financial condition and
results of operations and other portions of this report contain forward-looking
information that involves risks and uncertainties. Our actual results could
differ materially from those anticipated by this forward-looking information.
Factors that may cause such differences include, but are not limited to, those
discussed under the heading "Risk Factors" and elsewhere in this report. This
management's discussion and analysis of financial condition and results of
operations should be read in conjunction with the financial statements and the
related notes included elsewhere in this report.
General
During the fiscal year ended June 30, 2000 and the first six months of
fiscal year 2001 we incurred large losses and our liquidity was severely
strained. It was not possible to continue operations without significant
changes. In January 2001, we implemented a restructuring process intended to
allow us to begin to operate on a cash flow positive basis. The Internet
Commerce Center (ICC) division and the CableCommerce division were reduced to a
maintenance staff supporting existing customers, and all other employees were
laid off. Our wholly-owned subsidiary, IMI, Inc., also sometimes referred to as
Impact Media, was sold. We entered into an agreement with a third party to
negotiate compromise payment schedules with non-essential vendors for less than
the full amount owed. In addition, key management employees agreed to
voluntarily reduce their salaries.
This restructuring allowed us to focus our attention and resources on our
core Galaxy Mall business which was subsequently rebranded as StoresOnline.
During the subsequent 18 months, approximately $7.2 million was raised through
private placements of convertible notes and common stock the proceeds of which
were used to provide working capital for the business, to partially repay our
long term debt and pay our past due accounts payable. The following discussion
of the results of operations further expands on the effects of these changes.
Reverse Stock Split
On June 28, 2002, our stockholders approved amendments to our Certificate
of Incorporation to change our corporate name to "Imergent, Inc." and to effect
a one-for-ten reverse split of the issued and outstanding shares of our common
stock and reduce the authorized number of shares of common stock from
250,000,000 to 100,000,000. These changes were effected July 2, 2002. As a
result of the reverse stock split, every ten shares of our existing common stock
was converted into one share of our new common stock under our new name,
Imergent, Inc. Fractional shares resulting from the reverse stock split were
settled by cash payment. Throughout this discussion references to numbers of
shares and prices of shares have been adjusted to reflect the reverse stock
split.
Review by the Securities and Exchange Commission
On March 6, 2002, the Securities and Exchange Commission ("SEC") notified
us that they reviewed our annual report filed on Form 10-K for the fiscal year
ended June 30, 2001 and our quarterly report on Form 10-Q for the quarter ended
September 30, 2001. They sent us their letter of comment pointing out areas of
concern and requesting that we answer their questions and provide additional
information. During the ensuing six months, we exchanged correspondence with
members of the SEC staff and provided them with additional information. On
September 24, 2002 in a telephone conference call with the SEC staff, we
resolved certain of the more material issues; however we must still respond to
other comments from staff in their letter dated August 5, 2002. We believe that
these remaining comments will be satisfactorily resolved.
Fluctuations in Quarterly Results and Seasonality
In view of the rapidly evolving nature of our business and our limited
operating history, we believe that period-to-period comparisons of our operating
results, including our gross profit and operating expenses as a percentage of
net sales, are not necessarily meaningful and should not be relied upon as an
indication of future performance.
While we cannot say with certainty the degree to which we experience
seasonality in our business because of our limited operating history, our
experience to date indicates that we experience lower sales from our core
business during our first and second fiscal quarters. We believe this to be
attributable to summer vacations and the Thanksgiving and December holiday
seasons.
Merger of Imergent, Inc. and Galaxy Enterprises, Inc.
On June 26, 2000, we completed the merger of Galaxy Enterprises, Inc. into
one of our wholly owned subsidiaries. The merger was accounted for as a
pooling-of-interests. Accordingly, our historical consolidated financial
statements and the discussion and analysis of financial condition and results of
operations for the prior periods have been restated to include the operations of
Galaxy Enterprises, Inc. as if it had been combined with our Company at the
beginning of the first period presented.
The financial statements for the years ended June 30, 2001 and 2000 have
been reclassified to conform to fiscal year 2002 presentation, including
disclosures for discontinued operations.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
form the basis for the following discussion and analysis on critical accounting
policies and estimates. The preparation of these financial statements requires
us to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On a regular basis we evaluate our estimates and assumptions.
We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
A summary of our significant accounting policies is set out in Note 1 to
our Financial Statements. We believe the critical accounting policies described
below reflect our more significant estimates and assumptions used in the
preparation of our consolidated financial statements. The impact and any
associated risks on our business that are related to these policies are also
discussed throughout this Management's Discussion and Analysis of Financial
Condition and Results of Operations where such policies affect reported and
expected financial results.
Revenue Recognition
During the year ended June 30, 2001 the Company changed its product
offering at its Internet training workshops. The date of the change was October
1, 2000, the beginning of our second fiscal quarter of fiscal year 2001. Prior
to that time, customers were sold a service consisting of the construction of
Internet websites for their business, which service was to be provided at any
time during the 12 months following the sale. Included in the price paid for
this service was one year's hosting beginning when the website was published.
Revenue from these transactions was deferred at the time of sale and recognized
as the services were rendered or when the right to receive the services
terminated.
Beginning October 1, 2000, we discontinued selling the service and in its
place sold a new product called the StoresOnline Software ("SOS"). The SOS is a
software product that enables the customer to develop their Internet website
without additional assistance from us. When a customer purchases a SOS at one of
our Internet workshops, he or she receives a CD-ROM containing programs to be
used with their computer and a password and instructions that allow access to
our website where all the necessary tools are present to complete the
construction of the customer's website. When completed, the website can be
hosted with us or any other provider of such services. If they choose us there
is an additional setup and hosting fee (currently $150) for publishing and 12
months of hosting. This fee is deferred at the time of sale and recognized
during the subsequent 12 months.
The revenue from the sale of the SOS is recognized when the product is
delivered to the customer. We accept cash and credit cards as methods of payment
and we offer 24-month installment contracts to customers who prefer an extended
payment term arrangement. We offer these contracts to all workshop attendees not
wishing to use a check or credit card provided they complete a credit
application, give us permission to independently check their credit and are
willing to make an appropriate down payment. Installment contracts are carried
on our books as a receivable and the revenue generated by these installment
contracts is recognized when the product is delivered to the customer and the
contract is signed. This new revenue recognition policy was in effect for the
last three quarters of fiscal year 2001 and for all of fiscal year 2002.
SOP 97-2 states that revenue from the sale of software should be recognized
when the following four specific criteria are met: 1) persuasive evidence of an
arrangement exists, 2) delivery has occurred, 3) the fee is fixed and
determinable and 4) collectibility is probable. All of these criteria are met
when a customer purchases the SOS product. The customer signs one of our order
forms and a receipt acknowledging a sale and receipt and acceptance of the
product. As is noted on the order and acceptance forms, all sales are final. All
fees are fixed and final. Some states require a three-day right to rescind the
transaction. Sales in these states are not recognized until the rescission
period has expired. We offer customers the option to pay for the SOS with
Extended Payment Term Arrangements (EPTAs). The EPTAs generally have a
twenty-four month term. We have a standard of using long-term or installment
contracts and have a four-year history of successfully collecting under the
original payment terms without making concessions. Over the past four years, we
have collected or are collecting approximately 70% to 80% of all EPTAs issued to
customers. Not all customers live up to their obligations under the contracts.
We make every effort to collect on the EPTAs, including the engagement of
professional collection services. Despite our efforts, approximately 20 percent
of all EPTAs are determined to be uncollectible. All uncollectible EPTAs are
written off against an allowance for doubtful accounts, which allowance is
established at the time of sale based on our four-year history of extending
EPTAs. As a result, revenue from the sale of the SOS is recognized upon the
delivery of the product.
Allowance for Doubtful Accounts
We record an allowance for doubtful accounts and disclose the associated
expense as a separate line item in operating expenses. The allowance, which is
netted against our current and long term accounts receivable balances on our
consolidated balance sheets, totaled approximately $3.3 million and $3.7 million
as of June 30, 2002 and June 30, 2001, respectively. The amounts represent
estimated losses resulting from the inability of our customers to make required
payments. The estimates are based on historical bad debt write-offs, specific
identification of probable bad debts based on collection efforts, aging of
accounts receivable and other known factors. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required.
Income Taxes
In preparing our consolidated financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate. This
process involves estimating actual current tax liabilities together with
assessing temporary differences resulting from differing treatment of items for
tax and accounting purposes. These differences result in deferred tax assets and
liabilities which are included within the consolidated balance sheet, as
applicable. Our deferred tax assets consist primarily of net operating losses
carried forward. We then assess the likelihood that deferred tax assets will be
recovered from future taxable income, and, to the extent that we believe that
recovery is not more likely than not, we establish a valuation allowance. We
have provided a valuation allowance against all of our net deferred tax assets
at June 30, 2002 and 2001. To the extent we establish a valuation allowance
against our deferred tax assets or change this valuation allowance in a period,
we reflect the impact in the tax provision for (benefit from) income taxes in
the consolidated statements of operations.
Related Party Transactions
During the fiscal year ended June 30, 2002 we derived approximately
$5,100,000, or 14%, of our total revenues, from the sale to our customers of a
product which allows the customer to accept credit card payments for goods and
services sold by them through their website. In the past, we have experienced
difficulty in maintaining the arrangements that allow us to offer this product
to our customers and have experienced difficulty in establishing such a product
for resale at our workshops held outside the United States. In addition, from
time to time, credit card issuing organizations make changes that affect this
product which could negatively impact, or preclude, our offering this product
for sale in the United States in its present form. We presently obtain this
product for resale from Electronic Commerce International, Inc. ("ECI"), the
sole shareholder of which was John J. Poelman, our chief executive officer and
one of our directors and stockholders, who, effective October 1, 2002, sold his
interest in ECI to an unrelated third party. Were we to lose our access to this
product or if its cost increases our business would be severely and negatively
impacted and were we not to be able to obtain a comparable product for resale
outside the United States our ability to successfully execute our international
expansion would be compromised.
Total revenue generated by us from the sale of ECI merchant account
solutions was $5,106,494, $6,403,478 and $2,412,800 for the years ended June 30,
2002, 2001 and 2000, respectively. The cost to us for these products and
services totaled $994,043, $975,257 and $1,110,404 for the years ended June 30,
2002, 2001 and 2000, respectively. During the years ended June 30, 2002, 2001
and 2000, we processed leasing transactions for customers through ECI in the
amounts of $1,090,520, $3,386,231, and $2,450,292, respectively. As of June 30,
2002 and 2001, we had a receivable from ECI for leases in process of $0 and
$90,109, respectively. In addition, we have $26,702 and $516,858 recorded in
accounts payable as of June 30, 2002 and 2001, respectively, relating to the
amounts owed to ECI for the purchase of its merchant account product.
We offer our customers at our Internet training workshops, and through
backend telemarketing sales, certain products intended to assist the customer in
being successful with their business. These products include live chat and web
traffic building services. We utilize Electronic Marketing Services, LLC.
("EMS") to fulfill these services to our customers. In addition, EMS provides
telemarketing services, selling some of our products and services to those who
do not purchase at our workshops and to other leads. Ryan Poelman, who owns EMS,
is the son of John J. Poelman, Chief Executive Officer, a director and a
stockholder of the Company. Our revenues realized from the above products and
services were $4,806,497, $1,263,793 and $0 for the years ended June 30, 2002,
2001 and 2000, respectively. We paid EMS $479,984, $78,435, and $0 to fulfill
these services during the years ended June 30, 2002, 2001 and 2000,
respectively.
We engaged vFinance Investments, Inc. ("vFinance") as a financial advisor
and placement agent for our private placement of unregistered securities that
closed during May 2002. Shelly Singhal a former member of the Company's Board of
Directors was a principal of vFinance at the time of the private placement.
During the year ended June 30, 2002 the company paid vFinance $61,500 in fees
and commissions for their services. The offering was successful with adjusted
gross proceeds to the Company of $2,185,995.
We engaged SBI-E2 Capital USA Ltd. ("SBI") as a financial consultant to
provide us with various financial services. Shelly Singhal a former member of
the Company's Board of Directors is a managing director of SBI. During the year
ended June 30, 2002 SBI provided us with a Fairness Opinion relating to our
proposed merger with Category 5 Technologies, for which we paid $67,437, and
additional $85,000 is still payable to SBI for that opinion as of June 30, 2002.
We also paid SBI $58,679 for expenses and commissions relating to our
private placement of unregistered securities that closed during November 2001.
The offering was successful with adjusted gross proceeds to us of $2,803,466.
Pursuant to an agreement dated February 15, 2002, SBI also rendered certain
financial advisory services to us in connection with our private placement that
closed in May 2002, including delivery of a fairness opinion with respect to
such private placement. Pursuant to this agreement, we paid SBI a total of
$40,000 and issued to SBI and various of its designees an aggregate of 112,500
shares of our common stock.
During the 12 months ended June 30, 2001, we issued 12,500 warrants to
Shelly Singhal for non-director services rendered. The warrants were valued at
$40,657.
In each of the above-described transactions and business relationships, we
believe that the terms under which business is transacted with all related
parties are at least as favorable to us as would be available from an
independent third party providing the same goods or services.
Results of Operations
Years Ended June 30, 2002 and 2001
Revenue
Revenues for the year ended June 30, 2002 decreased to $37,350,850 from
$43,000,533 in the prior fiscal year, a decrease of 13%. Some revenues generated
at our Internet training workshops for fiscal year 2001 were from the design and
development of Internet web sites and the sale of the SOS product as described
above, while in fiscal year 2002 revenues from the same source were from the SOS
product only. Other revenues include fees charged to attend the workshop, web
traffic building products, mentoring, consulting services, access to credit card
transaction processing interfaces and sales of banner advertising. We expect
future operating revenue to be generated principally following a business model
similar to the one used in fiscal year 2002. The Internet environment continues
to evolve, and we intend to offer future customers new products as they are
developed. We anticipate that our offering of products and services will evolve
as some products are dropped and are replaced by new and sometimes innovative
products intended to assist our customers achieve success with their
Internet-related businesses.
Formerly we reported product sales that came from our subsidiary, IMI, Inc.
On January 11, 2001, we sold IMI. Accordingly, IMI operations from this and
prior periods are now reported as discontinued operations in the accompanying
consolidated statement of operations.
The decrease in revenues from fiscal 2001 to 2002 can be attributed to
various factors some of which increased revenues while others caused the
decline. There was a decrease in the number of Internet training workshops
conducted during the years. The number decreased to 258 workshops for the
current fiscal year from 337 in the fiscal year ended June 30, 2001, however the
average number of persons attending each workshop increased which partially
offset the total reduction of attendees during the year. This, in addition to an
increase in the sales price of the product, had a net effect of decreasing
revenues by approximately $1,450,000. Due to our lack of cash and because of
unfavorable economic conditions during the first two quarters of fiscal 2002 it
was necessary to reduce the number of workshops held and use our limited
resources to attract the maximum number of attendees to these fewer workshops.
We will seek to continue to hold workshops with a larger number of attendees in
future years. We will seek to increase the number of these larger workshops
during fiscal year 2003. During October and November 2001, we conducted
workshops on a test basis in New Zealand and Australia for the first time. The
workshops were moderately successful and we returned to these markets to conduct
additional workshops during the forth quarter of fiscal 2002. Revenues from
international workshops in fiscal year 2002 were $663,790.
Approximately 35% percent of primary workshop attendees (not including
their guests) made purchases at our workshops during fiscal year 2002. This
percentage remained approximately the same as has been our experience
historically.
The principal cause of the reduction in revenue during the fiscal year
ended June 30, 2002 was the loss of a benefit, beginning during the third
quarter of fiscal 2002, of the recognition of revenue deferred from historical
workshop sales at rates greater than the level at which revenue was required to
be deferred from current period. This benefit resulted from a change in the
business model and product offering at these workshops as noted above. This
benefit has now been fully realized and we do not expect it to reoccur. We
anticipate that in future years the amount of revenue recognized from earlier
periods will be approximately equal to that deferred into future periods. If we
should enjoy a rapid growth rate, it is possible that during any one quarter the
amount of revenue deferred into future periods will exceed that recognized
during the same quarter from sales in prior periods.
During the year ended June 30, 2002, we recognized $5,789,410 in revenue
from sales made in prior fiscal years and we deferred revenue from fiscal year
2002 of $461,376 to future years. The net change increased revenues for fiscal
year 2002 by $5,328,034. The beneficial deferred revenue impact on fiscal year
2002 occurred only during the first two quarters. Thereafter the amount of
revenue recognized from earlier quarters was approximately equal to that
deferred into future periods.
During the year ended June 30, 2001, we recognized $14,534,542 in revenue
from sales made in prior fiscal years and we deferred revenue from fiscal year
2001 of $5,073,856 to future years. The net change increased revenues for fiscal
year 2001 by $9,460,686.
Effective January 1, 2002, we began making our product offerings through
our StoresOnline subsidiary rather than our Galaxy Mall subsidiary. This
culminated an eighteen month long plan to fully incorporate the SOS throughout
the engineering and programming departments, servers and infrastructure and to
move away from a mall-based hosting environment. Our services have been used for
several years by non-mall based merchants, and we believe that principles taught
by us work equally well for standalone websites, as they do with sites hosted on
the mall. Although Galaxy Mall remains an active website, all new customers are
sold the SOS through our StoresOnline previews and workshops.
Effective January 1, 2002, the payment options available to customers at
our Internet Training Workshops were changed to eliminate the lease finance
option. Although approximately 25% of our customers chose the lease finance
option during calendar year 2001, we do not believe that the elimination of this
option will materially adversely affect the number of customers who purchase at
our workshops because we will continue to offer an installment contract payment
alternative. Total sales that were financed by our customers either through
leases or installment contracts were $11,984,881 in fiscal year 2002 and
$17,386,728 in fiscal year 2001.
Gross Profit
Gross profit is calculated as revenue less the cost of revenue, which
consists of the cost to conduct Internet training workshops, to program customer
storefronts, to provide customer technical support and the cost of tangible
products sold. Gross profit for the fiscal year ended June 30, 2002 decreased to
$30,825,050 from $34,574,958 in the prior year. The decrease in gross profit
primarily reflects the decreased sales volume related to the decrease in the
number of Internet training workshops and the reduced level of benefit from the
recognition of deferred revenue at rates in excess of the rates at which revenue
is deferred from the current period sales to future periods as noted below.
Gross profit percentages, however, increased for the fiscal year ended June
30, 2002 to 83% of revenue from 80% of revenue for the fiscal year ended June
30, 2001. The increase in gross profit as a percentage of revenue is due to
several factors: the new product sold at the workshop, the SOS, transferred much
of the cost of website construction from us to the customer, thus lowering the
cost of revenue from this type of sale; new programming tools and stringent cost
controls increased the productivity of the support group our customers use; our
cost for the online, real time credit card processing product delivered to
workshop customers decreased; hosting revenues increased with minimal
incremental cost being added to accommodate the new customers; and the cost of
conducting our Internet training workshops remaining relatively constant per
workshop, while the average number of attendees at each workshop and the selling
price of the products delivered at the workshops both increased.
We anticipate that gross profit as a percentage of revenue will decline in
fiscal year 2003 from the 83% achieved in fiscal year 2002. This decline is
expected because there will be no increased revenues as a result of the deferred
revenue amortization discussed above. We believe the achievable gross profit
percentage in future periods will be approximately 70%, similar to what was
historically experienced by us without regard to the amortization of the
deferred revenue during the fiscal year ended June 30, 2001.
Cost of revenues includes related party transactions of $994,043 in fiscal
year 2002 and $975,257 in fiscal year 2001. These are more fully described in
the notes to the financial statements as Note 21. We have determined that the
terms under which business is transacted with all related parties are at least
as favorable to us as would be available from an independent third party
providing similar goods or services.
