UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/ X / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ________ to ________.
Commission file 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 Identification No.)
incorporation or organization)
754 E. Technology Avenue
Orem, Utah 84097
---------- -----
(Address of Principal Executive Offices) (Zip Code)
(801) 227-0004
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the proceeding 12 months and (2) has been subject to such filing requirements
for the past 90 days. Yes X No
Indicate by check mark whether the registrant is an accelerated filer
(as defined in rule 12b-2 of the Exchange Act. Yes ________ No ____X_____
The number of shares outstanding of the registrant's common stock as of
October 31, 2003 was 11,309,719
When we refer in this Form 10-Q to "Imergent," the "Company," "we,"
"our," and "us," we mean Imergent, Inc., a Delaware corporation, together with
our subsidiaries and their respective predecessors.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets at September 30, 2003 (unaudited)
and at June 30, 2003......................................................3
Unaudited Condensed Consolidated Statements of Operations for the three months
September 30, 2003 and 2002...............................................4
Unaudited Condensed Consolidated Statement of Stockholders' Equity for the three
months ended September 30, 2003...........................................5
Unaudited Condensed Consolidated Statements of Cash Flows for the three months
ended September 30, 2003 and 2002.........................................6
Notes to Unaudited Condensed Consolidated Financial Statements ................7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General.......................................................................16
Critical Accounting Policies and Estimates....................................16
Related Party Transactions....................................................19
Results of Operations.........................................................19
Liquidity and Capital Resources...............................................23
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......26
Item 4. Controls and Procedures..........................................26
Part II - OTHER INFORMATION
Item 1. Legal Proceedings................................................25
Item 2. Changes in Securities and Use of Proceeds........................27
Item 3. Defaults Upon Senior Securities..................................27
Item 4. Submission of Matters to a Vote of Security Holders..............27
Item 5. Other Information................................................27
Item 6. Exhibits and Reports on Form 8-K.................................27
IMERGENT, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
September 30, 2003 June 30, 2003
----------------- -----------------
(Unaudited)
Assets
Current assets
Cash $ 2,444,115 $ 2,319,618
Trade receivables, net of allowance for doubtful accounts of $6,160,786 at
September 30, 2003 and $4,471,667 at June 30, 2003. 6,240,549 4,965,769
Other receivables 1,990 50,000
Inventories 34,026 34,194
Prepaid expenses 648,142 687,984
Credit card reserves, net of allowance for doubtful accounts of $243,385 at
September 30, 2003 and $319,812 at June 30, 2003. 528,081 450,200
----------------- -----------------
Total current assets 9,896,903 8,507,765
Property and equipment, net 179,867 200,174
Goodwill, net 455,177 455,177
Trade receivables, net of allowance for doubtful accounts of $3,028,587 at
September 30, 2003 and $2,131,593 at June 30, 2003. 3,023,826 2,254,969
Other assets, net of allowance for doubtful accounts of $100,783 at
September 30, 2003 and $100,783 at June 30, 2003. 203,481 103,460
----------------- -----------------
Total Assets 13,759,254 11,521,545
================= =================
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable $ 1,816,381 $ 1,413,112
Accounts payable - related party - 114,925
Accrued wages and benefits 324,490 411,620
Accrued liabilities 255,802 204,137
Current portion of capital lease obligations 16,729 26,536
Current portion of notes payable 60,987 121,206
Other current liabilities 41,192 35,840
Deferred revenue 401,258 653,463
----------------- -----------------
Total current liabilities 2,916,839 2,980,839
Capital lease obligations, net of current portion 1,802 1,802
Notes payable, net of current portion 400,000 435,857
----------------- -----------------
Total liabilities 3,318,641 3,418,497
----------------- -----------------
Commitments and contingencies
Stockholders' Equity
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 11,272,441
and 11,062,290 shares, at September 30, 2003 and June 30, 2003, respectively 11,273 11,063
Additional paid-in capital 72,787,896 72,605,749
Deferred compensation (19,347) (22,474)
Accumulated other comprehensive loss (4,902) (4,902)
Accumulated deficit (62,334,308) (64,486,389)
----------------- -----------------
Total stockholders' equity 10,440,613 8,103,047
----------------- -----------------
Total Liabilities and Stockholders' Equity $ 13,759,254 $ 11,521,545
================= =================
The accompanying notes are an integral part of these financial statements
IMERGENT, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Operations for the
For The Three Months Ended September 30, 2003 and 2002
------------------------------------------------
2003 2002
---------------------- ----------------------
Revenue $ 20,545,136 $ 11,283,849
Cost of revenue 4,361,702 2,234,716
Cost of revenue - related party - 223,716