Product Development
Product development expenses consist primarily of payroll and related
expenses. Product development expenses for the fiscal year ended June 30, 2002
decreased to $51,805 from $1,804,986 in the prior fiscal year. Product
development expenses in fiscal year 2001 were mostly the development expenses
for the Internet Commerce Center (ICC) and were largely incurred during the
first two fiscal quarters of that year. We have completed the basic development
of the ICC, as redefined by us. We continue to develop SOS enhancements, but
there are no other major development projects underway at this time.
We intend to make enhancements to our technology as business opportunities
present themselves, but our business model currently contemplates that in most
cases we will seek to pass these costs to our customers. We intend to expense
these costs as incurred. We will undertake additional development projects as
the needs are identified and as the funds to undertake the work are available.
Selling and Marketing
Selling and marketing expenses consist of payroll and related expenses for
sales and marketing, the cost of advertising, promotional and public relations
expenditures and related expenses for personnel engaged in sales and marketing
activities, and commissions paid to telemarketing companies. Selling and
marketing expenses for the fiscal year ended June 30, 2002 decreased to
$14,020,571 from $20,949,758 in the fiscal year 2001. The decrease in selling
and marketing expenses is primarily attributable to the decrease in the number
of workshops held during the current year and the associated expenses including
advertising and promotional expenses necessary to attract attendees. Advertising
expenses for fiscal 2002 were approximately $5.3 million compared to $6.0
million in fiscal 2001. The decrease is also attributable to the fact that we
incurred no marketing expenses in fiscal year 2002 with respect to our ICC and
CableCommerce products and services, whereas during fiscal year 2001 there were
approximately $1,700,000 in selling and marketing expenses associated with our
ICC and CableCommerce divisions. Selling and marketing expenses as a percentage
of sales decreased to 38% of revenues for the current fiscal year from 49% in
the previous 12-month period. We expect selling and marketing expenses to
increase as a percentage of revenues in the future due to the effects of
deferred revenue recognition explained above.
Selling and marketing expense includes related party transactions of
$479,984 in fiscal year 2002 and $78,435 in fiscal year 2001. These are more
fully described in the notes to the financial statements as Note 21. We have
determined, based on competitive bidding and experience with independent vendors
offering similar products and services, that the terms under which business is
transacted with related parties are at least as favorable to us as would be
available from an independent third party.
General and Administrative
General and administrative expenses consist of payroll and related expenses
for executive, accounting and administrative personnel, professional fees and
other general corporate expenses. General and administrative expenses for the
fiscal year ended June 30, 2002 decreased to $5,691,434 from $7,083,426 in the
previous fiscal year. This decrease is primarily attributable to the decrease in
payroll and related expenses that resulted from a reduction in the size of our
workforce, a reduction in the salaries of retained management personnel,
elimination of certain consulting fees associated with financial public
relations firms, and a reduction in legal expenses. Further cost reductions at
current revenue levels are unlikely. We anticipate that general and
administrative expenses will increase in future years as our business grows.
Bad Debt Expense
Bad debt expense consists mostly of actual and anticipated losses resulting
from the extension of credit terms to our customers when they purchase products
from us. We encourage customers to pay for their purchases by check or credit
card since these are the least expensive methods of payment, but we also offer
installment contracts with payment terms up to 24 months. We offer these
contracts to all workshop attendees not wishing to use a check or credit card
provided they complete a credit application, give us permission to independently
check their credit and are willing to make an appropriate down payment. These
installment contracts are sold to various finance companies, with partial or
full recourse, if our customer has a credit history that meets the finance
company's criteria. If not sold, we carry the contract and out-source the
collection activity. Our collection experience with these 24-month contracts is
satisfactory given the cost structure under which we operate. The sum of the
collected contracts plus the original principal balance of those currently
active as a percent of the original total value of the contracts in prior fiscal
years are: Fiscal year 1999 = 70%, Fiscal year 2000 = 77%, Fiscal year 2001 =
77%. All contracts from fiscal years 1999 and 2000 have reached the end of their
term, while some contracts from fiscal year 2001 are still active.
Bad debt expense was $6,675,238 in the fiscal year ended June 30, 2002
compared to $3,475,492 in the prior fiscal year. The increase is principally due
to an increase in the number of installment contracts carried by us. During the
first six months of fiscal year 2002 there were no finance companies willing to
purchase our contracts so we carried them ourselves. In January 2002, we were
once again able to sell contracts to a finance company, but on terms that were
less favorable than we had experienced in the past. The new finance company
agreed to purchase contracts only if they had full recourse on any uncollectable
contracts. We accepted these terms and as a result have incurred increased bad
debts. Based on our recent history it was necessary to increase the allowance
for doubtful accounts to provide for future losses. This increased bad debt
expense for fiscal 2002 by $1,089,798.
Depreciation and Amortization
Depreciation and amortization expenses consist of a systematic charge to
operations for the cost of long-term equipment and amortization of the goodwill
associated with the purchase of other businesses. Depreciation and amortization
expenses for the fiscal year ended June 30, 2002 decreased to $668,730 from
$1,296,519 in the prior 12-month period. This decrease was due to the disposal
of some computer equipment and other assets as well as from reduced amortization
due to the write-off of the goodwill associated with our StoresOnline (Canada)
subsidiary. In future periods, goodwill will no longer be amortized based on
SFAS 142 which could further reduce amortization expense.
Writedown of Goodwill and Acquired Technology
At December 31, 2000, we wrote off the goodwill relating to our
StoresOnline (Canada) subsidiary in the amount of $834,331 and the acquired
technology and goodwill related to our Digital Genesis operation in the amount
of $250,145. It was determined that the assets and technology were no longer
being used and had no market value. This write-off reduced the goodwill
amortization for fiscal year 2002 compared to fiscal 2001.
Interest Expense
Interest expenses for the fiscal year ended June 30, 2002 decreased to
$1,950,687 from $3,287,905 in fiscal 2001. Included in interest expense in
fiscal 2002 are $212,463 relating to the conversion of an 8% convertible
debenture issued to King William, LLC into common stock and $1,666,957 relating
to the conversion into common stock of convertible long term notes held by
investors who participated in a private placement of the notes in January and
April 2001. Upon conversion of these items the debt discount previously recorded
was written off in the current fiscal year instead of being amortized over the
life of the notes.
Included in interest expense in the fiscal year ended June 30, 2001 is a
one-time charge of $884,000 relating to the fair value of the beneficial
conversion feature of an 8% convertible debenture issued to King William, LLC,
the amortization of the discount relating to the beneficial conversion feature,
warrants issued in connection with the sale by us of convertible notes in
January and April 2001 and the actual interest accrued on the debenture and
notes.
Interest expense is anticipated to be significantly less in fiscal year
2003 due to the reduction in debt carried on our balance sheet.
Discontinued Operations
In January 2001, we sold our subsidiary, IMI, Inc. to a third party as
discussed above. As a result, the loss from discontinued operations is listed on
a separate line item in the statement of operations. The loss from discontinued
operations for fiscal year 2001 was $285,780.
Extraordinary Items
In January 2001, we entered into an agreement with an unrelated third party
to negotiate settlement agreements with vendors and other debtors, relating
mainly to the B2B and CableCommerce divisions, in an effort to improve our
financial condition. It was important to remove some of the debts so we could
attract the outside capital investment necessary to keep us solvent and provide
for future growth. We settled approximately $2.5 million in obligations in this
manner, resulting in an extraordinary gain of $1,688,956.
In December 2000, certain equipment and software related to closed
operations in Long Beach, California and American Fork, Utah were taken out of
service and disposed of resulting in a loss of $1,091,052. Additionally, there
was a gain on the disposal of IMI, Inc. in the fiscal year ended June 30 , 2001
of $363,656.
The total gain of all extraordinary items for the fiscal year ended June
30, 2001 was therefore $961,560. There was no extraordinary item in the fiscal
year ended June 30, 2002.
Income Taxes
Fiscal year 2002 is the first profitable year for the Company since its
inception. We have net operating loss carry forwards sufficient to reduce our
pretax profits to zero, therefore, we have not paid or accrued any federal
income taxes in this or prior fiscal years.
Years Ended June 30, 2001 and 2000
Revenue
Revenues for the year ended June 30, 2001 increased to $43,000,533 from
$22,149,649 in the prior fiscal year, an increase of 94%. Operating revenues for
both years are from the design and development of Internet web sites and related
consulting projects, revenues from our Internet training workshops (including
attendance at the workshop, rights to activate web sites and hosting), sales of
banner advertising, web traffic building products, mentoring and transaction
processing.
Formerly we reported product sales that came from our subsidiary, IMI, Inc.
On January 11, 2001, we sold IMI for $1,631,589, including $1,331,589 owed to us
by IMI at the time of the sale. We received a cash payment of $300,000 and a
promissory note for the balance. Accordingly, IMI operations from this and prior
periods are now reported as discontinued operations in the accompanying
consolidated statement of operations.
The increase in revenues from fiscal 2000 to 2001 can be attributed to two
major factors. First, there was an increase in the number of Internet training
workshops conducted during the year. The number increased to 337 workshops for
the current fiscal year from 250 in the fiscal year ended June 30, 2000.
The second factor contributing to the increased revenue was a change in the
business model for our Internet workshop training business. Since October 1,
2000, the product sold to our customers at our Internet Training Workshop has
been our SOS product. Under this new model, as discussed above, we now recognize
all of the revenue generated at our Internet workshops at the time the SOS
product is delivered. During the year ended June 30, 2001, we recognized
$14,534,542 in revenue from sales made in prior fiscal years and we deferred
revenue from the current fiscal year of $5,073,856 to future years. The net
change increased revenues for fiscal year 2001 by $9,460,686.
Gross Profit
Gross profit for the fiscal year ended June 30, 2001 increased to
$34,574,958 from $13,684,558 in the prior year. The increase in gross profit
primarily reflects the increased sales volume of services provided through our
Internet training workshops and the effect on revenues from the sale of the
StoresOnline software as explained above.
Gross profit percentages increased for the fiscal year ended June 30, 2001
to 80% of revenue from 62% of revenue for the fiscal year ended June 30, 2000.
The increase in gross profit as a percentage of revenue is due to several
factors: additional revenue from prior product offerings recognized during
fiscal 2001 from prior years had no corresponding cost of revenue; new
programming tools and stringent cost controls increased the productivity of the
support group our customers use; and the cost of conducting our Internet
training workshops remaining relatively constant per workshop, while the number
of workshops and the selling price of the products delivered at the workshops
both increased. The percentage of attendees at the workshops who purchased the
StoresOnline software remained approximately the same as it had been in the
former business model.
Cost of revenues includes related party transactions of $975,257 in fiscal
year 2001 and $1,110,404 in fiscal year 2000. These are more fully described in
the notes to the financial statements as Note 21. We believe that the terms
under which business is transacted with all related parties are at least as
favorable to us as would be available from an independent third party providing
the same goods or services.
Product Development
Product development expenses for the fiscal year ended June 30, 2001
decreased to $1,804,986 from $6,462,999 in the prior fiscal year. Most of the
expenses were for development of the Internet Commerce Center (ICC) and were
incurred prior to December 2000. By the end of fiscal year 2001 we had completed
the basic development of the ICC, as redefined by us.
Selling and Marketing
Selling and marketing expenses for the fiscal year ended June 30, 2001
increased to $20,949,758 from $18,536,486 in the previous 12-month period. The
increase in selling and marketing expenses is primarily attributable to the
increase in the number of workshops held during the year and the associated
advertising and promotional expenses necessary to attract attendees. Advertising
expenses in fiscal year 2001 were approximately $6.0 million compared to $5.9
million in fiscal 2000. During fiscal year 2001 there were approximately
$1,700,000 in selling and marketing expenses associated with our ICC and
CableCommerce divisions, down from approximately $4,500,000 in fiscal year 2000.
Selling and marketing expenses as a percentage of sales decreased to 49% of
revenues for the fiscal year 2001 from 84% in the previous 12-month period.
General and Administrative
General and administrative expenses for the fiscal year ended June 30,
2001 decreased to $7,083,426 from $24,517,450 in the previous fiscal year. This
decrease is attributable to the decrease in payroll and related expenses that
resulted from the relocation of our headquarters to Orem, Utah from Long Beach,
California, the resignation of senior management personnel who were not
replaced, a reduction in the salaries of retained management personnel and
cutbacks in administrative staff associated with the reorganization of the ICC
and CableCommerce divisions. During the fiscal year ended June 30, 2000, we
incurred certain administrative expenses that were not repeated in fiscal 2001,
consisting of one-time legal, accounting and other costs associated with the
acquisition by us of Galaxy Enterprises, Inc., and the issuance of common stock
for services in the amount of $3,660,498 and to executive officers in exchange
for cancellation of options in the amount of $8,400,000.
During the first quarter of fiscal year 2001, we implemented our previously
announced consolidation strategy to relocate our headquarters operation from
Long Beach, California to Orem, Utah. The headquarters of our Galaxy Mall, Inc.
subsidiary has been in Orem since 1997. We realized significant improvements in
operations and savings in general and administrative expenses as a result of our
relocation. The cost structure is more favorable in Orem due to lower prevailing
wage rates in the local labor market, as well as lower costs for facilities,
outside professional services and other costs of operations. Beginning in
October 2000, we reduced personnel in accounting, the in-house legal department,
and general administrative positions.
Bad Debt Expense
Bad debt expense consists mostly of actual and anticipated losses resulting
from the extension of credit terms to our customers when they purchase products
from us. We encourage customers to pay for their purchases by check or credit
card since these are the least expensive methods of payment, but we also offer
installment contracts with payment terms up to 24 months. We offer these
contracts to all workshop attendees not wishing to use a check or credit card
provided they complete a credit application, give us permission to independently
check their credit and are willing to make an appropriate down payment. These
installment contracts are sold to various finance companies, with partial or
full recourse, if our customer has a credit history that meets the finance
company's criteria. If not sold, we carry the contract and out-source the
collection activity. Our collection experience with these 24-month contracts is
satisfactory given the cost structure under which we operate.
Bad debt expense was $3,475,492 in the fiscal year ended June 30, 2001
compared to $1,159,022 in the prior fiscal year. The increase is principally due
to the increase in the number of installment contracts accepted by us as the
sales volume grew. At the time of a contract sale to a finance company 20% of
the sales price is placed in a reserve account held by the finance company. If
our customer does not make its payments on the contract, the finance company may
charge the reserve for the unpaid balance previously funded to the extent there
are funds available in the reserve account. At maturity of the customer
contract, the net balance of the reserve is returned to us. One of the finance
companies holding a reserve that may be due to us if the contracts are collected
has experienced financial difficulties and may not be able to return these
reserves. We therefore established a loss provision of approximately $950,000.
This reserve is included in bad debt expense for fiscal year 2001.
Depreciation and Amortization
Depreciation and amortization expenses consist of a systematic charge to
operations for the cost of long-term equipment and a write down of the goodwill
associated with the purchase of other businesses. Depreciation and amortization
expenses for the fiscal year ended June 30, 2001 increased to $1,296,519 from
$1,191,143 in the prior 12-month period. This increase was due to the purchase
of additional equipment and software.
Writedown of Goodwill and Acquired Technology
At December 31, 2000, we wrote off the goodwill relating to our
StoresOnline (Canada) subsidiary in the amount of $834,331 and the acquired
technology and goodwill related to our Digital Genesis operation in the amount
of $250,145. It was determined that the assets and technology were no longer
being used and had no market value.
Interest Expense
Interest expense for the fiscal year ended June 30, 2001 decreased to $
3,287,905 from $4,573,695 in the prior fiscal year. We included in interest
expense in fiscal year 2001 a one-time charge of $884,000 relating to the fair
value of the beneficial conversion feature of an 8% convertible debenture issued
to King William, LLC, the amortization of the discount relating to the
beneficial conversion feature, warrants issued in connection with the sale by us
of convertible notes in January and April 2001 and the actual interest accrued
on the debenture and notes. We repaid the various debt instruments primarily
attributable to the interest expense for fiscal year ended June 30, 2000.
Discontinued Operations
In January 2001, we sold our subsidiary, IMI, Inc. to a third party as
discussed above. As a result, the gain or loss from discontinued operations is
listed on a separate line item in the statement of operations. The loss from
discontinued operations for fiscal 2001 was $285,780, compared to a loss of
$1,318,515 in the prior 12-month period.
Extraordinary Items
In January 2001, we entered into an agreement with an unrelated third party
to negotiate settlement agreements with vendors and other debtors, relating
mainly to the ICC and CableCommerce divisions, in an effort to improve our
balance sheet ratios. It was important to reduce some of the debts so we could
attract the outside capital investment necessary to keep us solvent and provide
for future growth. We settled approximately $2.5 million in obligations in this
manner, resulting in an extraordinary gain of $1,688,956.
In December 2000, certain equipment and software related to closed
operations in Long Beach, California and American Fork, Utah were taken out of
service and disposed of resulting in a loss of $1,091,052. Additionally, there
was a gain on the disposal of IMI, Inc. in the fiscal year ended June 30, 2001
of $363,656.
The total gain of all extraordinary items for the fiscal year ended June
30, 2001 was therefore $961,560. There was no extraordinary item in the fiscal
year ended June 30, 2000.
Income Taxes
We have not generated any taxable income to date and, therefore, we have
not paid any federal income taxes. The use of our net operating loss carry
forwards, which begin to expire in 2010, may be subject to certain limitations
in the event of a change of control under Section 382 of the Internal Revenue
Code of 1986, as amended.
Liquidity and Capital Resources
The accompanying financial statements have been prepared on the basis that
the Company will continue as a going concern, which contemplates the realization
of assets and satisfaction of liabilities in the normal course of business. The
Company has primarily incurred losses since its inception, fiscal year 2002
being our first profitable year. We have a cumulative net loss of a $69,520,461
through June 30, 2002. The Company has historically relied upon private
placements of its stock and issuance of debt to generate funds to meet its
operating needs. Management's plans include the raising of additional debt or
equity capital. However, there can be no assurance that additional financing
will be available on acceptable terms, if at all. The Company continues to work
to improve the strength of its balance sheet and has restructured its ongoing
operations in an effort to improve profitability and operating cash flow. If
adequate funds are not generated the Company may not be able to execute its
strategic plan and may be required to obtain funds through arrangements that
require it to relinquish rights to all or part of the intellectual property of
its Stores Online software or control of its business. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Cash
At the close of the year ended June 30, 2002, we had working capital of
$289,438 compared to a working capital deficit of $11,352,351 at June 30, 2001.
Our shareholders equity was $2,468,574 at June 30, 2002 compared to a capital
deficit of $9,306,829 at June 30, 2001. We generated revenues from continuing
operations of $37,350,850 for the fiscal year 2002 and $43,000,533 for the year
ended June 30, 2001. For the year ended June 30, 2002 we generated net income of
$2,198,769 and for the year ended June 30, 2001, we incurred a net loss of
$3,638,736. For the year ended June 30, 2002 and the year ended June 30, 2001,
we recorded negative cash flows from continuing operations of $3,548,931 and
$7,347,123, respectively.
At June 30, 2002, we had $519,748 cash on hand, an increase of $370,583
from June 30, 2001.
Net cash used in operating activities was $3,548,931 for the fiscal year
ended June 30, 2002. Net cash used in operations was mainly net income from
continuing operations of $2,198,769, a provision for bad debts of $6,675,238,
and depreciation and amortization of $3,078,953, but offset by a decrease in
deferred revenue of $5,328,034, a decrease in accounts payable and accrued
liabilities of $1,654,092 and an increase in accounts receivable of $8,250,722.
The decrease in deferred revenue is the result of our change in the product
offered at our Internet training workshops. The products sold after September
30, 2000 did not require us to defer revenue, but during the current fiscal year
we continued to recognize revenue deferred in prior periods. This is explained
in detail in the revenue section above. The decrease in accounts payable of
$1,335,964 and other liabilities of $318,128 is the result of paying past due
vendor invoices using proceeds from the private sale of equity securities,
settlement of outstanding liabilities by issuing stock instead of paying in cash
and cash payments to officers of accrued bonuses earned in prior years of
$425,857. The increase in accounts receivable occurred because we were unable to
sell our installment contracts during the first two quarters of fiscal year 2002
and as a result carried them ourselves.
Net cash provided by financing activities for the fiscal year ended June
30, 2002 was $4,018,433. We sold common stock to investors in two private
placements that generated $4,712,712 in net proceeds to us during the fiscal
year and repaid loans to banks and others, including our officers, in the amount
of $598,121.
In May 2001 we began a private placement of unregistered common stock at
$3.00 per share in an attempt to raise $3 million. In November 2001 we completed
the offering with adjusted gross proceeds to us of $2,803,466, of which $291,200
was received during fiscal year 2001 with the balance being received in fiscal
year 2002.
In March 2002 we began an additional private placement of unregistered
common stock at $.40 per share in an attempt to raise $2.5 million. The share
price was lower than the offering of May 2001 because our stock was trading
below the levels at May 2001 and we needed to offer investors a substantial
discount in order to raise the much-needed additional capital. We completed the
offering in June with adjusted gross proceeds to us of $2,185,995.
Accounts Receivable
Accounts receivable, carried as a current asset, net of allowance for
doubtful accounts, were $2,247,129 at June 30, 2002 compared to $1,099,744 at
June 30, 2001. Also at June 30, 2001, there was a related party current account
receivable of $90,109, but none at June 30, 2002. Accounts receivable, carried
as a long-term asset, net of allowance for doubtful accounts, was $1,673,740 at
June 30, 2002 compared to $900,198 at June 30, 2001. We offer our customers a
24-month installment contract as one of several payment options. The payments
that become due more than 12 months after the end of the fiscal year are carried
as long-term trade receivables. A relatively constant and significant portion of
our revenues have been made on this installment contract basis. We have in the
past sold, on a discounted basis, a portion of these installment contracts to
third party financial institutions for cash. Because these financial
institutions are small, they are limited in the quantities of contracts they can
purchase from us. As a result, we were unable to sell any contracts during the
first two quarters of fiscal year 2002. We continued to offer installment
payment terms to our customers and carried the contracts in-house. In January
2002 we signed a contract with a new finance company to begin purchasing
contracts. Unfortunately the terms were not as good as previously and the
contracts were sold with recourse. In the event our customer did not meet their
contractual obligation the finance company could look to us to cover their
losses. This inability to sell our installment contracts at historic levels has
caused the increase in the accounts receivable balance and had a material
negative impact on our near-term liquidity and cash position.
Other assets relating to our installment contract sales at June 30, 2002
were $417,384 compared to $993,992 net of an allowance for doubtful accounts at
June 30, 2001. These assets relate to transactions conducted prior to the new
relationship we entered into in January 2002. When installment contracts were
sold without recourse to the previous finance companies, the purchaser held
approximately 20% of the purchase price in a reserve account that will be
returned to us if the contracts are paid in full by our customer. If the
customer fails to pay, the purchaser may charge this reserve account for the
deficiency. Our obligation to accept such charge backs was limited to the amount
in the reserve account.
Delisting of Common Stock
On January 10, 2001, our common stock was delisted from the Nasdaq National
Market, and began to trade on the National Association of Securities Dealers OTC
Electronic Bulletin Board. The delisting of our common stock has had an adverse
impact on the market price and liquidity of our securities and has adversely
affected our ability to attract additional investors. This has a material
adverse effect on our liquidity, because sales of additional shares of our
common stock is currently the principal potential source of additional funds
that may be required to operate our businesses.
Arrangements with King William, LLC
In July 2000, we entered into a securities purchase agreement with King
William, LLC. Under the terms of the agreement, we issued to King William an 8%
convertible debenture due July 31, 2003, in the principal amount of $4.5
million. The debenture was convertible into shares of our common stock at the
lower of $17.90 or a conversion rate of 80% of the average market price of the
common stock during any three non-consecutive trading days during the 20 trading
days prior to conversion. The purchase price for the debenture was payable in
two tranches. The first tranche of $2.5 million was paid at the closing in July
2000. The second tranche of $2.0 million was to be payable three business days
after our satisfaction of certain conditions, which conditions were never
satisfied. Effective as of January 25, 2001, we reached an agreement with King
William LLC to restructure this debenture. Under the terms of the agreement no
second tranche of the debenture would be available, the note was amended so that
it would be repaid in installments with a 15% prepayment premium over the
remainder of calendar year 2001, and a related Private Equity Credit Agreement
was terminated. Under this agreement, King William's right to convert the
debenture into shares of our common stock was modified to permit such conversion
only if the trading price of our common stock was in excess of $30.00 for 20
consecutive trading days or we failed to make a scheduled payment of principal.
We also agreed to re-price the warrants issued to King William in connection
with the issuance of the debenture to $2.50 per share and we issued to King
William a warrant for an additional 26,900 shares of common stock at $2.50 per
share. As of the date of the restructuring agreement we were in default of our
obligations under the convertible debenture, but King William waived all of
these defaults pursuant to the terms of the restructuring agreement.
We made the initial payment of $250,000 required under the restructuring
agreement but did not make the next two payments totaling $497,000, and on May
9, 2001 we entered into a waiver agreement with King William. Pursuant to this
agreement King William converted $200,000 principal balance of the remaining
balance of the convertible debenture into 80,000 shares of common stock. The
$200,000 was credited toward the payment due February 28, 2001 and the balance
of $50,000 was rescheduled to be paid on March 10, 2002 and the payments
originally due April 10, 2001 and May 10, 2001 were rescheduled to January 10,
2002 and February 10, 2002 respectively. Under the Agreement, King William
waived its right to make further conversions on account of our failure to make
the missed payments.
Effective July 11, 2001, we entered into a second restructuring agreement
with King William pursuant to which we paid in full and final satisfaction of
the Debenture (i) a cash payment of $100,000, (ii) a $400,000 promissory note
and (iii) 280,000 shares of our common stock that were issued in September 2001.
King William has agreed to forgive the $400,000 promissory note if we meet
certain specific requirements.
We recorded the value of the beneficial conversion feature on the $2.5
million that has been drawn down on the $4.5 million principal amount as
additional paid in capital and interest expense of $884,000 during our first
fiscal quarter ended September 30, 2000 because the convertible debenture was
immediately exercisable.
Effective February 13, 2002, we entered into a modification to the second
restructuring agreement with King William pursuant to which we issued 10,000
shares of our unregistered common stock in exchange for (i) a change in the
terms of the $400,000 note to extend the final payment date to July 10, 2006,
(ii) the ability to pay interest in our common stock if we so elect, (iii)
relief from the obligation to register any of the shares owned by King William
or to be received by them through the exercise of warrants and (iv) King William
waived any default under the second restructuring agreement. The stock was
valued at $13,000, the fair market value on February 13, 2002.
In connection with the securities purchase agreement, we issued to King
William a warrant to purchase 23,100 shares of common stock. In connection with
the issuance of the debenture, we also issued to Roth Capital Partners, Inc., a
warrant to purchase 9,000 shares of common stock and to Carbon Mesa Partners,
LLC, a warrant to purchase 1,000 shares of common stock. Each of the warrants is
exercisable for five years from the date of issue, at an exercise price of
$16.25 per share and with cashless exercise and piggyback registration rights.
The fair value of the warrants has been recorded at $371,000. Of the $371,000,
$259,000 is accounted for as capital and debt discount and is amortized over the
life of the debt. The remaining balance is accounted for as debt issuance costs
classified as other assets and is amortized over the life of the debt.
Accounts Payable
Accounts payable at June 30, 2002, totaled $1,327,102, including amounts
payable to a related party, as compared to $2,663,066 at June 30, 2001 and
compared to $4,708,716 as of March 31, 2001. The reduction between March and
June 2001 is primarily due to the settlement agreements reached with vendors as
described above and funded with proceeds from the sale of convertible notes,
common stock and unsecured loans from certain of our officers. The reduction
between June 30, 2001 and June 30, 2002 is due to the payment of overdue vendor
invoices. Our accounts payable as of June 30, 2002 were mostly within our
vendor's terms of payment. Our business operations are dependent on the ongoing
willingness of our suppliers and service providers to continue to extend their
payment terms. A number of suppliers and service providers now require payment
in advance or on delivery. Any interruption in our business operations or the
imposition of more restrictive payment terms for payments to additional
suppliers and service providers would have a further negative impact on our
liquidity.
Deferred Revenue
Deferred revenue at June 30, 2002 totaled $705,558 as compared to
$6,033,592 at June 30, 2001. We recognize deferred revenue as the services
related to the deferred revenue are rendered or when the time period in which
customers have the right to receive the services expires. The decrease from the
prior fiscal year end is the result of a change at October 1, 2000 in the
products offered at our Internet training workshops.
We changed the product offered through our Internet workshop training
business and since October 1, 2000, have delivered a new product called the
StoresOnline Software, as discussed above.
Under this new model, we now recognize all of the revenue generated at our
Internet workshops at the time of the sale and delivery of the SOS product to
our customer.
Stockholders' Equity (Capital Deficit)
Shareholders' equity at June 30, 2002 was $2,468,574 compared to capital
deficit of $9,306,829 at June 30, 2001. This mainly resulted from additions to
common stock and paid-in capital from our sale of unregistered common stock to
private investors of $4,712,712 and the conversion of debentures and notes into
equity of $4,263,179. It also increased because of fiscal year 2002 net income
of $2,198,769.
Financing Arrangements
We accept payment for the sales made at our Internet training workshops by
cash, credit card, installment contract, or until December 31, 2001, a third
party leasing option. As part of our cash flow management and in order to
generate liquidity, we have sold on a discounted basis a portion of the
installment contracts generated by us to third party financial institutions for
cash. Because these finance companies are small and have limited resources they
have not been able to purchase all of the contracts we would like to sell. See
"Liquidity and Capital Resources - Accounts Receivable," for further
information.
Impact of Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No. 141, "Business Combinations"
and No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which
establishes new standards for the treatment of goodwill and other intangible
assets. SFAS 142 is effective for fiscal years beginning after December 31, 2001
and permits early adoption for companies with a fiscal year beginning after
March 15, 2001. SFAS 142 prescribes that amortization of goodwill will cease as
of the adoption date. Additionally, we will be required to perform an impairment
test as of the adoption date, annually thereafter, and whenever events and
circumstances occur that might affect the carrying value of these assets. We
have not yet determined what effect, if any, the impairment test of goodwill
will have on our results of operations and financial position.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations (SFAS 143). Under this standard, asset retirement obligations will
be recognized when incurred at their estimated fair value. In addition, the cost
of the asset retirement obligations will be capitalized as a part of the asset's
carrying value and depreciated over the asset's remaining useful life. SFAS No.
143 is effective for fiscal years beginning after June 15, 2002. The Company
does not expect that adoption of SFAS No. 143 will have a material impact on its
financial condition or results of operations.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144). This standard requires
that all long-lived assets (including discontinued operations) that are to be
disposed of by sale be measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS 144 expands the scope of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS 144 is
effective for fiscal years beginning after December 15, 2001. The Company does
not expect the implementation of SFAS 144 to have a material effect on its
financial condition or results of operations.
In April 2002, the FASB issued SFAS No. 145, Rescission of SFAS Nos. 4, 44,
and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002 (SFAS
145). This standard rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements and excludes
extraordinary item treatment for gains and losses associated with the
extinguishment of debt that do not meet the APB Opinion No. 30, Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (APB 30) criteria. Any gain or loss on extinguishment of debt that
was classified as an extraordinary item in prior periods presented that does not
meet the criteria in APB 30 for classification as an extraordinary item shall be
reclassified. SFAS 145 also amends SFAS 13, Accounting for Leases as well as
other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. Certain provisions of SFAS are effective for transactions occurring
after May 15, 2002 while other are effective for fiscal years beginning after
May 15, 2002. The Company has not assessed the potential impact of SFAS 145 on
its financial condition or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities (SFAS 146). This standard addresses financial
accounting and reporting for costs associated with exit or disposal activities
and replaces 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) (EITF 94-3). SFAS 146
requires that a liability for costs associated with an exit or disposal activity
be recognized when the liability is incurred. Under EITF 94-3, a liability for
exit costs, as defined in EITF No. 94-3 were recognized at the date of an
entity's commitment to an exit plan. The provisions of SFAS 146 are effective
for exit or disposal activities that are initiated by the Company after December
31, 2002.
Item 7A. Quantitative and Qualitative Disclosures About Market Risks
We do not believe we have material market risk exposure. We do not invest
in market risk sensitive instruments for trading purposes. Our excess cash is
placed in short-term interest-bearing accounts or instruments that are based on
money market rates.
Although we conduct some business outside of the United States, to date our
exposure to foreign currency rate fluctuations has not been significant. If we
increase our international business, we could be subject to risks typical of an
international business, including but not limited to differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility.
Item 8. Financial Statements and Supplementary Data
See Item 14(a) for an index to the consolidated financial statements and
supplementary financial information that are attached hereto.
Item 9. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure
On February 4, 2002, we engaged Grant Thornton LLP as our independent
auditor following our dismissal, effective January 31, 2002, of Eisner LLP
(formerly known as Richard A. Eisner & Company, LLP) ("Eisner"). Our board of
directors approved the engagement of Grant Thornton LLP and the dismissal of
Eisner.
Eisner had served as our independent accountants since April 4, 2001.
Eisner's auditors' report on our consolidated financial statements as of and for
the year ended June 30, 2001 contained a separate paragraph stating that it had
substantial doubt about our ability to continue as a going concern. Our
financial statements did not include any adjustments that might result from the
outcome of this uncertainty. Except as noted above, Eisner's report on our
financial statements for the fiscal year ended June 30, 2001 contained no
adverse opinions or disclaimer of opinions, and were not qualified as to audit
scope, accounting principles, or uncertainties.
We notified Eisner that during the most recent fiscal year and the interim
period from July 1, 2001 through January 31, 2002, we were unaware of any
disputes between us and Eisner as to matters of accounting principles or
practices, financial statement disclosure, or audit scope or procedure, which
disagreements, if not resolved to the satisfaction of Eisner, would have caused
it to make a reference to the subject matter of the disagreements in connection
with its reports.
Effective February 4, 2002, we engaged Grant Thornton LLP as our
independent auditors with respect to our fiscal year ending June 30, 2002. We
had previously retained Grant Thornton LLP on an interim basis during our
previous fiscal year, from January 22, 2001 to April 4, 2001. Grant Thornton LLP
had reviewed our interim financial statements for the quarter ended December 31,
2000, but did not issue any reports thereon. Other than this limited engagement,
during our most recent fiscal year and through February 4, 2002, we had not
consulted with Grant Thornton LLP regarding either: (i) the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our financial statements,
and neither a written report was provided to us nor was oral advice provided
that Grant Thornton LLP concluded was an important factor considered by us in
reaching a decision as to the accounting, auditing or reporting issue; or (ii)
any matter that was either the subject of a disagreement, as that term is
defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to
Item 304 of Regulation S-K, or a reportable event, as that term is defined in
Item 304 (a)(1)(v) of Regulation S-K.
On April 4, 2001, we engaged Eisner as our independent auditor concurrent
with our termination of Grant Thornton, LLP. Our board of directors approved the
engagement of Eisner as our independent auditors with respect to our fiscal year
ending June 30, 2001. Grant Thornton was retained on an interim basis to replace
KPMG LLP, which had served as our independent auditor between June, 1998 and
January 12, 2001.
KPMG LLP's independent auditor's report on our consolidated financial
statements for the years ended June 30, 2000 and 1999 contained a separate
paragraph stating that it had substantial doubt as to our ability to continue as
a going concern. Our financial statements do not include any adjustments that
might result from the outcome of this uncertainty. Except as noted above, KPMG
LLP's reports on our consolidated financial statements for the fiscal years
ended June 30, 2000 and 1999 contained no adverse opinions or disclaimer of
opinions, and were not qualified as to audit scope, accounting principles, or
uncertainties.
We notified KPMG LLP that during the two most recent fiscal years and the
interim period from July 1, 2000 through January 12, 2001, we were unaware of
any disputes between us and KPMG LLP as to matters of accounting principles or
practices, financial statement disclosure, or audit scope of procedure, which
disagreements, if not resolved to the satisfaction of KPMG LLP would have caused
them to make a reference to the subject matter of the disagreements in
connection with their reports.
We engaged Grant Thornton LLP on January 22, 2001 to review our interim
report on Form 10-Q for the three-month period ended March 31, 2001. On April 4,
2001, we terminated their engagement.
During the fiscal year ended June 30, 2000 and through April 4, 2001, we
had not consulted with Eisner regarding either the application of accounting
principles to a specified transaction, either completed or proposed, or the type
of audit opinion that might be rendered on our financial statements, and neither
a written report was provided to us nor oral advice was provided that Eisner
concluded was an important factor considered by us in reaching a decision as to
the accounting, auditing or financial reporting issue, or any matter that was
either the subject of a disagreement.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item 12 is hereby incorporated by
reference to the information in our definitive proxy statement to be filed
within 120 days after the close of our fiscal year.
Item 11. Executive Compensation
The information required by this Item 12 is hereby incorporated by
reference to the information in our definitive proxy statement to be filed
within 120 days after the close of our fiscal year. Such incorporation by
reference shall not be deemed to specifically incorporate by reference the
information referred to in Item 402(a)(8) of Regulation S-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item 12 is hereby incorporated by
reference to the information in our definitive proxy statement to be filed
within 120 days after the close of our fiscal year.
Item 13. Certain Relationships and Related Transactions
The information required by this Item 13 is hereby incorporated by
reference to the information in our definitive proxy statement to be filed
within 120 days after the close of our fiscal year.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements
The following financial statements of Imergent, Inc., and related
notes thereto and auditors' report thereon are filed as part of this Form 10-K:
PAGE
Independent Auditor's Report dated September 20, 2002 43
Independent Auditor's Report dated August 3, 2001 44
Independent Auditor's Report dated August 21, 2000 45
Consolidated Balance Sheets as of June 30, 2002 and 2001 46
Consolidated Statements of Operations for the years ended June 30,
2002, 2001 and 2000 47
Consolidated Statements of Stockholders' Equity /Capital Deficit
for the years ended June 30, 2002, 2001 and 2000 48
Consolidated Statements of Cash Flows for the years ended June
30, 2002, 2001 and 2000 49
Notes to Consolidated Financial Statements 51
2. Financial Statement Schedules
The following financial statement schedule of Imergent, Inc. is
filed as part of this Form 10-K. All other schedules have been
omitted because they are not applicable, not required, or the
information is included in the consolidated financial statements
or notes thereto.
PAGE
Schedule II - Valuation and Qualifying Accounts 74
3. Exhibits
The exhibits listed on the accompanying index to exhibits
immediately following the financial statements are filed as part
of, or hereby incorporated by reference into, this Form 10-K.
(b) Reports on Form 8-K During the Last Quarter of Fiscal 2002
We filed no reports on Form 8-K during the last quarter of fiscal
2002.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Imergent, Inc. (formerly Netgateway, Inc.)
We have audited the accompanying consolidated balance sheet of Imergent, Inc.
(formerly Netgateway, Inc.) and Subsidiaries as of June 30, 2002, and the
related consolidated statements of operations, stockholders' equity (capital
deficit), and cash flows for the year then ended. In connection with our audit
of the consolidated financial statements, we have also audited the financial
statement schedule for the year ended June 30, 2002. These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Imergent, Inc. and
Subsidiaries as of June 30, 2002, and the consolidated results of their
operations and their consolidated cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States of
America. Also in our opinion, the financial statement schedule, when considered
in relation to the consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 4 to the
financial statements, the Company has primarily incurred losses since its
inception and has an accumulated deficit of $69,520,461 as of June 30, 2002.