---------------------- ----------------------
Total cost of revenue 4,361,702 2,458,432
---------------------- ----------------------
Gross profit 16,183,434 8,825,417
Operating Expenses
Research and Development 76,694 76,810
Selling and marketing 6,223,131 4,243,288
Selling and marketing - related party - 278,060
General and administrative 1,758,275 857,608
Depreciation and amortization 27,423 148,417
Bad debt expense 6,220,234 2,287,733
---------------------- ----------------------
Total operating expenses 14,305,757 7,891,916
Earnings from operations 1,877,677 933,501
Other income (expense)
Other income 970 2,873
Interest income 275,244 155,764
Interest expense (1,810) (8,988)
---------------------- ----------------------
Total other income 274,404 149,649
---------------------- ----------------------
Net Earnings 2,152,081 1,083,150
====================== ======================
Basic earnings (loss) per share:
Basic $ 0.19 $ 0.10
Diluted 0.18 0.10
Weighted average shares outstanding:
Basic 11,152,998 10,999,478
Diluted 11,966,483 11,035,459
The accompanying notes are an integral part of these financial statements
IMERGENT, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statement of Stockholders' Equity
For the Three Months Ended September 30, 2003
Common Stock Additional
--------------------------------- Paid-in Deferred
Shares Amount Capital Compensation
- --------------------------------------------------------------------- ------------- ------------------ -----------------
Balance July 1, 2003 11,062,290 $ 11,063 $ 72,605,749 $ (22,474)
Amortization of deferred compensation - - - 3,127
Expense for options granted to consultants - - 61,774 -
Common stock issued upon exercise of options and warrants 210,151 210 120,372 -
Net earnings - - - -
- --------------------------------------------------------------------- ------------- ------------------ -----------------
Balance September 30, 2003 11,272,441 $ 11,273 $ 72,787,896 $ (19,347)
================ ============= ================== =================
(Continued Below)
The accompanying notes are an integral part of these financial statements
IMERGENT, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statement of Stockholders' Equity
For the Three Months Ended September 30, 2003
(Continued from Above)
Accumulated
Other Total
Accumulated Comprehensive Stockholders
Deficit loss Equity
- -------------------------------------------------------- -------------------- ---------------------- ----------------------
Balance July 1, 2003 $(64,486,389) $ (4,902) $ 8,103,047
Amortization of deferred compensation - - 3,127
Expense for options granted to consultants - - 61,774
Common stock issued upon exercise of options and warrants - - 120,582
Net earnings 2,152,081 - 2,152,081
- --------------------------------------------------------- -------------------- ---------------------- -----------------------
Balance September 30, 2003 $(62,334,308) $ (4,902) $10,440,612
==================== ======================= =======================
The accompanying notes are an integral part of these financial statements
IMERGENT, INC AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
For the Three Months Ended September 30, 2003 and 2002
2003 2002
---------------------- -----------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income from operations $ 2,152,081 $ 1,083,150
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization 27,423 148,417
Amortization of deferred compensation 3,127 3,128
Expense for stock options issued to consultants 61,774
Provision for bad debts 6,220,234 2,287,733
Changes in assets and liabilities:
Trade receivables and unbilled receivables (8,199,145) (3,452,066)
Inventories 168 -
Prepaid expenses and other current assets 39,542 -
Credit card reserves (140,617) 14,815
Other assets (52,011) 153,323
Deferred revenue (252,205) (139,591)
Accounts payable - related party (114,925) (20,785)
Accounts payable, accrued expenses and other liabilities 373,727 (229,471)
-----------------------------------------------
Net cash provided by (used in) operating activities 119,173 (151,347)
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of equipment (7,116) (26,318)
-----------------------------------------------
Net cash (used in) investing activities (7,116) (26,318)
-----------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of options and warrants 118,593 -
Bank overdraft borrowings (270) (122,098)
Repayment of capital lease obligations (9,807) (41,712)
Repayment of notes (96,076) (61,620)
-----------------------------------------------
Net cash provided by (used in) financing activities 12,440 (225,430)
-----------------------------------------------
NET INCREASE (DECREASE) IN CASH 124,497 (403,095)
CASH AT THE BEGINNING OF THE QUARTER 2,319,618 519,748
-----------------------------------------------
CASH AT THE END OF THE QUARTER $ 2,444,115 $ 116,653
===============================================
Supplemental disclosures of non-cash transactions:
Common stock issued for outstanding liabilities - 15,000
Accrued interest added to note payable balance - 8,635
The accompanying notes are an integral part of these financial statements
IMERGENT, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
September 2003 and 2002
(1) Description of Business
Imergent, Inc. (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. from
Netgateway, Inc. Imergent is an e-Services company that provides eCommerce
technology, training and a variety of web-based technology and resources to
nearly 150,000 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.
(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. All significant intercompany balances and transactions
have been eliminated in consolidation.
(b) Cash and Cash Equivalents
Highly liquid investments with original maturities of three months or less when
purchased are considered cash equivalents. The carrying amounts reported in the
consolidated balance sheets for these instruments approximate their fair value.
(c) Accounts Receivables and Allowances
The Company offers to its 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. The remainder of the
EPTAs (those not sold to third parties) is retained as short term and long term
Accounts Receivable on the Company's consolidated balance sheet.
The Company records an allowance for doubtful accounts, at the time the EPTA
contract is perfected, for all EPTA contracts. The allowances represent
estimated losses resulting from the customers' failure to make required
payments. The allowances for EPTAs retained by the Company are netted against
the current and long term accounts receivable balances on the consolidated
balance sheets, and the associated expense is recorded as bad debt expense in
operating expenses.
EPTAs retained by the Company are charged off against the allowance when the
customers involved are no longer making required payments and the EPTAs are
determined to be uncollectible. Interest accrued is discontinued and written off
when an EPTA becomes delinquent.
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. The Company also provides an allowance for EPTAs estimated to be
recoursed back to the Company.
All allowance 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 allowances become inadequate
additional allowances may be required.
(d) Transfers of Financial Assets
Transfers of financial assets are accounted for as having been transferred, when
control over the assets has been surrendered. Control over transferred assets is
deemed to be surrendered when (1) the assets have been isolated from the
Company, (2) the transferee obtains the right (free of conditions that constrain
it from taking advantage of the right) to pledge or exchange the transferred
assets, and (3) the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their
maturity.
(e) Goodwill and Intangible Assets
As required by Statement of Financial Accounting Standards ("SFAS") 142,
beginning on July 1, 2002 goodwill is no longer amortized but is 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) Financial Instruments
The carrying values of cash, trade-receivable, accounts payable, accrued
liabilities, capital lease obligations, and notes payable approximated fair
value due to either the short maturity of the instruments or the recent date of
the initial transaction or the restructuring.
(g) Income Taxes
The Company utilizes the liability method of accounting for income taxes. Under
the liability method, deferred income tax assets and liabilities are provided
based on the difference between the financial statement and tax bases of assets
and liabilities as measured by the currently enacted tax rates in effect for the
years in which these differences are expected to reverse. Deferred tax expense
or benefit is the result of changes in deferred tax assets and liabilities. An
allowance against deferred tax assets is recorded in whole or in part when it is
more likely than not that such tax benefits will not be realized.
Deferred tax assets are 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. Deferred tax assets consist primarily of net operating losses
carried forward. The Company has provided a valuation allowance against all of
its net deferred tax assets at September 30, 2003 and against all of its
deferred tax assets at June 30, 2003. Fiscal year 2002 was the first profitable
year for the Company since its inception. However, differences between
accounting principles generally accepted in the United States of America ("US
GAAP") and accounting for tax purposes caused the Company to have a tax loss for
the fiscal year ended June 30, 2002. For the year ended June 30, 2003 the
Company has taxable income of approximately $8.2 million. Taxable income for the
quarter ended September 30, 2003 is estimated to be approximately $4.0 million.
The Company's net operating loss carry forward ("NOL"), which is approximately
$43 million, represents the losses reported for income tax purposes from the
inception of the Company through June 30, 2002. FY 2003 was the first year in
the Company's history that generated taxable income. Section 382 of the Internal
Revenue Code ("Section 382") imposes limitations on a corporation's ability to
utilize its NOLs if it experiences an "ownership change". In general terms, an
ownership change results from transactions increasing the ownership of certain
stockholders in the stock of a corporation by more than 50 percentage points
over a three-year period. Since our formation, we have issued a significant
number of shares, and purchasers of those shares have sold some of them, with
the result that two changes of control as defined by Section 382 have occurred.
As a result of the most recent ownership change, utilization of our NOLs is
subject to an annual limitation under Section 382 determined by multiplying the
value of our stock at the time of the ownership change by the applicable
long-term tax-exempt rate resulting in an annual limitation amount of
approximately $127,000. Any unused annual limitation may be carried over to
later years, and the amount of the limitation may under certain circumstances be
increased by the "recognized built-in gains" that occur during the five-year
period after the ownership change (the "recognition period"). The Company
believes that it will have significant recognized built-in gains and that during
the recognition period the limitation will be increased by approximately $15
million based on an independent valuation of the Company as of April 3, 2002.