These factors, among others, as discussed in Note 4 to the financial statements,
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 4. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ GRANT THORNTON LLP
Salt Lake City, Utah
September 20, 2002
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Imergent, Inc. (formerly known as Netgateway, Inc.)
We have audited the accompanying consolidated balance sheet of
Imergent, Inc. (formerly known as Netgateway, Inc.) and subsidiaries as of June
30, 2001, and the related consolidated statements of operations, capital
deficit, and cash flows for the year then ended. Our audit also includes the
financial statement schedule in so far as it relates to the year ended June 30,
2001 listed in the Index at Item 14(a). These consolidated financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
the significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present
fairly, in all material respects, the consolidated financial position of
Imergent, Inc. (formerly known as Netgateway, Inc.) and subsidiaries at June 30,
2001, and the consolidated results of their operations and their consolidated
cash flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
The accompanying consolidated financial statements and financial
statement schedule have been prepared assuming that the Company will continue as
a going concern. As discussed in Note 4 to the financial statements, the Company
has suffered recurring net losses and has a capital deficit that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 4. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
Eisner LLP (formerly known as RICHARD A. EISNER & COMPANY, LLP)
New York, New York
August 3, 2001,
With respect to Notes 10, 13, 14 and 23
September 30, 2001
With respect to Note 2(b)
July 3, 2002
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Imergent, Inc. (formerly Netgateway, Inc.):
We have audited the consolidated statements of operations, stockholders' deficit
and cash flows of Imergent, Inc. (formerly Netgateway, Inc.) and subsidiaries
for the year ended June 30, 2000. In connection with our audit of the
consolidated financials statements, we have audited the financial statement
schedule for the year ended June 30, 2000. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statements presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of their operations and their cash
flows of Imergent, Inc. (formerly Netgateway, Inc.) and subsidiaries for the
year ended June 30, 2000, in conformity with accounting principles generally
accepted in the United States of America. Also in our opinion, the related
financial statement schedule, when considered in relation to the consolidated
financials statements taken as a whole, present fairly, in all material
respects, the information set forth therein.
The accompanying financial statements and financial statement schedule have been
prepared assuming that the Company will continue as a going concern. As
discussed in Note 4 to the financial statements, the Company has suffered
recurring losses from operations and has a net capital deficiency that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 4. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ KPMG LLP
Los Angeles, California
August 21, 2000, except as to Note 19,
which is as of January 11, 2001
and Note 2(b) which is as of July 3, 2002
IMERGENT, INC. AND SUBSIDIARIES
(formerly Netgateway, Inc.)
Consolidated Balance Sheets
June 30, 2002 and 2001
2002 2001
-----------------------------------
Assets
Current assets
Cash $ 519,748 $ 149,165
Trade receivables, net of allowance for doubtful accounts of $1,918,673
at June 30, 2002 and $1,103,603 at June 30, 2001. 2,247,129 1,099,744
Accounts receivable - related party - 90,109
Inventories 23,416 44,726
Prepaid expenses 607,857 115,935
Common stock subscriptions receivable - 107,000
Credit card reserves, net of allowance for doubtful accounts of $137,370
at June 30, 2002 and $173,000 at June 30, 2001. 1,022,701 1,187,502
Other current assets - 3,220
-----------------------------------
Total current assets 4,420,851 2,797,401
Property and equipment, net 409,460 774,862
Goodwill, net 455,177 588,544
Trade receivables, net of allowance for doubtful accounts of $1,357,938
at June 30, 2002 and $1,011,774 at June 30, 2001. 1,673,740 900,198
Other assets, net of allowance for doubtful accounts of $0 at June 30, 2002
and $1,390,640 at June 30, 2001. 417,384 993,992
-----------------------------------
Total Assets $ 7,376,612 $ 6,054,997
===================================
Liabilities and Stockholders' Equity / (Capital Deficit)
Current liabilities
Accounts payable $ 1,215,400 $ 2,146,208
Accounts payable - related party 111,702 516,858
Bank overdraft 150,336 666,683
Accrued wages and benefits 681,472 581,400
Past due payroll taxes 26,797 497,617
Accrued liabilities 548,016 567,916
Current portion of capital lease obligations 80,938 37,802
Current portion of notes payable 160,671 97,779
Notes payable - officers and stockholders - 490,000
Loan payable - 100,000
Other current liabilities 450,523 423,578
Current portion of deferred revenue 705,558 5,618,849
Convertible debenture - 2,405,062
-----------------------------------
Total current liabilities 4,131,413 14,149,753
Deferred revenue, net of current portion - 414,743
Convertible long term notes - 442,172
Capital lease obligations, net of current portion 27,906 -
Notes payable, net of current portion 393,560 -
-----------------------------------
Total liabilities 4,552,879 15,006,667
-----------------------------------
Commitments and contingencies - -
Minority interest 355,159 355,159
-----------------------------------
Stockholders' Equity / (Capital Deficit)
Capital stock, par value $.001 per share
Preferred stock - authorized 5,000,000 shares; none issued - -
Common stock - authorized 100,000,000 shares; issued and outstanding
10,995,774 and 2,446,018 shares, at June 30, 2002 and June 30, 2001,
respectively 10,996 2,446
Additional paid-in capital 72,017,928 62,069,306
Common stock subscription - 398,200
Deferred compensation (34,987) (52,649)
Accumulated other comprehensive loss (4,902) (4,902)
Accumulated deficit (69,520,461) (71,719,230)
-----------------------------------
Total stockholders' equity / (capital deficit) 2,468,574 (9,306,829)
-----------------------------------
Total Liabilities and Stockholders' Equity / (Capital Deficit) $ 7,376,612 $ 6,054,997
===================================
See Notes to Consolidated Financial Statements
IMERGENT, INC. AND SUBSIDIARIES
(formerly Netgateway, Inc.)
Consolidated Statements of Operations for the
Years Ended June 30,
----------------------------------------------
2002 2001 2000
----------------------------------------------
Revenue $ 37,350,850 $ 43,000,533 $ 22,149,649
Cost of revenue 5,531,757 7,450,318 7,354,687
Cost of revenue - related party 994,043 975,257 1,110,404
----------------------------------------------
Total cost of revenue 6,525,800 8,425,575 8,465,091
----------------------------------------------
Gross profit 30,825,050 34,574,958 13,684,558
Product development 51,805 1,804,986 6,462,999
Selling and marketing 13,540,587 20,871,323 18,536,486
Selling and marketing - related party 479,984 78,435 -
General and administrative 5,691,434 7,083,426 24,517,450
Depreciation and amortization 668,730 1,296,519 1,191,143
Bad debt expense 6,675,238 3,475,492 1,159,022
Writedown of goodwill and acquired technology - 1,084,476 -
----------------------------------------------
Total operating expenses 27,107,778 35,694,657 51,867,100
Income (loss) from continuing operations 3,717,272 (1,119,699) (38,182,542)
Other income (expense) 432,184 93,088 (33,677)
Interest expense (1,950,687) (3,287,905) (4,573,695)
---------------- ---------------- -------------
Total other expenses (1,518,503) (3,194,817) (4,607,372)
----------------------------------------------
Income (loss) before discontinued operations and extraordinary items 2,198,769 (4,314,516) (42,789,914)
Discontinued Operations:
(Loss) from discontinued operations, less applicable tax expense
(benefit) of $0 - (285,780) (1,318,515)
----------------------------------------------
Income (loss) before extraordinary items 2,198,769 (4,600,296) (44,108,429)
Extraordinary items:
Loss on disposal of assets subsequent to merger - (1,091,052) -
Gain on disposal of segment subsequent to merger - 363,656 -
Gain from settlement of debt - 1,688,956 -
----------------------------------------------
Extraordinary items - 961,560 -
----------------------------------------------
Net income (loss) $ 2,198,769 $ (3,638,736) $(44,108,429)
==============================================
Basic earnings (loss) per share:
Income (loss) from continuing operations $ 0.37 $ (1.94) $ (23.12)
Income (loss) from discontinued operations - (0.12) (0.71)
Extraordinary items - 0.43 -
----------------------------------------------
Net income (loss) $ 0.37 $ (1.63) $ (23.83)
==============================================
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ 0.37 $ (1.94) $ (23.12)
Income (loss) from discontinued operations - (0.12) (0.71)
Extraordinary items - 0.43 -
----------------------------------------------
Net income (loss) $ 0.37 $ (1.63) $ (23.83)
==============================================
Weighted average shares outstanding:
Basic 5,873,654 2,227,965 1,851,114
Diluted 5,878,404 2,227,965 1,851,114
See Notes to Consolidated Financial Statements
IMERGENT, INC. AND SUBSIDIARIES
(formerly Netgateway, Inc.)
Consolidated Statements of Stockholders' Equity / (Capital Deficit)
For the Year Ended June 30, 2002, 2001, and 2000
Total
Accumulated Stockholders'
Common Stock Additional Common Other Equity
----------------- Paid-in Stock Deferred Accumulated Comprehensive (Capital
Shares Amount Capital Subscribe Compensation Deficit loss Deficit)
-------------------------------------------------------------------------------------------
Balance July 1, 1999 1,355,920 $ 1,355 $ 5,921,290 $ - $ (52,919) $(23,972,503) $ (3,598) $(8,106,375)
Common stock issued for prepaid
advertising 5,000 5 299,995 - - - - 300,000
Common stock issued for services 53,860 54 3,660,444 - - - - 3,660,498
Warrants issued to settle an
obligation - - 53,534 - - - - 53,534
Sale of common stock for cash 415,535 415 25,313,448 - - - - 25,313,863
Warrants issued for debt issue costs - - 145,876 - - - - 145,876
Conversion of debt to common stock 8,000 8 199,992 - - - - 200,000
Options issued for services - - 172,853 - - - - 172,853
Stock option compensation - - 1,069,900 - (1,069,900) - - -
Amortization of deferred compensation - - - - 615,825 - - 615,825
Exercise of warrants 2,587 3 27,868 - - - - 27,871
Cashless exercise of options and
warrants 118,877 119 (119) - - - - -
Common stock issued for cancellation
of options 120,000 120 8,399,880 - - - - 8,400,000
Exercise of stock options 34,572 35 1,174,784 - - - - 1,174,819
Common stock issued upon onversion
of subsidiary common stock 23,958 24 898,385 - - - - 898,409
Sale of common stock for cash 14,593 15 299,985 - - - - 300,000
Stock option compensation - - 255,000 - (218,000) - - 37,000
Common stock issued in business
acquisition 11,971 12 138,613 - - - - 138,625
Comprehensive income (loss)
- --------------------------
Net income (loss) - - - - - (44,108,429) - (44,108,429)
Foreign currency translation
adjustment - - - - - - (669) (669)
----------------
Comprehensive income (loss) (44,109,098)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance June 30, 2000 2,164,873 2,165 58,031,728 - (724,994) (68,080,932) (4,267) (10,776,300)
Common stock issued upon conversion
of subsidiary common stock 3,714 4 139,286 - - - - 139,290
Stock options exercised 2,001 2 6,773 - - - - 6,775
Shares issued for services 4,780 5 17,195 - - - - 17,200
Amortization of deferred compensation - - - - 258,375 - - 258,375
Forfeiture of stock options - - (413,970) - 413,970 - - -
Beneficial conversion feature on
convertible debenture - - 884,000 - - - - 884,000
Warrants issued for convertible
debentures - - 371,000 - - - - 371,000
Repricing of warrants issued for
convertible debentures - - 9,008 - - - - 9,008
Warrants issued for restructuring of
debenture - - 129,927 - - - - 129,927
Debt discount on convertible note
warrants - - 512,540 - - - - 512,540
Beneficial conversion feature on
convertible note - - 1,347,480 - - - - 1,347,480
Partial conversion of convertible
debenture 80,000 80 199,920 - - - - 200,000
Conversion of related party note
payable 39,333 39 117,961 - - - - 118,000
Coversion of officers accrued
liabilities 151,317 151 453,799 - - - - 453,950
Warrants issued for services - - 223,903 - - - - 223,903
Imputed Interest on notes payable to
officers - contributed - - 38,756 - - - - 38,756
Private placement offering
subscriptions received, net - - - 398,200 - - - 398,200
Comprehensive income (loss)
- ---------------------------
Net income (loss) - - - - - (3,638,736) - 3,638,736)
Foreign currency translation
adjustment - - - - - 438 (635) (197)
----------------
Comprehensive income (loss) (3,638,933)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance June 30, 2001 2,446,018 2,446 62,069,306 398,200 (52,649) (71,719,230) (4,902) (9,306,829)
Stock options exercised 691 1 1,726 - - - - 1,727
Amortization of deferred compensation - - - - 16,145 - - 16,145
Forfeiture of deferred compensation - - (1,517) - 1,517 - - -
Imputed Interest on officer/director
notes payable - - 12,639 - - - - 12,639
Stock options issued to consultants - - 6,400 - - - - 6,400
Common stock issued for loan
restructuring 10,000 10 12,990 - - - - 13,000
Conversion of convertible
debenture 280,000 280 2,115,604 - - - - 2,115,884
Conversion of long term notes 859,279 859 2,146,436 - - - - 2,147,295
Private placement of common
stock 7,164,094 7,164 5,103,748 (398,200) - - - 4,712,712
Common stock shares issued for
outstanding liabilities 83,192 83 449,148 - - - - 449,231
Common stock shares issued for
services 132,500 133 15,468 - - - - 15,601
Common stock issued for settlement
agreements 20,000 20 85,980 - - - - 86,000
Comprehensive income (loss)
- --------------------------
Net income - - - - - 2,198,769 - 2,198,769
Foreign currency translation
adjustment - - - - - - - -
--------------
Comprehensive income (loss) 2,198,769
- ----------------------------------------------------------------------------------------------------------------------------------
Balance June 30, 2002 10,995,774 $10,996 $72,017,928 $ - $ (34,987) $(69,520,461) $ (4,902) $ 2,468,574
==============================================================================================
See Notes to Consolidated Financial Statements
IMERGENT, INC AND SUBSIDIARIES
(formerly Netgateway, Inc.)
Consolidated Statements of Cash Flows
For the Years Ended June 30,
2002 2001 2000
----------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income (loss) from continuing operations $ 2,198,769 $ (4,314,516) $ (42,789,914)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization 668,730 1,296,519 1,191,143
Amortization of deferred compensation 16,145 258,375 652,825
Write down of goodwill and acquired technology - 1,084,476 -
Expense for stock options issued to consultant 6,400 - -
Provision for bad debts 6,675,238 3,475,492 1,159,022
Interest expense from beneficial conversion feature - 884,000 -
Imputed interest expense on notes payable 12,639 38,756 -
Loss on issue of common stock below market value 199,657 - -
Common stock issued for loan restructuring 13,000 - -
Common stock issued for services 15,601 17,200 3,660,498
Warrants and options issued for services - 81,315 263,387
Amortization of debt issue costs 437,478 496,530 585,592
Amortization of beneficial conversion feature & debt discount 1,956,600 366,966 4,022,550
Stock issued in exchange for cancellation of options - - 8,400,000
Changes in assets and liabilities:
Trade receivables and unbilled receivables (8,250,722) (3,312,950) (3,208,334)
Inventories 21,310 17,299 (31,024)
Prepaid expenses and other current assets (381,702) 867,494 -
Credit card reserves (90,533) (598,324) -
Other assets (65,415) (51,204) (871,561)
Deferred revenue (5,328,034) (9,460,686) 8,023,545
Accounts payable, accrued expenses and other liabilities (1,654,092) 1,506,135 2,502,544
-----------------------------------------------------
Net cash used in continuing operating activities (3,548,931) (7,347,123) (16,439,729)
Net cash used in discontinued operations - (655,220) (200,544)
-----------------------------------------------------
Net cash used in operating activities (3,548,931) (8,002,343) (16,640,273)
-----------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of subsidiary - 300,000 -
Acquisition of equipment (99,579) (100,765) (2,946,055)
Collection of notes receivable - - 30,000
Proceeds from disposition of equipment 660 - -
-----------------------------------------------------
Net cash provided by (used in) investing activities (98,919) 199,235 (2,916,055)
-----------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from common stock subscribed - 291,200 -
Proceeds from issuance of common stock 4,712,712 - 25,313,863
Proceeds from exercise of options and warrants 1,727 6,775 1,202,690
Bank overdraft borrowings (516,347) 355,007 64,883
Proceeds from issuance of notes payable - officers - 821,000 -
Proceeds from issuance of convertible long-term notes 273,976 2,076,500 -
Proceeds from issuance of long term debenture - 1,114,950
Proceeds from issuance of convertible debenture - 2,500,000 -
Proceeds from loan payable - 100,000 -
Proceeds from financing of insurance premium 144,486 - -
Repayment of convertible debenture (100,000) (152,212) -
Repayment of notes payable - officers - (213,000) -
Repayment of note payable - bank (97,779) - -
Repayment of capital lease obligations - (69,963) -
Repayment of note to related party (380,000) - (1,799)
Repayment of notes (20,342) - (6,433,500)
Cash paid for debt issue costs - (370,025) (64,771)
-----------------------------------------------------
Net cash provided by financing activities 4,018,433 5,345,282 21,196,316
-----------------------------------------------------
NET INCREASE (DECREASE) IN CASH 370,583 (2,457,826) 1,639,988
CASH AT THE BEGINNING OF THE YEAR 149,165 2,606,991 967,672
Effect of exchange rate changes on cash balances - - (669)
-----------------------------------------------------
CASH AT THE END OF THE YEAR $ 519,748 $ 149,165 $ 2,606,991
=====================================================
Supplemental disclosures of non-cash transactions:
Subscribed stock issued 398,200 - -
Conversion of debenture to common stock 2,115,884 200,000 200,000
Conversion of notes payable - officers to common stock - 118,000 -
Conversion of amounts due to officers to common stock - 453,950 -
Conversion of long term notes to common stock 2,147,295 - -
Common stock issued for settlement agreements 86,000 - -
Value of warrants in connection with the issuance of convertible
debenture - 509,935 -
Value of warrants in connection with the issuance of convertible
long term notes - 655,128 -
Beneficial conversion feature on convertible long term notes - 1,347,480 -
Restructuring premium on convertible debentures - 375,000 -
Issuance of common stock for business acquisition - - 138,625
Warrants issued for debt issue costs - - 145,876
Common stock issued for prepaid advertising - - 300,000
Common stock issued for outstanding liabilities 449,231 - -
Convertible debenture settled for note payable 400,000 - -
Accrued interest added to note payable balance 30,087 - -
Fixed assets acquired through capital lease obligations 71,042 - -
Supplemental disclosure of cash flow information:
Cash paid for Interest 3,359 109,940 883,139
See Notes to Consolidated Financial Statements
IMERGENT, INC. AND SUBSIDIARIES
(formerly Netgateway, Inc.)
Notes to Consolidated Financial Statements
June 30, 2002, 2001 and 2000
(1) Description of Business
Imergent, Inc. (formerly known as "Netgateway, Inc.", referred to
hereinafter as Imergent or the "Company"), was incorporated as a Nevada
corporation on April 13, 1995. In November 1999, it was reincorporated under the
laws of Delaware. Effective July 3, 2002, a Certificate of Amendment was filed
to its Certificate of Incorporation to change its name to Imergent, Inc.
Imergent is an e-Services company that provides eCommerce technology, training
and a variety of web-based technology and resources to over 100,000 small
businesses and entrepreneurs annually. The Company's affordably priced
e-Services offerings leverage industry and client practices, and help increase
the predictability of success for Internet merchants. The Company's services
also help decrease the risks associated with e-commerce implementation by
providing low-cost, scalable solutions with minimal lead-time, ongoing industry
updates and support. The Company's strategic vision is to remain an eCommerce
provider tightly focused on its target market.
During the year ended June 30, 2001 the Company consolidated its
operations into one facility in Utah. During this process certain equipment was
disposed of and the net book value of the equipment was written off. The write
down of these assets are included as an extraordinary item due to the fact that
they were part of previously separate entities in a pooling of interests
combination at June 30, 2000. In addition, in January 2001, the Company sold one
of its subsidiaries that was previously reported as a separate segment, and
accordingly has reported the gain realized on the sale as an extraordinary item
in the accompanying consolidated financial statements. During the year ended
June 30, 2001, the Company settled certain of its liabilities with its vendors
for amounts less than the outstanding balances. The gain realized on these
settlements has been recorded as an extraordinary item in the accompanying
consolidated financial statements.
In January 2001, the Company sold one of its subsidiaries that was
previously reported as a separate segment, and accordingly has reported the
operations as discontinued operations in the accompanying consolidated financial
statements.
(2) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries which include Netgateway, Galaxy
Enterprises, Inc., Galaxy Mall, Inc., StoresOnline Inc., StoresOnline, LTD., and
StoresOnline.com, Inc. The acquisition of Galaxy Enterprises ("Galaxy") by
Imergent on June 26, 2000 was accounted for under the pooling-of-interests
method and accordingly all periods prior to the acquisition have been restated
to include the accounts and results of operations of Galaxy Enterprises. All
Galaxy common stock and common stock option information has been adjusted to
reflect the exchange ratio. All significant intercompany balances and
transactions have been eliminated in consolidation.
(b) Reverse Stock Split
On June 28, 2002 the shareholders of the Company approved a one-for-ten
reverse split of the Company's outstanding common stock shares, which became
effective July 3, 2002. All data for common stock shares, options and warrants
have been adjusted to reflect the one-for-ten reverse split for all periods
presented. In addition, all common stock share prices and per share data for all
periods presented have been adjusted to reflect the one-for-ten reverse stock
split.
(c) Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventory consists mainly of products provided in conjunction with the
Internet training workshops.
(d) Property and Equipment
Property and equipment are stated at cost. Depreciation expense is
computed principally on the straight-line method in amounts sufficient to
allocate the cost of depreciable assets, including assets held under capital
leases, over their estimated useful lives ranging from 3 to 5 years. The cost of
leasehold improvements is being amortized using the straight-line method over
the shorter of the estimated useful life of the asset or the terms of the
related leases. Depreciable lives by asset group are as follows:
Computer and office equipment ...................3 to 5 years
Furniture and fixtures...........................4 years
Computer software................................3 years
Leasehold improvements...........................term of lease
Normal maintenance and repair items are charged to costs and expenses
as incurred. The cost and accumulated depreciation of property and equipment
sold or otherwise retired are removed from the accounts and any related gain or
loss on disposition is reflected in net income for the period.
(e) Intangible Assets
Intangible assets are amortized on a straight-line basis over their
estimated useful lives as follows:
Acquired technology..........................5 to 7 years
Goodwill....................................... 10 years
As required by SFAS 142, beginning in July 1, 2003 goodwill will no
longer be amortized but will be tested on an annual basis for impairment by
comparing its fair value to its carrying value. If the carrying amount of
goodwill exceeds its fair value, an impairment loss will be recognized in an
amount equal to that excess.
(f) Product and Development Expenditures
Product and development costs are expensed as incurred. Costs related
to internally developed software are expensed until technological feasibility
has been achieved, after which the costs are capitalized.
(g) Impairment of Long-Lived Assets
The Company reviews long-lived assets and intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future undiscounted operating cash flows projected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell.
During the fiscal year ended June 30, 2001 the Company wrote off fixed
assets with a book value totaling $1,091,052 as part of the closing of the
American Fork, Long Beach, and Canadian offices included in extraordinary items
(See Note 20). In addition, as a result of corporate restructuring, acquired
technology and goodwill aggregating $1,084,476 was determined to be impaired and
was written off during the fiscal year ended June 30, 2001 (See note 9).
(h) Financial Instruments
The carrying values of cash, accounts receivable, notes receivable,
accounts payable, accrued liabilities, capital lease obligations, current
portion of notes payable and convertible debenture approximated fair value due
to either the short maturity of the instruments or the recent date of the
initial transaction or the restructuring.
(i) Income Taxes
Income taxes are accounted for under the asset and liability method.
The asset and liability method recognizes deferred income taxes for the tax
consequences of "temporary differences" by applying enacted statutory tax rates
applicable to future years to differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities.
Deferred tax assets are to be recognized for temporary differences that
will result in tax deductible amounts in future years and for tax carryforwards
if, in the opinion of management, it is more likely than not that the deferred
tax assets will be realized.
(j) Accounting for Stock Options
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations, in accounting for its
fixed plan employee stock options. As such, compensation expense would be
recorded on the date of grant only if the current market price of the underlying
stock exceeded the exercise price. Compensation expense related to stock options
granted to non-employees is accounted for under Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
whereby compensation expense is recognized over the vesting period based on the
fair value of the options on the date of grant.
(k) Revenue Recognition
During the year ended June 30, 2001, the Company changed its product
offering at its Internet training workshops. The date of the change was October
1, 2000, the beginning of the Company's second fiscal quarter of fiscal year
2001. Prior to that time, customers were sold a service consisting of the
construction of Internet websites for their business, which service was to be
provided at any time during the 12 months following the sale. Included in the
price paid for this service was one year's hosting beginning when the website
was published. Revenue from these transactions was deferred at the time of sale
and recognized as the services were rendered or when the right to receive the
services terminated.
Beginning October 1, 2000, the Company discontinued selling the service and
in its place sold a new product called the StoresOnline Software ("SOS"). The
SOS is a software product that enables the customer to develop their Internet
website without additional assistance from the Company. When a customer
purchases the SOS he or she receives a CD-ROM containing programs to be used
with their computer and a password and instructions that allow access to the
Company's website where all the necessary tools are present to complete the
construction of the customer's website. When completed, the website can be
hosted with the Company or any other provider of such services. If they choose
the Company, an additional setup and hosting fee (currently $150) is required
for publishing and 12 months of hosting. This fee is deferred at the time of
sale and recognized over the subsequent 12 months.
The revenue from the sale of the SOS is recognized when the product is
delivered to the customer. The Company accepts cash and credit cards as methods
of payment and offers 24-month installment contracts to customers who prefer an
extended payment term arrangement. The Company offers these contracts to all
workshop attendees not wishing to use a check or credit card provided they
complete a credit application, give the Company permission to independently
check their credit and are willing to make an appropriate down payment.
Installment contracts are carried on the Company's books as a receivable and the
revenue generated by these installment contracts is recognized when the product
is delivered to the customer and the contract is signed. This new revenue
recognition procedure was in effect for the last three quarters of fiscal year
2001 and for all of fiscal year 2002.
Extended payment term arrangements for software sales that are longer
than 12 months are governed by the AICPA Statement of Position 97-2, Software
Revenue Recognition. This Statement of Position permits the recognition of
revenue at the time of sale, rather than as the monthly payments become due, if
the vendor's fee is fixed or determinable and collectibility is probable.
Paragraph 28 states, "...Further, if payment of a significant portion of the
software licensing fee is not due until after expiration of the license or more
than twelve months after delivery, the licensing fee should be presumed not to
be fixed or determinable. However, this presumption may be overcome by evidence
that the vendor has a standard business practice of using long-term or
installment contacts and a history of successfully collecting under the original
payment terms without making concessions." The Company has been offering these
24-month installment contracts for more than four years and collecting them
without making concessions, as defined in the AICPA Technical Practice Aids
5100.56. Therefore it is appropriate that the Company recognize the revenue at
the time of delivery of the product
SOP 97-2 states that revenue from the sale of software should be
recognized when the following four specific criteria are met: 1) persuasive
evidence of an arrangement exists, 2) delivery has occurred, 3) the fee is fixed
and determinable and 4) collectibility is probable. All of these criteria are
met when a customer purchases the SOS product. The customer signs a Company
order form and a receipt acknowledging a sale and receipt and acceptance of the
product. As noted on the order and acceptance forms, all sales are final. All
fees are fixed and final. Some states require a three-day right to rescind the
transaction. Sales in these states are not recognized until the rescission
period has expired. The Company offers customers the option to pay for the SOS
with Extended Payment Term Arrangements (EPTAs). The EPTAs generally have a
twenty-four month term. The Company has a standard of using long-term or
installment contracts and has a four-year history of successfully collecting
under the original payment terms without making concessions. Over the past four
years the Company has collected or is collecting approximately 70% to 80% of all
EPTAs issued to customers. Not all customers live up to their obligations under
the contracts. The Company makes every effort to collect on the EPTAs, including
the engagement of professional collection services. Despite the Company's
efforts, approximately 20 percent of all EPTAs are determined to be
uncollectible. All uncollectible EPTAs are written off against an allowance for
doubtful accounts, which allowance is established at the time of sale based on
the Company's four-year history of extending EPTAs. As a result, revenue from
the sale of the SOS is recognized upon the delivery of the product.
Revenue related to the sale of certificates for web site hosting and
banner licenses is recognized over the period representing the life of the
certificate and the length of the prepaid service. Revenue related to banner
advertising services is recognized over the period such advertising is usable
and revenue related to the delivery of mentoring services is recognized over the
estimated service period. Revenue recorded relating to the sale of merchant
account software is reflected net of the cost of the product paid since the
Company does not take title to the product prior to its sale.
Revenues relating to the design and development of Internet Web sites
and related consulting projects is recognized using the percentage-of-completion
method. Unbilled receivables represent time and costs incurred on projects in
progress in excess of amounts billed, and are recorded as assets. Deferred
revenue represents amounts billed in excess of costs incurred, and is recorded
as a liability. To the extent costs incurred and anticipated costs to complete
projects in progress exceed anticipated billings, a loss is recognized in the
period such determination is made for the excess.
(l) Comprehensive Income (Loss)
Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income" establishes standards for reporting and
displaying comprehensive income (loss) and its components in a full set of
general-purpose financial statements. This statement requires that an enterprise
classify items of other comprehensive income (loss) by their nature in a
financial statement and display the accumulated balance of other comprehensive
income (loss) separately from retained earnings and additional paid-in capital
in the equity section of a statement of financial position. The Company's only
other comprehensive income (loss) were foreign currency translation adjustments
related to its Canadian subsidiary, StoresOnline, Ltd.
(m) Business Segments and Related Information
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" establishes standards for the way public business enterprises are
to report information about operating segments in annual financial statements
and requires enterprises to report selected information about operating segments
in interim financial reports issued to shareholders. It also establishes
standards for related disclosure about products and services, geographic areas
and major customers.
The Company has historically operated under two principal business
segments (Internet services and multimedia products). The primary business
segment (Internet services) is engaged in the business of providing its
customers the ability to (i) acquire a presence on the Internet and (ii) to
advertise and sell their products or services on the Internet. A secondary
business segment (multimedia services) was engaged in providing assistance in
the design, manufacture and marketing of multimedia brochure kits, shaped
compact discs and similar products and services intended to facilitate
conducting business over the Internet. This second segment was sold on January
11, 2001 and the gain on the sale is reported as an extraordinary item in the
accompanying consolidated financial statements. As a result, the Company
currently operates in one business segment.
(n) Foreign Currency Translation
The financial statements of the Company's Canadian subsidiary,
StoresOnline.com, Ltd. have been translated into U.S. dollars from its
functional currency in the accompanying consolidated financial statements in
accordance with Statement of Financial Accounting Standards No. 52, "Foreign
Currency Translation." Balance sheet accounts of StoresOnline.com, Ltd. are
translated at period-end exchange rates while income and expenses are translated
at the average of the exchange rates in effect during the period. Translation
gains or losses that related to the net assets of StoresOnline.com Ltd. are
shown as a separate component of stockholders' equity (capital deficit) and
comprehensive income (loss). There were no gains or losses resulting from
realized foreign currency transactions (transactions denominated in a currency
other than the entities' functional currency) during the years ended June 30,
2002, 2001 and 2000.
(o) Per Share Data
Basic net income (loss) per share is computed by dividing net income
(loss) available to common shareholders by the weighted average number of common
shares outstanding during the period. Diluted net income (loss) per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity.
Unexercised stock options to purchase 313,265 shares of the Company's
common stock and unexercised warrants to purchase 502,212 shares of the
Company's common stock were outstanding as of June 30, 2002, of which 1,236
stock options and 2,278 warrants were included in the diluted per share
computation. Unexercised stock options to purchase 374,038 and 451,265 shares of
the Company's common stock and unexercised warrants to purchase 210,735 and
122,490 shares of the Company's common stock at June 30, 2001 and 2000,
respectively, in addition to shares of common stock from the conversion of
subsidiary common stock and convertible debentures of 1,462,470 and 13,185 as of
June 30, 2001 and 2000, respectively, were not included in the per share
computations because their effect would have been antidilutive as a result of
the Company's loss.
(p) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities at the balance sheet date, and
the reporting of revenues and expenses during the reporting periods to prepare
these financial statements in conformity with accounting principles generally
accepted in the United States of America. Actual results could differ from those
estimates. The Company has estimated that allowances for bad debt for Trade
Receivables should be $3,276,611 as of June 30, 2002. In addition, the Company
has recorded an allowance for doubtful accounts of $137,370 for estimated credit
card chargebacks relating to the most recent 180 days of credit card sales.
(q) Reclassifications
Certain amounts reported in 2001 and 2000 have been reclassified to
conform to the 2002 presentation.
(r) Discontinued Operations
APB Opinion No. 30 states that discontinued operations refers to the
operations of a segment of a business that has been sold, abandoned, spun off,
or otherwise disposed of or, although still operating, is the subject of a
formal plan for disposal. In accordance with APB Opinion No. 30, the results of
continuing operations are reported separately from discontinued operations and
any gain or loss from disposal of a segment is reported in conjunction with the
related results of discontinued operations, except where such effect is
classified as an extraordinary item following a pooling-of-interests
combination. In accordance with APB Opinion No. 16, the difference between the
proceeds received from the sale of the Company's subsidiary and the carrying
amount of the Company's investment sold is reflected as an extraordinary gain on
disposal in the consolidated statements of operations.
(s) Advertising Costs
The Company expenses costs of advertising and promotions as incurred,
with the exception of direct-response advertising costs. SOP 97-3 provides that
direct-response advertising costs that meet specified criteria should be
reported as assets and amortized over the estimated benefit period. The
conditions for reporting the direct-response advertising costs as assets include
evidence that customers have responded specifically to the advertising, and that
the advertising results in probable future benefits. The Company uses
direct-response marketing to register customers for its workshops. The Company
is able to document the responses of each customer to the advertising that
elicited the response. Advertising expenses included in selling and marketing
expenses for the years ended June 30, 2002, 2001 and 2000 were approximately
$5.3 million, $6.0 million and $5.9 million, respectively. As of June 30, 2002
the Company recorded $217,534 of direct response advertising related to future
workshops as an asset.
(t) Commission Expense
Commission expense relating to third-party telemarketing activity is
recognized as incurred.
(u) Recently Issued Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No. 141, "Business Combinations"
and No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which
establishes new standards for the treatment of goodwill and other intangible
assets. SFAS 142 is effective for fiscal years beginning after December 31, 2001
and permits early adoption for companies with a fiscal year beginning after
March 15, 2001. The Company did not early adopt FAS 142. SFAS 142 prescribes
that amortization of goodwill will cease as of the adoption date. Additionally,
the Company will be required to perform an impairment test as of the adoption
date, annually thereafter, and whenever events and circumstances occur that
might affect the carrying value of these assets. The Company has not yet
determined what effect, if any, the impairment test of goodwill will have on the
Company's results of operations and financial position.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS 143). Under this standard, asset retirement
obligations will be recognized when incurred at their estimated fair value. In
addition, the cost of the asset retirement obligations will be capitalized as a
part of the asset's carrying value and depreciated over the asset's remaining
useful life. SFAS No. 143 is effective for fiscal years beginning after June 15,
2002. The Company does not expect that adoption of SFAS No. 143 will have a
material impact on its financial condition or results of operations.
In October, 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144). This standard requires
that all long-lived assets (including discontinued operations) that are to be
disposed of by sale be measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS 144 expands the scope of discontinued
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity and will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS 144 is
effective for fiscal years beginning after December 15, 2001. The Company does
not expect the implementation of SFAS 144 to have a material effect on its
financial condition or results of operations.
In April 2002, the FASB issued SFAS No. 145, Rescission of SFAS Nos. 4,
44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002
(SFAS 145). This standard rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64,
Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements and excludes
extraordinary item treatment for gains and losses associated with the
extinguishment of debt that do not meet the APB Opinion No. 30, Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (APB 30) criteria. Any gain or loss on extinguishment of debt that
was classified as an extraordinary item in prior periods presented that does not
meet the criteria in APB 30 for classification as an extraordinary item shall be
reclassified. SFAS 145 also amends SFAS 13, Accounting for Leases as well as
other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. Certain provisions of SFAS are effective for transactions occurring
after May 15, 2002 while others are effective for fiscal years beginning after
May 15, 2002. The Company has not assessed the potential impact of SFAS 145 on
its financial condition or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146). This standard addresses
financial accounting and reporting for costs associated with exit or disposal
activities and replaces 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) (EITF 94-3). SFAS
146 requires that a liability for costs associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF 94-3, a
liability for exit costs, as defined in EITF No. 94-3 were recognized at the
date of an entity's commitment to an exit plan. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated by the Company
after December 31, 2002.
(3) Business Combination
On June 26, 2000, the Company issued 392,998 shares of its common stock
in exchange for all of the outstanding common stock of Galaxy Enterprises. This
business combination has been accounted for as a pooling-of-interests and,
accordingly, the consolidated financial statements for periods prior to the
combination include the accounts and results of operations of Galaxy
Enterprises.
Prior to the combination, Galaxy Enterprises' fiscal year ended
December 31. In recording the pooling-of-interests combination, Galaxy
Enterprises' financial statements for the twelve months ended June 30, 1999,
were combined with the Company's financial statements for the same period. An
adjustment has been made to capital deficit to eliminate the effect of including
Galaxy Enterprises' results of operations for the six months ended December 31,
1998, in both the years ended June 30, 1999 and June 30, 1998. The adjustment
results in the Company eliminating the related net income of $1,733,441 in
fiscal year 1999, which includes $3.7 million in revenue.
The results of operations as previously reported by the separate
enterprises and the combined amounts presented in the accompanying consolidated
financial statements are summarized below:
c
------------------------ ---------------------
Nine months ended Year ended
March 31, 2000 June 30, 1999
------------------------ ---------------------
Net revenues:
Imergent $ 2,535,863 $ $157,282
Galaxy Enterprises 12,665,271 10,123,158
------------------------ ---------------------
Combined $ 15,201,134 $ 10,280,440
Discontinued Operations
Income (loss) from
discontinued operations (1,028,781) 3,013
Extraordinary item:
Imergent $ _ $ 1,653,232
Galaxy Enterprises - -
------------------------ ---------------------
Combined $ _ $ 1,653,232
Net (loss) income:
Imergent $ (28,178,092) $ (10,775,703)
Galaxy Enterprises (6,204,080) (4,367,788)
------------------------ ---------------------
Discontinued Operations (1,028,781) 3,013
------------------------ ---------------------
Combined (35,410,953) (15,140,478)
On January 7, 2000, prior to completion of the combination between
Imergent and Galaxy Enterprises, the Company advanced $300,000 in bridge
financing to Galaxy Enterprises for working capital purposes and for the payment
of certain professional fees incurred by Galaxy Enterprises in connection with
the merger. On February 4, 2000, the Company advanced an additional $150,000 to
Galaxy Enterprises for working capital purposes and for the payment of certain
professional fees incurred by Galaxy Enterprises in connection with the merger.
Each loan was secured by a pledge of Galaxy Enterprises' common stock from John
J. Poelman, the chief executive officer and largest shareholder of Galaxy
Enterprises prior to the merger. The notes bore interest at 9.5% and were due
and payable on the earlier of June 1, 2000 or the consummation date of the
merger. The maturity date of the notes was later extended to the earlier of
September 1, 2000 or the consummation date of the merger.
After completion of the merger, the Company contributed these loans to
the capital of its subsidiary, Galaxy Enterprises, and released the pledges
securing those loans. Prior to the consummation of the merger, the Company
entered into certain transactions in the normal course of business with Galaxy
Enterprises. For the year ended June 30, 2000, the Company generated revenue of
$470,000 from Galaxy Enterprises. For the year ended June 30, 2000, Galaxy
Enterprises generated revenue of $350,000 from Imergent. The revenue and
expenses associated with these intercompany transactions have been eliminated in
the consolidation of these entities.
(4) Going Concern
The accompanying financial statements have been prepared on the basis
that the Company will continue as a going concern, which contemplates the
realization of assets and satisfaction of liabilities in the normal course of
business. The Company has primarily incurred losses since its inception, and has
a cumulative net loss of a $69,520,461 through June 30, 2002. At June 30, 2002
the Company had working capital of $289,438 and an equity balance of $2,468,574.
For the years ended June 30, 2002, 2001 and 2000 the Company recorded negative
cash flows from continuing operations of $3,857,303, $8,002,343 and $16,640,273
respectively. The Company has historically relied upon private placements of its
stock and issuance of debt to generate funds to meet its operating needs.
Management's plans include the raising of additional debt or equity capital.
However, there can be no assurance that additional financing will be available
on acceptable terms, if at all. The Company continues to work to improve the
strength of its balance sheet and has restructured its ongoing operations in an
effort to improve profitability and operating cash flow. If adequate funds are
not generated the Company may not be able to execute its strategic plan and may
be required to obtain funds through arrangements that require it to relinquish
rights to all or part of the intellectual property of its Stores Online software
or control of its business. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
(5) Acquisitions
In January 1999, the Company acquired 100% of the outstanding stock of
Spartan Multimedia, Inc., a Canadian corporation, in exchange for 18,572 shares
of common stock of StoresOnline.com, Ltd., a wholly-owned Canadian subsidiary
valued at $557,145. The shares are convertible on a one-to-one basis into common
stock of the Company. The issuance of an additional 18,572 shares was contingent
upon the attainment of certain performance standards in future periods. In April
1999, the Board of Directors approved the issuance of the contingent shares and
waived the performance standards. Accordingly, the consideration increased to
$1,392,858. The acquisition of Spartan Multimedia, Inc. was recorded using the
purchase method of accounting. The consideration was allocated based on the
relative fair values of the tangible and intangible assets and liabilities
acquired. The operations of Spartan Multimedia, Inc. are included in the
consolidated statement of operations of the Company from January 15, 1999.
During the year ended June 30, 2001 the Company ceased the operations of
StoresOnline.com, Ltd. and has written off the net book value of the goodwill
related to the acquisition of StoresOnline.com, Ltd., a total of $834,331 that
is included in operating expenses for the year ended June 30, 2001.
The StoresOnline.com Ltd. shares held by third parties has been
recognized as a minority interest until such time as the shares are converted to
the Company's common stock. As of June 30, 2002, 27,649 shares had been
converted and recorded in stockholders' equity (capital deficit).
Effective May 31, 1999, Galaxy Enterprises acquired substantially all
the net assets of Impact Media, LLC ("Impact") using the purchase method of
accounting by assuming the liabilities of Impact. The purchase of Impact
resulted in the recording of goodwill in the amount of $117,655, which was the
extent to which liabilities assumed exceeded the fair values of the assets
acquired. The terms of the Impact Media acquisition provided for additional
consideration of up to 25,000 shares of common stock to be paid if certain
agreed-upon targets are met during the years ended May 31, 2000 and May 31,
2001. As of June 30, 2000, one of the targets had been met, and as a result
11,971 shares of the Company's common stock were transferred to the former
owners of Impact. The Company recorded additional goodwill of $138,625 for the
fair value of these shares as an additional investment in Galaxy Enterprises'
subsidiary, IMI, Inc. IMI, Inc. continued to conduct the business acquired from
Impact. In January 2001, the Company sold its ownership interest in IMI, Inc
(See Note 19).
(6) Change in Method of Accounting for Revenue
Effective October 1, 1999, the Company changed its method of accounting
for certain revenue from the completed contract method to the
percentage-of-completion method. The Company believes the
percentage-of-completion method more accurately reflects the earnings process
under the Company's contracts. The percentage-of-completion method is preferable
according to Statement of Position 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts, issued by the American
Institute of Certified Public Accountants. The new method has been applied
retroactively by restating the Company's consolidated financial statements for
prior periods in accordance with Accounting Principles Board Opinion No. 20.
The impact of the accounting change was a decrease in net loss and loss per
share as follows:
Net Loss Loss per Share
------------ ------------------
Three months ended September 30, 1999......$ 8,294 $0.00
Year ended June 30, 1999 ..................$ 13,858 $0.00
(7) Selling of Accounts Receivable With Recourse
The Company offers to customers the option to finance, through Extended
Payment Term Arrangements (EPTAs), purchases made at the Internet training
workshops. A significant portion of these EPTAs, are then sold, on a discounted
basis, to third party financial institutions for cash. EPTAs sold to third party
financial institutions are generally subject to recourse by the purchasing
finance company after an EPTA is determined to be uncollectible. For the fiscal
year ended June 30, 2002 the company sold contracts totaling $4,279,724. The
Company maintains a two percent bad debt allowance for doubtful accounts on all
EPTAs that are purchased by finance companies. The Company works with various
finance companies and continues to seek relationships with other potential
purchasers of these EPTAs.
(8) Property and Equipment
Property and equipment balances at June 30, 2002 and 2001 are
summarized as follows:
----------------------------------
2002 2001
----------------------------------
Computers and office equipment....... $ 1,384,557 $ 1,488,716
Furniture and fixtures.................... 10,406 10,406
Leasehold improvements................ 30,791 30,791
Software.................................. 847,448 820,472
Automobiles.................................. 31,000 -
Less accumulated depreciation.......... (1,894,742) (1,575,523)
----------------------------------
$ 409,460 774,862
==================================
Amounts included in property and equipment for assets capitalized under
capital lease obligations as of June 30, 2002 and 2001 are $422,106 and 394,384,
respectively. Accumulated depreciation for the items under capitalized leases
was $303,206 and 320,763 as of June 30, 2002 and 2001, respectively.
(9) Goodwill
Goodwill as of June 30, 2002 and 2001 is summarized as follows:
------------------------------------
2002 2001
------------------------------------
Goodwill $ 867,003 $ 867,003
Less accumulated amortization (411,826) (278,459)
------------------------------------
$ 455,177 $ 588,544
====================================
Net acquired technology and goodwill balances of $910,043 and $174,433 were
written off during the second quarter of Fiscal 2001 as part of a corporate-wide
business restructuring (see Note 2(g)).
(10) Loans Payable
In May 2001, the Company borrowed $100,000 from an individual who is
the principal member of the company that purchased IMI from the Company. The
amount was non-interest bearing and due on demand. In September 2001 the loan
was converted into 33,333 shares ($3.00 per share) of common stock of the
Company in connection with the Company's raising capital in a private placement
of equity securities (See Note 18).
(11) Notes Payable
A note payable of $97,779 to a financial institution, bearing interest at the
prime rate plus 3% per annum (10% at June 30, 2001) was due on November 1, 2001.
The note was secured by certain equipment of the Company and was guaranteed by
the Company's current Chief Executive Officer. The note was paid in full on
September 24, 2001. Notes payable at June 30, 2002 consist of $430,087 of
principal and interest payable to King William (see Note 13) and $124,144 due to
Imperial Premium Finance Company. Maturities of notes payable are as follows:
Year ending June 30,
2003 $ 160,671
2004 34,407
2005 34,407
2006 34,407
2007 290,339
Thereafter -
------------
$ 554,231
============
(12) Notes Payable - Officers and Stockholders
During the year ended June 30, 2001 several officers and members of the
Board of Directors loaned the Company an aggregate of $821,000. The loans were
non-interest bearing exclusive of a note in the amount of $250,000 that bears
interest at 18% per annum. The balance at June 30, 2001 was $140,000. The
Company has imputed interest on the non-interest bearing loans at the rate of
18% per annum and recorded an aggregate of $38,756 as interest expense and as a
contribution to capital during the year ended June 30, 2001. Principal payments
made during the year ended June 30, 2001 aggregated $213,000 and in April 2001
the Company's President exchanged $118,000 of the amount due for 39,333 shares
(market pricing on the date of conversion) of the Company's common stock. The
total balance of the notes payable to officers and directors at June 30, 2001
was $490,000.
During the year ended June 30, 2002 several officers and members of the
Board of Directors loaned the Company an aggregate of $273,976. Principal
payments made during the year ended June 30, 2002 totaled $380,000. In addition,
$383,976 was exchanged for 127,992 shares of common stock of the Company ($3.00
per share) during the year ended June 30, 2002.
(13) Convertible Debenture
In July 2000, the Company entered into a securities purchase agreement
with King William, LLC ("King William"). Under the terms of the agreement, the
Company issued to King William an 8% convertible debenture due July 31, 2003 in
the principal amount of $4.5 million. The debenture was convertible at King
William's option into the number of shares of our common stock at the lower of
$17.90 or a conversion rate of 80% of the average market price of the common
stock during any three non-consecutive trading days during the 20 trading days
prior to conversion. The purchase price for the debenture was payable in two
tranches. The first tranche of $2.5 million was paid at the closing in July
2000. The value of the beneficial conversion feature on the $2.5 million that
has been drawn down was recorded as additional paid in capital and interest
expense of $884,000 for the year ended June 30, 2001, as the convertible
debentures were immediately exercisable.
In connection with the securities purchase agreement, the Company
issued to King William a warrant to purchase 23,100 shares of the Company's
common stock. In connection with the issuance of the debenture, the Company also
issued to Roth Capital Partners, Inc., a warrant to purchase 9,000 shares of
common stock and to Carbon Mesa Partners, LLC, a warrant to purchase 1,000
shares of common stock. Each of the warrants is exercisable for five years from
the date of issue, at an exercise price of $16.25 per share and with cashless
exercise and piggyback registration rights. The fair value of the warrants has
been determined to equal $371,000 using the Black-Scholes pricing model with the
following assumptions: dividend yield of zero, expected volatility of 80%,
risk-free interest rate of 6.5% and expected life of 5 years. The $371,000 was
accounted for as additional paid in capital and debt discount and was amortized
over the life of the debt. The unamortized balance at June 30, 2002 and 2001 is
$0 and $168,636, respectively.
Effective January 25, 2001, the Company reached an agreement with King
William to restructure the debenture (the "Restructuring Agreement"). As of the
date of the Restructuring Agreement the Company was in breach and/or violation
of the Purchase Agreement, the Debenture, the King William Warrant Agreement,
the Registration Rights Agreements and the Equity Agreement. However, pursuant
to the terms of the Restructuring Agreement the holder of the convertible
debenture has waived all of these defaults as of the date of the Restructuring
Agreement. Under the terms of the Restructuring Agreement the agreements were
terminated effective as of the date of the Restructuring Agreement and no
termination payment or additional warrants were issued in connection therewith.
Under the terms of the Restructuring and Amendment Agreement the second
tranche of the debenture will not be available to the Company. The Company
agreed to repay the full amount of the Debenture plus a 15% premium ($375,000)
with respect to the original principal amount in ten payments. As of the date of
the Restructuring and Amendment Agreement the principal amount including accrued
and unpaid interest was $2,972,781. Additionally, the Company has allowed King
William to retain the right to convert any or all portions of the outstanding
debt to equity, but only after the stock has traded at or above $30.00 for
twenty consecutive trading days, or if the Company does not make a required
payment of principal. Warrants already earned by King William were re-priced at
$2.50 per share and King William was issued a warrant for an additional 26,900
shares of common stock at $2.50 per share. The incremental fair value of the
re-pricing of the warrants and the issuance of new warrants, valued using the
Black-Scholes pricing model with the following assumptions: dividend yield of
zero, expected volatility of 170%, risk-free interest rate of 5% and expected
life of 5 years, was $9,008 and $129,927, respectively. These costs were
classified on the balance sheet as debt financing costs and were being amortized
over the life of the debt. The unamortized balance as of June 30, 2002 and 2001
is $0 and $75,783, respectively. The initial payment of $250,000, as called for
by the Restructuring and Amendment Agreement, was made during the first week of
February 2001. A second payment to be paid on February 28, 2001 was not made.
In May 2001 King William elected to convert $200,000 of the principal
and accrued and unpaid interest of the debenture (Conversion Amount) into 80,000
shares of Common Stock of the Company, at a conversion price of $2.50 per share.
The Conversion Amount was credited toward the payment of $250,000 due on
February 28, 2001, with the balance plus interest accrued to be paid on March
10, 2002. In addition, in May 2001, the Company entered into a Waiver Agreement
with King William, LLC to amend certain of the terms of the Restructuring
Agreement and to waive certain existing defaults under the Restructuring
Agreement. The Waiver Agreement amended the Restructuring Agreement payment
schedule to postpone the remaining April 2001 payment of $247,278 to February
2002 and the May 2001 payment of $247,278 to March 2002. As of the date of the
Waiver Agreement King William has withdrawn and waived all defaults and
violations.
Effective July 11, 2001 the Company and King William entered into a
Second Restructuring Agreement. The Company agreed to pay, and King William
agreed to accept, in full and final satisfaction of the Debenture at a closing
effective September 10, 2001, (i) a cash payment of $100,000, (ii) a $400,000
promissory note of the Company due August 2004 bearing interest at 8% per annum
and (iii) 280,000 shares of the Company's common stock. No accrued interest was
payable in connection with these payments. King William has agreed to certain
volume limitations relating to the subsequent sale of its shares of the
Company's common stock and has also agreed to forgive the promissory note if the
Company meets certain specific requirements including a minimal amount
($2,250,000) of proceeds King William receives from its sale of Company common
stock. The Final Conversion Shares insure that King William will receive
sufficient shares so that on the day of the closing King William will
beneficially own common shares equal to 9.99% of the then outstanding shares of
the Company. In September 2001 the Company issued the final conversion shares
equal to 280,000. No gain or loss on the exchange of shares for debt was
recorded in the accompanying financial statements. The Company was in default
under the Second Restructuring Agreement for failure to make interest payments
on November 10, 2001 and February 10, 2002, as called for by the agreement. King
William may have accelerated payment of the unpaid balance of the note plus
accrued interest upon written notice to the Company. No written notice of
default had been received.
Effective February 13, 2002 the Company and King William agreed to
amend certain terms of the Second Restructuring Agreement. The New Note is
amended to provide for a final maturity on July 10, 2006 and to provide that
interest shall accrue at the rate stated in the New Note and be added to the
principal balance until August 13, 2002. In addition, interest payable may be
paid in either cash or common stock of the Company, which common stock is to be
valued at an amount equal to the average closing bid price of the Company's
common stock during the five trading days prior to the date the interest payment
is made. Upon the signing of this agreement the Company issued 10,000 shares of
restricted common stock valued at $13,000. The Company is no longer required to
file a registration statement with respect to the common stock of the Company
currently held by King William or acquirable by it upon exercise of the warrants
held by it. King William has waived any default by the Company under the Second
Agreement and the New Note. Finally, the selling limitations in Section 4 of the
Second Agreement are no longer in effect and King William is only bound by the
limitations under Rule 144 relating to the resale of any securities.
(14) Convertible Long Term Notes
In January and April 2001, the Company issued long term Convertible
Promissory Notes ("Notes") in a private placement offering totaling $2,076,500.
The terms of Notes required them to be repaid on July 1, 2004 and April 4, 2004,
respectively, plus accrual of interest at the rate of eight percent (8%) per
annum. The Notes were convertible prior to the Maturity Date at the option of
the Holder any time after July 1, 2001, or by the Company at any time after July
1, 2001 upon certain conditions as detailed in the Notes. The Notes were
convertible into shares of common stock of the Company by dividing the Note
balance on the date of conversion by $2.50, subject to Conversion Price
Adjustments as defined in the agreement. The relative fair value of this
Beneficial Conversion Feature of the notes was calculated to be $1,347,480 and
was recorded as debt discount on the balance sheet, and was amortized over the
life of the Notes in accordance with Emerging Issues Task Force issue 00-27
effective November 16, 2000.
In connection with the sale of the Notes, the Company issued a warrant
to purchase a share of the Company's common stock at an exercise price of $5.00
per share for every two shares of Common Stock into which the Note is originally
convertible. The Company issued a total of 366,100 warrants in connection with
the sale of the Notes, with a date of expiration not to exceed sixty calendar
days following the commencement date of the warrants. The relative fair value of
the warrants has been determined to be $512,540 and has been recorded as debt
discount on the balance sheet and is amortized over the life of the Notes in
accordance with Emerging Issues Task Force issue 00-27 effective November 16,
2000. None of the warrants were exercised.
The beneficial conversion feature and debt discounts of $1,347,480 and
$512,540, respectively, have been netted against the $2,076,500 balance of the
Notes on the Balance Sheet and are being amortized over the life of the Notes in
accordance with Emerging Issues Task Force issue 00-27 effective November 16,
2000. The unamortized balance of the beneficial conversion feature and debt
discount at June 30, 2002 and 2001 was $0 and $1,634,328, respectively.
On July 15, 2001 the Company sent a letter to all holders of the Notes
explaining their right to convert their investment into common stock. The letter
included a calculation of the interest the note holder had earned and offered to
convert both the principal balance of the Note and the accrued interest into
common stock at a conversions price of $2.50 per share.
As of December 31, 2001, all Note holders, holding $2,147,295 of
aggregate principal and accrued interest, had exercised their right to convert
both principal and accrued interest into 859,279 shares of common stock.
(15) Income Taxes
Income tax expense for the years ended June 30, 2002, 2001 and 2000
represents the Utah and California state minimum franchise tax and is included
in selling, general and administrative expenses in the accompanying consolidated
statements of operations.
Income tax (benefit) expense attributable to income (loss) from
operations during the years ended June 30, 2002, 2001 and 2000 differed from the
amounts computed by applying the U.S. federal income tax rate of 34 percent as a
result of the following:
2002 2001 2000
Computed "expected" tax (benefit) expense $ 747,580 $ (1,237,170) $(14,996,866)
Decrease (increase) in income tax resulting
from: State and local income tax benefit, net of
federal effect 101,583 (192,125) (2,114,471)
Change in the valuation allowance for
deferred tax assets (5,634,171) 1,657,117 14,133,260
Other (including cancellation of debt) 4,785,008 (227,822) 122,077
Non-deductible stock compensation - - 2,856,000
---------------- ---------------- --------------
Income tax expense $ - $ - $ -
================ ================ ==============
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at June 30,
2002 and 2001 are presented below:
2002 2001
----------------------- --------------------
Deferred tax assets:
Net operating loss carryforwards $ 15,430,985 $ 17,754,865
Stock option expense 2,131,625 2,286,615
Deferred compensation 451,105 471,501
Accounts receivable principally due to
allowance for doubtful accounts 1,226,526 998,477
Accrued expenses 346,206 110,306
Other 13,801 112,926
Deferred revenue 263,255 2,413,436
Legal fees 429,439 460,524
Property and equipment 139,085 -
Debt issuance costs 74,024 1,550,938
-------------------- ------------------
Total gross deferred tax assets 20,506,051 26,159,588
Less valuation allowance (20,506,051) (26,140,222)
Deferred tax liability:
Property and equipment, principally due to
differences in depreciation - (19,366)
------------------- -------------------
Net deferred tax assets $ - $ -
======================= ====================
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become includable. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment. Based on
the projections for future taxable income over the periods which the deferred
tax assets are deductible, management believe it is more likely than not that
the Company will not realize the benefits of these deductible differences. Such
potential future benefits have been fully reserved, and accordingly, there are
no net deferred tax assets.
As of June 30, 2002, the Company has net operating loss ("NOL")
carryforwards of approximately of $40,000,000 available to reduce future taxable
income of which a substantial portion is subject to limitations in accordance
with Section 382 of the Internal Revenue Code. Additionally, the NOL
carryforwards may be subject to further limitations should certain future
ownership changes occur. The NOL carryforwards expire through 2022.
(16) Commitments and Contingencies
Operating Leases
The Company leases certain of its equipment and corporate offices under
long-term operating lease agreements expiring at various dates through 2005.
Future aggregate minimum obligations under operating leases as of June 30, 2002,
exclusive of taxes and insurance, are as follows:
Year ending June 30,
2003 $ 275,650
2004 279,975
2005 247,724
Thereafter -
---------------
Total $ 803,349
===============
Rental expense for the years ended June 30, 2002, 2001 and 2000 was
approximately $270,000, $582,000 and $721,000, respectively.
Employment Agreements
In connection with the merger in June 2000, the Company entered into
employment agreements with four of its employees expiring June 2002. The
agreements require aggregate salary payments of approximately $358,000, bonus
payments in September 2000 of approximately $69,000 and the granting of 78,000
options to purchase the Company's common stock with an exercise price to be
determined on the date of the grant. As of June 30, 2002 the options have not
been granted.
In January 2001, the Company entered into severance agreements with
three former executives of the Company. The agreements require cash payments
aggregating $97,000 through June 30, 2001, and two of them provide for a
one-half interest in certain licenses and equipment owned by the Company and a
grant of options to purchase common stock of the Company proportionate to any
options granted to the Chairman of Board of the Company. In August 2001, two of
the individuals issued a demand letter to the Company, claiming that certain
payments stipulated in the agreements had not been made and purporting to
reassert their rights under their respective employment agreements. These
demands were subsequently resolved and withdrawn. As of June 30, 2002 no options
have been granted to the Chairman of the Board or the former executives.
Private Placement of Stock
The private placement conducted in January-April 2001 to a group of
accredited investors occurred in part while a dormant but not effective
registration statement was on file with the SEC with respect to a public
offering of the Company's common stock by a third party deemed by current SEC
interpretations to be an offering by the Company. Although the Company believes
that these unregistered securities were issued pursuant to an available
exemption under applicable securities laws, other current interpretations by
securities regulators may not be consistent with their view and if in fact the
interpretation is proven incorrect then, among other consequences, the
purchasers of such securities would be entitled to exercise rescission rights
with respect to their investment of total proceeds of $2,076,500, plus interest
at rates determined by state statutes from the date of such offering to the date
of payment. If the Company were required to make such an offer and it was
accepted, then the required payments would exceed current cash resources of the
Company and would require the Company to seek additional financing, most likely
in the form of additional issuances of common stock, to make such payments and
would materially and adversely affect the financial condition of the Company.
Category 5 Complaint
On October 23, 2001, the Company signed an Agreement and Plan of Merger
with Category 5 Technologies, Inc. (C5T), pursuant to which, subject to
stockholder approval, the Company would be acquired through a merger of a
subsidiary of C5T into the Company. On January 15, 2002, the Company and C5T
issued a joint press release to announce that they had executed a Termination
and Release Agreement on January 14, 2002 to terminate the Agreement and Plan of
Merger and to abandon the merger contemplated by such agreement. Pursuant to and
upon the terms and conditions contained in the Termination and Release
Agreement, the Company agreed to pay a reimbursement fee of $260,630 in various
monthly installments of at least $20,000 to C5T in connection with the
termination of the merger. The Company did not pay the first monthly installment
due under the Termination and Release Agreement on February 1, 2002. On February
8, 2002, the Company received notice from Category 5 that it was in default
under the Termination and Release Agreement, and on February 12, 2002, the
Company received an acceleration notice from Category 5, whereby Category 5
demanded payment of the entire reimbursement fee plus interest by February 18,
2002. The February 18, 2002 payment was not made. On April 8, 2002, C5T filed a
Summons and Complaint against the Company for Breach of Contract, in the Third
Judicial District Court in and for Salt Lake County, State of Utah, whereby C5T
seeks judgment against the Company for breach of the Agreement and damages for
the full amount of the Expense Reimbursement Fee. On April 11, 2002 the Company
entered into a Waiver Agreement with C5T whereby payments due under the
Termination Agreement are postponed for one year. Under the Waiver Agreement,
the first payment will be due on February 1, 2003. The lawsuit has not, however,
been withdrawn and the Company has been given an extension of time to respond.
The Company does not believe that it is obligated to pay the Expense
Reimbursement Fee; however, the Company is continuing to evaluate this situation
and is working to resolve it. Due to the uncertainty of the outcome, the entire
$260,630 fee has been accrued by the Company and is carried as a current
liability.
Compliance with State and Federal Regulations
From time to time, the Company receives inquiries from attorney general
offices and other regulators about civil and criminal compliance matters with
various city, county, state and federal regulations. These inquiries sometimes
rose to the level of threatened or actual investigations and/or litigation. In
the past, the Company has received letters of inquiry from and/or has been made
aware of investigations by government officials of the states of Hawaii,
Illinois, Kentucky, Nebraska, North Carolina, Utah, Vermont, Texas, California
and others, as well as from a regional office of the Federal Trade Commission
and has responded to these inquiries and has generally been successful in
addressing the concerns of these persons and entities, although there is often
no formal closing of the inquiry or investigation. In the opinion of management,
the outcome of any of these presently existing matters should not have a
material adverse effect on the results of operations, cash flows or financial
position of the Company.
General Litigation
The Company is involved in various legal proceedings arising in the
normal course of its business. In the opinion of management, the outcome, if
any, resulting from these matters will not have a material adverse effect on the
results of operations, cash flows or financial position of the Company, but
there can be no guarantee to this effect.
(17) Stock Option Plan
In July 1998, the Board of Directors adopted the 1998 Stock
Compensation Program ("Program") which consists of, among other things, a
non-qualified stock option plan. An aggregate of 100,000 shares were reserved
for issuance under the Program. During the year ended June 30, 1999, the Company
granted 98,335 options under the Program at exercise prices greater than and
below the estimated market price of the Company's common stock on the date of
grant ranging from $20.00 to $133.00 per share. The weighted-average fair value
of options granted during the year ended June 30, 1999 under the Program was
$34.40 per share. During the year ended June 30, 2000, the Company granted
12,642 options under the Program at exercise prices greater than and below the
estimated market price of the Company's common stock on the date of grant
ranging from $35.00 to $60.00 per share. The weighted-average fair value of
options granted during the year ended June 30, 2000 under the Program was $35.90
per share. During the year ended June 30, 2001 the Company cancelled 60,326
options granted under the Program. The Company did not grant any options during
the year ended June 30, 2001. During the year ended June 30, 2002, 250 options
were cancelled. As of June 30, 2002 and 2001, options available for future
grants under the Program totaled 65,613 and 65,363, respectively.
In December 1998, the Board of Directors adopted the 1998 Stock Option
Plan (Plan) for Senior Executives. An aggregate of 500,000 shares were reserved
for issuance under the Plan. During the year ended June 30, 1999, the Company
granted 254,667 options under the Plan at exercise prices greater than and below
the estimated market price of the Company's common stock on the date of grant
ranging from $20.00 to $65.00 per share. The weighted-average fair value of the
options granted under the Plan during the year ended June 30, 1999 was $26.90
per share. Subsequent to June 30, 1999, 224,667 of these options were cancelled.
During the year ended June 30, 2000, the Company granted 55,071 options under
the Plan at exercise prices greater than and below the estimated market price of
the Company's common stock on the date of grant ranging from $35.00 to $92.50
per share. The weighted-average fair value of the options granted under the Plan
during the year ended June 30, 2000 was $67.30 per share. During the year ended
June 30, 2001 the Company granted 167,500 options under the Plan, with a
weighted-average fair value of $7.10 per share. During the year ended June 30,
2002, 18,750 options were cancelled. There were 370,625 and 351,875 options
available for future grants under the Plan as of June 30, 2002 and 2001,
respectively.
In July 1999, the Board of Directors adopted the 1998 Stock Option Plan
(Option Plan) for Non-Executives. An aggregate of 200,000 shares were reserved
for issuance under the Option Plan; the reserve amount was later increased to
500,000 shares. During the year ended June 30, 2000, the Company granted 223,783
options under the Option Plan at exercise prices greater than and below the
estimated market price of the Company's common stock on the date of grant
ranging from $17.80 to $145.00 per share. The weighted-average fair value of the
options granted under the Option Plan during the year ended June 30, 2000 was
$73.40 per share. Also during the year ended June 30, 2000, 27,978 of these
options were canceled. During the year ended June 30, 2001 the Company granted
165,550 options under the Option Plan, with a weighted-average fair value of
$7.40 per share. During the year ended June 30, 2002, the Company granted 6,000
options under the Option Plan, with a weighted average fair value of $5.20,
while 691 options were exercised. As of June 30, 2002 and 2001, there were
385,530 and 346,827 options, respectively, available for future grants under the
Option Plan.
Pursuant to the terms of the Company's merger with Galaxy Enterprises
in June 2000, each outstanding option to purchase shares of Galaxy Enterprises'
common stock under Galaxy Enterprises' 1997 Employee Stock Option Plan was
assumed by the Company, whether or not vested and exercisable subject to the per
share equivalent used to issue common shares in the merger accounted for as a
pooling of interests. The Company assumed options exercisable for an aggregate
of 106,347 shares of its common stock.
The following is a summary of stock option activity under the Company's
stock option plans:
----------------------------------------
Number of Shares Weighted average
exercise price
----------------------------------------
Balance at July 1, 1999 408,976 $ 36.50
Granted....................................... 346,050 66.00
Exercised.................................... (34,572) 34.00
Canceled or expired.......................... (269,189) 31.30
----------------------------------------
Balance at June 30, 2000 451,265 62.40
Granted...................................... 333,051 7.30
Exercised.................................... (2,001) 2.50
Canceled or expired.......................... (408,275) 45.00
----------------------------------------
Balance at June 30, 2001 374,038 21.10
Grantedn..................................... 6,000 5.20
Exercised.................................... (691) 2.50
Canceled or expired........................... (66,082) 8.70
---------------------------------------
Balance at June 30, 2002 313,265 $ 23.30
========================================
The following table summarizes information about shares under option as
of June 30, 2002:
- --------------------------------------------------------------------- -------------------------------
Outstanding Exercisable
- --------------------------------------------------------------------- -------------------------------
Weighted
Average
Remaining
Range of Exercise Number of Contractual Weighted-Average Number of Weighted-Average
Prices Options Life Price Options Price
- --------------------------------------------------------------------- -------------------------------
$.00 - $4.99 40,724 8.52 $ 2.50 40,724 $ 2.50
$5.00 - $7.49 47,250 8.42 5.03 42,563 5.03
$7.50 41,000 8.52 7.50 20,625 7.50
$7.60 - $10.00 42,750 8.50 9.99 875 9.99
$10.01 - $29.99 74,324 6.33 17.80 47,862 17.24
$30.00 - $59.99 16,330 7.57 37.70 16,172 37.77
$60.00 - $89.99 35,878 7.07 75.80 35,863 75.65
$90.00 - $113.10 15,009 7.18 103.80 14,344 102.99
---------------------------------------------- -------------------------------
313,265 7.70 $ 23.30 219,028 $ 27.70
============================================== ===============================
The Company applies APB Opinion No. 25 in accounting for stock options
granted to employees, under which no compensation cost for stock options is
recognized for stock option awards granted at or above fair market value. The
Company recognized $652,825 of compensation expense for options granted below
fair market value during the year ended June 30, 2000. The Company granted no
employee stock options below market price during the years ended June 30, 2002
and 2001.
Had the Company determined compensation cost based on the fair value at
the grant date for its stock options under SFAS No. 123, the Company's net
income (loss) would have been changed to the pro forma amounts indicated below
for the years ended June 30, 2002, 2001 and 2000.
2002 2001 2000
--------------------------------------------------
Net income (loss) as reported $ 2,198,769 $(3,638,736) $(44,108,429)
Net income (loss) proforma 1,839,009 $(5,396,419) $(46,776,831)
Net (income) loss per share as reported:
Basic $ 0.37 $(1.63) $(23.83)
Diluted $0.37 $(1.63) $(23.83)
Net (income) loss per share pro forma:
Basic $0.31 $(2.42) $(25.27)
Diluted $0.31 $(2.42) $(25.27)
The weighted average fair value at date of grant for options granted
during 2002, 2001 and 2000 was calculated using the Black-Scholes pricing model
with the following weighted average assumptions: dividend yield of zero for each
year, expected volatility of 262%, 384% and 80%, respectively, risk free
interest rate of 5%, 5%, and 5.5%, respectively and expected life of 4 years.
(18) Stockholders' Equity
Year ended June 30, 2000
In July 1999, the Company entered into a Cable Reseller and Mall
agreement with MediaOne of Colorado, Inc. (MediaOne) whereby the Company also
issued to MediaOne 5,000 shares of common stock and warrants to purchase 20,000
shares of common stock. The exercise price of the warrants is dependent upon the
market price of the Company's common stock on the date that the warrants are
earned under certain performance criteria. As of June 30, 2002, the performance
criteria had not been met.
In October 1999, the Company issued 118,877 shares of common stock upon
the cashless exercise of warrants and 120,000 shares of common stock valued at
$8,400,000 to three executives upon the cancellation of 198,000 options.
In November and December 1999, the Company sold 415,535 shares of
common stock in a public offering generating net proceeds of $25,313,863. The
Company also granted 19,025 warrants as stock issuance costs.
During the period December 1999 through June 2000, the Company issued
23,958 shares of common stock upon the exchange of common stock of its
StoresOnline.com, Ltd. subsidiary, pursuant to the terms of the original
issuance of StoresOnline.com Ltd.'s common stock.
During the year ended June 30, 2000, the Company issued 53,859 shares
of common stock valued at $3,660,498 for services, of which 50,000 shares were
issued to the chief executive officer of the Company.
During the year ended June 30, 2000, the Company sold 14,593 shares of
common stock in exchange for cash of $300,000.
Year ended June 30, 2001
During the year ended June 30, 2001, the Company issued 3,714 shares of
common stock upon the exchange of common stock of its StoresOnline.com, Ltd.
subsidiary, pursuant to the terms of the original issuance of common stock of
StoresOnline.com Ltd. In addition, the Company issued 2,001 shares upon the
exercise of employee options and issued 700 shares at fair market value on the
date of issuance of common stock pursuant to employment contracts during the
year ended June 30, 2001. The Company also issued 151,317 shares of common stock
to officers of the Company for payment of past due wages, employment agreement
obligations, and accrued liabilities at fair market value on the date of
issuance. In addition, the Company issued 39,333 shares of common stock to an
officer of the Company as payment in full of a note due to the officer, and
issued 4,080 shares of common stock to an outside party for services at fair
market value on the date of issuance.
In June 2001 pursuant to a private placement agreement, the Company
received subscription agreements aggregating $398,200 for the sale of common
stock at a price of $3.00 per share. As of June 30, 2001 the Company had
collected $291,200 of these subscriptions and recorded a receivable of $107,000
that was subsequently received.
Year ended June 30, 2002
On August 1, 2001, the Company entered into an agreement with
Electronic Commerce International ("ECI"), a company owned by Jay Poelman who
was at that time a director of and the president of the Company, pursuant to
which, among other matters, the Company agreed to issue to them a total of
83,192 shares of common stock of the Company at a price of $3.00 per share in
exchange for the release by ECI of trade claims by them against the Company
totaling $249,575. In connection with the exchange, the Company recorded a
charge of $199,657, representing the difference between the market value and the
exchange rate, which is included in cost of revenue.
During September 2001 the Company issued 280,000 common shares upon
conversion of a long-term convertible debenture (see Note 13).
On November 13, 2001, the Company issued 233,333 shares of the common
stock of the Company, and recorded an amount of $150,000 in its accounts
payable, pursuant to the October 10, 2001 agreement with SBI E-2 Capital (USA)
Ltd., for services as a financial advisor to the Company in connection with the
acquisition of the Company by Category 5 Technologies. A member of the Company's
Board of Directors at that time was a managing director of SBI E-2 Capital (USA)
Ltd. The business combination transaction between the Company and Category Five
Technologies, Inc. was never consummated. On account of the termination of this
proposed transaction, SBI E-2 Capital (USA) Ltd. was not able to complete the
provision of the financial advisory services to the Company. On February 1, 2002
an agreement was entered into between the Company and SBI E-2 Capital (USA) Ltd.
to rescind and nullify the issuance of the common stock pursuant to the October
10 agreement and the related designation by SBI E-2 Capital (USA) Ltd. of
certain persons to whom certain of the shares should be issued. Pursuant to the
Rescission Agreement, the certificates representing all 233,333 shares of the
common stock were returned to the Company, together with all documentation to
transfer legal title in the common stock back to the Company. In addition, SBI
E-2 and the designees disclaimed any interest whatsoever in the common stock.
Upon receipt of the certificates representing the common stock, the Company
directed its transfer agent to cancel the common stock from its books and
records. As a result of the Rescission Agreement, the Company did not record the
issuance of the shares during the three months ending December 31, 2001 and does
not reflect the shares outstanding as of June 30, 2002.
On November 28, 2001 the Company issued 5,000 shares of common stock as
settlement for contractual obligations to National Financial Communications
Corp. (NFCC).
On November 28, 2001 the Company issued 15,000 shares of common stock
as settlement for contractual obligations to Howard Effron.
During the twelve month period June 30, 2002, the Company converted
long-term convertible notes totaling $2,147,294 of principle and interest into
859,279 shares of common stock ( see Note 14.)
On February 27, 2002 the Company issued 10,000 shares of common stock
pursuant to the amendment of the Second Restructuring Agreement with King
William LLC.
On June 12, 2002 the Company issued an aggregate of 112,500 shares of
common stock to SBI and its designees for services rendered in connection with
the Company's private placement that closed in May 2002 (see Note 21).
On June 20, 2002 the Company issued 20,000 shares of common stock to
Howard Effron for services as a financial advisor.
During the twelve month period ended June 30, 2002, the Company issued
691 shares of common stock upon the exercise of employee stock options.
During the twelve months ended June 30, 2002, the Company closed two
private placements. In the first, which closed in November 2001, the Company
issued 1,061,226 shares of common stock at a price of $3.00 per share and
recorded $285,223 of placement agent and finders' fees relating to the private
placement offering against Additional Paid in Capital. In the second private
placement, which closed in May 2002, the Company issued 6,102,869 shares of
common stock at a price of $0.40 per share and recorded $228,691 of placement
agent and finders' fees relating to the private placement offering against
Additional Paid in Capital.
(19) Discontinued Operations
On January 11, 2001, the Company sold all of the outstanding shares of
IMI, Inc. (see Note 20) and accordingly has reported the operations of IMI as
discontinued operations for all of the periods presented. Certain information
with respect to discontinued operations of IMI is summarized as follows.
Operating results for the year ended June 30, 2001 include the operating
activity through January 11, 2001.
----------------------------------
Year Ended June 30
----------------------------------
2001 2000
----------------------------------
Revenue $ 1,116,863 $5,275,110
Cost of revenue 703,831 5,467,840
----------------------------------
Gross profit (loss) 413,032 (192,730)
Total operating expenses 698,580 1,124,467
----------------------------------
Loss from discontinued operations
before other item shown below (285,548) (1,317,197)
Other expense (232) (1,318)
----------------------------------
Net loss from discontinued operations $(285,780) $(1,318,515)
==================================
(20) Extraordinary Items
During the year ended June 30, 2001, the Company restructured its
operations and combined its California facility with its facility in Utah. In
connection with this decision, certain assets of the Company, which were owned
prior to the merger in June 2000, were disposed. In accordance with Accounting
Principles Board Opinion No.16 Accounting for Business Combinations relating to
the disposition of assets of the previously separate entities in a pooling of
interests combination, the Company recorded an extraordinary charge of an
aggregate of $1,091,052.
On January 11, 2001, the Company sold all of the outstanding shares of
IMI, Inc., dba Impact Media, a wholly-owned subsidiary, for $1,631,589 to
Capistrano Capital, LLC ("Capistrano"). The principal shareholder of Capistrano
subsequently became a stockholder of the Company. The Company received from
Capistrano a cash payment of $300,000, with the balance owing of $1,331,589 in
the form of a long-term note bearing interest at 8% per annum, payable by
Capistrano. Principal payments under the note are due based on IMI's product
sales, due no later than January 2011. Due to the uncertainty of the ultimate
collectibility of the note, management has recorded a reserve on the entire note
balance at June 30, 2001. The reserve has been netted against the gain on
disposal of IMI. The net gain recorded on the sale of $363,656 has been included
as an extraordinary item as a gain on disposal of assets subsequent to merger in
the accompanying financial statements.
In January 2001 the Company entered into an agreement with an unrelated
third party to negotiate settlement agreements with vendors and other debtors,
relating mainly to the ICC (business-to-business) and CableCommerce divisions.
Prior to June 30, 2001 approximately $2.5 million in obligations were settled
for approximately $800,000, resulting in an extraordinary gain of $1,688,956.
(21) Related Entity Transactions
The Company utilizes the services of Electronic Commerce International,
Inc. ("ECI"), a Utah corporation, to provide a credit card merchant account
solution to our customers and formerly provided a leasing opportunity to
customers who purchased our products at the Internet training workshops. The
Company buys a product from ECI that provides on-line, real-time processing of
credit card transactions and resells it to its customers. John J. Poelman, Chief
Executive Officer, a director and a stockholder of the Company, was the sole
owner of ECI during the fiscal years ended June 30, 2002, 2001 and 2000. Total
revenue generated by the Company from the sale of ECI merchant account solutions
was $5,106,494, $6,403,478 and $2,412,800 for the years ended June 30, 2002,
2001 and 2000, respectively. The cost to the Company for these products and
services totaled $994,043, $975,257 and $1,110,404 for the years ended June 30,
2002, 2001 and 2000, respectively. During the years ended June 30, 2002, 2001
and 2000 the Company processed leasing transactions for its customers through
ECI in the amounts of $1,090,520, $3,386,231, and $2,450,292, respectively. As
of June 30, 2002 and 2001 the Company had a receivable from ECI for leases in
process of $0 and $90,109, respectively. In addition, the Company had $26,702
and $516,858 as of June 30, 2002 and 2001, respectively, recorded in accounts
payable relating to the amounts owed to ECI for the purchase of the merchant
account software.
The Company offers its customers at its Internet training workshops,
and through backend telemarketing sales, certain products intended to assist the
customer in being successful with their business. These products include live
chat and web traffic building services. The Company utilizes Electronic
Marketing Services, LLC. ("EMS") to fulfill these services to the Company's
customers. In addition, EMS provides telemarketing services, selling some of the
Company's products and services. Ryan Poelman, who owns EMS, is the son of John
J. Poelman, Chief Executive Officer, a director and a stockholder of the
Company. The Company's revenues generated from the above products and services
were $4,806,497, $1,263,793 and $0 for the years ended June 30, 2002, 2001 and
2000, respectively. The Company paid EMS $479,984, $78,435, and $0 to fulfill
these services during the years ended June 30, 2002, 2001 and 2000,
respectively.
The Company engaged vFinance Investments, Inc. ("vFinance") as a
financial advisor and placement agent for its private placement of unregistered
securities that closed during May 2002. Shelly Singha1, a former member of the
Company's Board of Directors, was a principal of vFinance at the time of private
placement. During the year ended June 30, 2002 the Company paid vFinance $61,500
in fees and commissions for their services. The offering was successful with
adjusted gross proceeds to the Company of $2,185,995.
The Company engaged SBI-E2 Capital USA Ltd. ("SBI") as a financial
consultant to provide various financial services. Shelly Singhal, a former
member of the Company's Board of Directors, is a managing director of SBI.
During the year ended June 30, 2002 SBI provided the Company with a Fairness
Opinion relating to the proposed merger with Category 5 Technologies, for which
the Company was billed $152,437, of which the Company has paid $67,437, and
$85,000 was still payable to SBI as of June 30, 2002.
The Company also paid SBI $58,679 for expenses & commissions relating
to its private placement of unregistered securities which closed during November
2001. Adjusted gross proceeds to the Company from the offering totaled
$2,898,455.
In addition, the Company paid SBI a total of $40,000 and issued to it
and various of its designees an aggregate of 112,500 shares of the Company's
common stock in payment for services rendered to the Company in connection with
its private placement of common stock that closed in May 2002.
During the year ended June 30, 2001 the Company issued 12,500 warrants
to Shelly Singhal, a former member of the Company's Board of Directors, for
non-director services rendered. The warrants were valued using the Black-Scholes
pricing model at $40,657.
(22) Segment Information
The Company has operated under two principal business segments
(Internet services and multimedia products). The primary business segment
(Internet services) is engaged in the business of providing its customers the
ability to (i) acquire a presence on the Internet and (ii) to advertise and sell
their products or services on the Internet. A secondary business segment
(multimedia services) has been engaged in providing assistance in the design,
manufacture and marketing of multimedia brochure kits, shaped compact discs and
similar products and services intended to facilitate conducting business over
the Internet. This second segment was sold on January 11, 2001 and accordingly
is reported as discontinued operations in the accompanying consolidated
statements of operations. As a result, the Company now operates in one business
segment.
(23) Subsequent Event
On June 28, 2002 a special shareholders meeting was held to vote on
three proposed amendments to the Certificate of Incorporation of the Company.
The three proposed amendments included a one-for-ten reverse split of common
stock shares, a reduction in the authorized number of shares outstanding from
250,000,000 to 100,000,000, and a change in the name of the Company to Imergent,
Inc. All three proposed amendments were approved. Effective July 3, 2002 the
shares of common stock began trading under the name Imergent, Inc. Also,
beginning July 3, 2002 the shares of common stock outstanding of the Company
reflected the one-for-ten reverse split.
(24) Quarterly Financial Information (unaudited)
Fiscal Year 2002 Quarter Ended
--------------------------------------------------------------------------
09/30/01 12/31/01 03/31/02 06/30/02
------------------ ----------------- ------------------ ------------------
Revenue $ 11,634,043 $ 7,455,746 $ 7,296,696 $ 10,964,365
Gross profit 10,044,474 6,159,180 5,804,382 8,817,014
Income (loss) from continuing operations 2,335,308 (185,688) 377,335 (328,186)
Income (loss) from discontinued operations - - - -
Income (loss) from extraordinary items - - - -
Net income (loss) $ 2,335,308 $ (185,688) $ 337,335 $ (328,186)
Basic income (loss) per share:
Income (loss) from continuing operations $ 0.68 $ (0.04) $ 0.08 $ (0.04)
Income (loss) from discontinued operations - - - -
Income (loss) from extraordinary items - - - -
Net income (loss) $ 0.68 $ (0.04) $ 0.07 $ (0.04)
Diluted income (loss) per share:
Income (loss) from continuing operations $ 0.66 $ (0.04) $ 0.08 $ (0.04)
Income (loss) from discontinued operations - - - -
Income (loss) from extraordinary items - - - -
Net income (loss)
$ 0.66 $ (0.04) $ 0.07 $ (0.04)
Weighted average Common shares outstanding
Basic 3,450,711 4,388,230 4,833,462 9,035,396
Diluted (1) 3,539,724 4,388,230 4,833,462 9,035,396
Fiscal Year 2001 Quarter Ended
--------------------------------------------------------------------------
09/30/00 12/31/00 03/31/01 06/30/01
------------------ ----------------- ------------------ ------------------
Revenue $ 7,425,857 $ 14,179,643 $ 7,886,385 $ 13,508,648
Gross profit 5,235,950 11,952,131 5,753,014 11,633,863
Income (loss) from continuing operations (6,478,573) (2,011,994) 1,211,000 2,965,051
Income (loss) from discontinued operations (201,462) (83,190) (1,128) -
Income (loss) from extraordinary items - (1,091,052) 363,656 1,688,956
Net income (loss) $(6,680,035) $ (3,186,236) $ 1,573,528 $ 4,654,007
Basic income (loss) per share:
Income (loss) from continuing operations $ (3.00)$ $ (0.90) $ 0.60 $ 1.20
Income (loss) from discontinued operations (0.10) (0.10) - -
Income (loss) from extraordinary items - (0.50) 0.20 0.70
Net income (loss) $ (3.10) $ (1.50) $ 0.80 $ 1.90
Diluted income (loss) per share:
Income (loss) from continuing operations $ (3.00) $ (0.90) $ 0.30 $ 0.90
Income (loss) from discontinued operations (0.10) (0.10) - -
Income (loss) from extraordinary items - (0.50) 0.10 0.40
Net income (loss) $ (3.10) $ (1.50) $ 0.40 $ 1.30
Weighted average Common shares outstanding
Basic 2,169,146 2,169,146 2,169,479 2,404,402
Diluted (1) 2,169,146 2,169,146 4,127,412 3,950,085
Fiscal Year 2000 Quarter Ended
--------------------------------------------------------------------------
9/30/99 12/31/99 3/31/00 6/30/00
------------------ ----------------- ------------------ ------------------
Revenue $ 3,942,509 $ 4,671,502 $ 6,587,123 $ 6,948,515
Gross profit 1,638,160 3,584,244 5,024,566 3,437,588
Loss from continuing operations (5,143,546) (21,687,644) (7,550,983) (8,407,741)
Loss from discontinued operations (75,471) (756,644) (196,666) (289,734)
Net loss $(5,219,017) $(22,444,288) $(7,747,649) $ (8,697,475)
Basic and diluted loss per share:
Loss from continuing operations $ (3.70) $ (12.30) $ (4.80) $ $ (2.30)
Loss from discontinued operations (0.10) (0.40) (0.10) (0.10)
Net loss $ (3.80) $ (12.70) $ (4.90) $ (2.40)
(1) Includes the dilutive effect of options, warrants and convertible securities.
(25) Income (Loss) Per Share
The following data was used in computing income (loss) per share:
Year ended June 30,
------------------------------------------------------
2002 2001 2000
--------------- ----------------- -------------------
Income (loss) available to common shareholders $ 2,198,769 $ (3,638,736) $ (44,108,429)
Basic EPS
- --------------------------------------------------------------------------------------------------------------
Shares
Common shares outstanding entire period 2,446,018 2,164,873 1,561,315
Weighted average common shares:
Issued during period 3,427,636 63,092 289,799
Canceled during period - - -
--------------- ----------------- -------------------
Weighted average common shares outstanding
during period 5,873,654 2,227,965 1,851,114
--------------- ----------------- -------------------
Income (loss) per common share - basic $ 0.37 $ (1.63) $ (23.83)
=============== ================= ===================
Diluted EPS
- --------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding
during period - basic 5,873,654 2,227,965 1,851,114
Dilutive effect of stock equivalents 4,750 - -
--------------- ----------------- -------------------
Weighted average common shares outstanding
during period - diluted 5,878,404 2,227,965 1,851,114
--------------- ----------------- -------------------
Income (loss) per common share - diluted $ 0.37 $ (1.63) (23.83)
=============== ================= ===================
Income (loss) per share is computed independently for each of the
quarters presented. Therefore, the sum of quarterly income (loss) per share
amounts do not necessarily equal the total for the year due to rounding.
IMERGENT, INC.
Schedule II- Valuation and Qualifying Accounts
Years ended June 30, 2002, 2001 and 2000
Balance at Charged to Balance at
Beginning Costs and Deductions/ End of
of Period Expenses Write-off Period
Year ended June 30, 2002
Deducted from accounts receivable:
Allowance for doubtful accounts
sales returns, credit card
chargebacks, and other assets $ 3,679,017 $ 6,675,238 $ 6,940,274 $ 3,413,981
Year ended June 30, 2001 Deducted from accounts receivable:
Allowance for doubtful accounts
sales returns, credit card 960,601 3,475,492 757,076 3,679,017
chargebacks, and other assets
Year ended June 30, 2000 Deducted from accounts receivable:
Allowance for doubtful accounts
sales returns, credit card $ 36,925 1,159,022 235,346 $ 960,601
chargebacks and other assets
EXHIBIT INDEX
Exhibit Incorporated by Reference
No. Exhibit Description
Filed
Form Date Number Herewith
2.1 Agreement and Plan of Merger dated March 10, 2000 by and among 8-K 3/21/00 10.1
Netgateway, Inc., Galaxy Acquisition Corp. and Galaxy
Enterprises, Inc.
3.1 Certificate of Incorporation S-1 6/1/99 3.1
3.2 Certificate of Amendment to Certificate of Incorporation S-1 9/7/00 3.1
3.3 Certificate of Amendment to Certificate of Incorporation - - - X
3.4 Amended and Restated Bylaws 10-Q 11/20/01 3.2
3.5 Certificate of Ownership and Merger (4) S-1/A 11/12/99 3.3
3.6 Articles of Merger S-1/A 11/12/99 3.4
4.1 Form of Common Stock Certificate - - - X
4.2 Form of Representatives' Warrant S-1 6/1/99 4.1
10.1 1998 Stock Compensation Program S-1 6/1/99 10.6
10.2 1998 Stock Option Plan for Senior Executives S-1 6/1/99 10.7
10.3 1999 Stock Option Plan for Employees S-1/A 10/14/99 10.35
10.4 Internet Services Agreement dated as of October 25, 1999 S-1/A 11/12/99 10.53
between Netgateway, Inc. and Bergen Brunswig Drug Company
10.5 Securities Purchase Agreement dated July 31, 2000 between S-1 9/7/00 10.95
Netgateway, Inc. and King William, LLC.
10.6 Form of 8% Convertible Debenture Due July 31, 2003 S-1 9/7/00 10.96
10.7 Registration Rights Agreement dated July 31, 2000 between S-1 9/7/00 10.97
Netgateway, Inc. and King William, LLC
10.8 Form of Common Stock Purchase Warrant S-1 9/7/00 10.98
10.9 Private Equity Credit Agreement dated August 2, 2000 between S-1 9/7/00 10.99
Netgateway, Inc. and King William, LLC
10.10 Registration Rights Agreement dated August 2, 2000 between S-1 9/7/00 10.100
Netgateway, Inc. and King William, LLC
10.11 Stock Purchase Agreement dated January 11, 2001 between Galaxy 8-K 1/16/01 10.82
Enterprises, Inc. and Capistrano Capital, LLC.
10.12 Note dated January 11, 2001 issued to Galaxy Enterprises, Inc. 8-K 1/16/01 10.83
by IMI, Inc.
10.13 Security Agreement dated January 11, 2001 among Galaxy 8-K 1/16/01 10.84
Enterprises, Inc., Galaxy Mall, Inc. Netgateway, Inc. and IMI,
Inc.
10.14 Restructuring and Amendment Agreement dated January 25, 2001 10-Q 2/14/01 10.85
between Netgateway and King William, LLC
10.15 Settlement Agreement and Mutual Release dated March 27, 2001 10-Q 5/15/01 10.86
between CONVANSYS, Inc. and Netgateway, Inc.
10.16 Form of Convertible Promissory Note. 10-Q 5/15/01 10.87
10.17 Form of Note Purchase Agreement. 10-Q 5/15/01 10.88
10.18 Form of Note Purchase Agreement with warrants. 10-Q 5/15/01 10.89
10.19 Form of Common Stock Purchase Warrant. 10-Q 5/15/01 10.90
10.20 Waiver Agreement dated May 9, 2001 between Netgateway and King 10-Q 5/15/01 10.91
William, LLC.
10.21 Letter Agreement dated January 10, 2001 between Netgateway and 10-Q 5/15/01 10.92
Keith Freadhoff.
10.22 Letter Agreement dated January 10, 2001 between Netgateway and 10-Q 5/15/01 10.93
Donald M. Corliss.
10.23 Letter Agreement dated January 10, 2001 between Netgateway and 10-Q 5/15/01 10.95
Jill Glashow Padwa
10.24 Form of Debt Settlement Agreement with Netgateway executive 10-K 10/15/01 10.115
officers dated as of April 5, 2001
10.25 Form of Private Placement Subscription Agreement 10-K 10/15/01 10.116
10.26 Second Restructuring Agreement dated as of July 11, 2001 10-K 10/15/01 10.117
between Netgateway, Inc. and King William, LLC
10.27 Promissory Note from Netgateway, Inc. to King William, LLC 10-K 10/15/01 10.118
10.28 Finder's Agreement dated as of June 14, 2001 between SBI 10-K 10/15/01 10.119
E2-Capital (USA) Inc. and Netgateway, Inc.
10.29 Lease dated May 7, 1999 between Novell, Inc. and Galaxy Mall, 10-K 10/15/01 10.120
Inc., along with a first amendment dated as of September 17,
1999 and a second amendment dated as of September 18, 2000
10.30 Placement Agent Agreement dated as of June 1, 2001 between 10-K 10/15/01 10.121
Netgateway, Inc. and Alpine Securities, Inc.
10.31 Agreement and Plan of Merger among Netgateway, Inc., Category 5 10-Q 11/20/01 2.1
Technologies, Inc., and C5T Acquisition Corp., dated October
23, 2001
10.32 Engagement Agreement dated October 10, 2001 between Netgateway, 10-Q 11/20/01 10.124
Inc. and SBI E2-Capital (USA) Ltd.
10.33 Termination and Release Agreement dated January 14, 2002 among 8-K 1/18/02 2.1
Netgateway, Inc., Category 5 Technologies, Inc. and C5T
Acquisition Corp.
10.34 Rescission Agreement dated February 1, 2002 between Netgateway, 10-Q 2/14/02 10.125
Inc and SBI-E2 Capital (USA) Ltd. et al.
10.35 Letter Agreement re: Modification of August Restructuring 10-Q 5/8/02 10.126
Agreement as of February 13, 2002 between Netgateway, Inc. and
King William LLC
10.36 Agreement dated February 15, 2002 between SBI E2-Capital (USA) X
Ltd. and Netgateway, Inc.
10.37 Agreement dated March 22, 2002 between vFinance Investments, X
Inc. and Netgateway, Inc.
18.1 Letter dated February 9, 2000 from KPMG LLP 10-Q 2/15/00 18.1
21.1 Subsidiaries of Netgateway X
23.1 Consent of KPMG LLP X
23.2 Consent of Eisner LLP (formerly known as Richard A. Eisner & X
Company, LLP)
23.3 Consent of Grant Thornton LLP X
99.1 Certification pursuant to 18 U.S.C. Section 1350 X
99.2 Certification pursuant to 18 U.S.C. Section 1350 X
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Imergent, Inc.
By: /s/ John J. Poelman
October 15, 2002 John J. Poelman
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Donald L. Danks
October 15, 2002 Donald L. Danks
Chairman of the Board of Directors
/s/ John J. Poelman
October 15, 2002 John J. Poelman
Chief Executive Officer and Director
October 15, 2002 /s/ Frank C. Heyman
Frank C. Heyman
Chief Financial Officer
October 15, 2002 /s/ Brandon Lewis
Brandon Lewis
President and Director
CERTIFICATION
I, John J. Poelman, certify that:
1. I have reviewed this annual report on Form 10-K of Imergent, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
October 15, 2002 /s/ JOHN J. POELMAN
John J. Poelman,
Chief Executive Officer
CERTIFICATION
I, Frank C. Heyman, certify that:
1. I have reviewed this annual report on Form 10-K of Imergent, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
October 15, 2002 /s/ FRANK C. HEYMAN
Frank C. Heyman
Chief Financial Officer