The Company also believes that based on a valuation of the Company as of June
25, 2000, which is currently underway, the earlier ownership change will also
have significant recognized built-in gains and that during the recognition
period the limitation will be further increased by approximately $28 million
thus allowing the Company to utilize its entire NOL. Therefore no provision for
income taxes has been established in the Statement of Operations for the
three-month periods ended September 30, 2003 and 2002. Significant management
judgment was required in estimating the amount of the recognized built in gain.
If it is determined that the actual amount of recognized built in gain is less
than our estimate, the Company may be required to make a cash payment for taxes
due on its income for fiscal year 2004, plus related interest, which could
materially adversely impact the Company's financial position.
(h) Accounting for Stock Options and Warrants
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. The Company had options outstanding of 1,174,635
as of September 30, 2003 and 1,193,528 as of June 30, 2003, with varying prices
between $1.56 and $113.10.
The Company had 631,460 warrants outstanding as of September 30, 2003 and
631,460 warrants outstanding as of June 30, 2003 with varying strike prices
between $.40 and $115.50 and expiration dates between February 22, 2004 and
April 9, 2008.
(i) Stock-Based Compensation
The Company has applied the disclosure provisions of Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure -- An Amendment of FASB Statement No. 123," for the
three months ended September 30, 2003 and 2002. Issued in December 2002, SFAS
No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation" to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based compensation. In addition, this
Statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. As permitted by SFAS No. 148, the Company
continues to account for stock options under APB Opinion No. 25, under which no
compensation has been recognized. The following table illustrates the effect on
net earnings and earnings per share for the three months ended September 30,
2003 and 2002, respectively, if the Company had applied the fair value
recognition provisions of SFAS No. 123, as amended by SFAS No. 148 to
stock-based compensation:
3 Months Ending September 30,
----------------------------------
2003 2002
----------------------------------
Net earnings as reported $2,152,081 $ 1,083,150
Net earnings proforma $2,056,895 $ 1,071,661
Net earnings per share as reported:
Basic $ 0.19 $0.10
Diluted $ 0.18 $0.10
Net earnings per share pro forma:
Basic $0.18 $0.10
Diluted $0.17 $0.10
The fair value of these options was estimated at the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions: expected volatility of 181 percent for 2003 and 262 percent for
2002; average risk-free interest rate of 4 percent for 2003 and 5 percent for
2002; and an expected life between 1 and 10 years for 2003 and 2002. Dividends
were assumed as not being paid during the period of calculation.
Option pricing models require the input of highly subjective assumptions
including the expected stock price volatility. Also, the Company's employee
stock options have characteristics significantly different from those of traded
options including long-vesting schedules and changes in the subjective input
assumptions that can materially affect the fair value estimate. Management
believes the best assumptions available were used to value the options and the
resulting option values were reasonable as of the date of the grant.
Pro Forma information should be read in conjunction with the related historical
information and is not necessarily indicative of the results that would have
been attained had the transaction actually taken place.
(j) Revenue Recognition
Beginning October 1, 2000, the Company has sold a license to use a new product
called the StoresOnline Software ("SOS"). The SOS is a web based software
product that enables the customer to develop their Internet website without
additional assistance from the Company. When a customer purchases a SOS license
at one of the Company's 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 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 to host with the Company there is an additional
setup and hosting fee (currently $150) for publishing and 12 months of hosting.
This fee is deferred at the time it is paid and recognized during the subsequent
12 months. A separate file is available and can be used if the customer decides
to create their website on their own completely without access to the Company
website and host their site with another hosting service.
The revenue from the sale of the SOS license is recognized when the product is
delivered to the customer. The Company accepts cash and credit cards as methods
of payment and the Company 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 permission for the Company to
independently check their credit and are willing to make an appropriate down
payment. Installment contracts ("EPTAs") are either sold to third party
financial institutions for cash on a discounted basis, or carried on the
Company's books as a receivable. The revenue generated by sales to "EPTA
customers is recognized when the product is delivered to the customer and the
contract is signed. At that same time an allowance for doubtful accounts is
established. This procedure has been in effect for all of fiscal year 2003 and
2004.
The American Institute of Certified Public Accountants Statement of Position
97-2 ("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 the
Company's order forms and a receipt acknowledging 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. The Company offers customers the option to pay for the SOS
license with Extended Payment Term Arrangements ("EPTAs"). The EPTAs generally
have a twenty-four month term. The Company has offered its customers the payment
option of a long-term installment contract for more than five years and has a
history of successfully collecting under the original payment terms without
making concessions. During fiscal years ended June 30, 1999 through 2003, the
Company has collected or is collecting approximately 70% 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 our efforts, approximately 47
percent of all EPTAs become uncollectible during the life of the contract. All
uncollectible EPTAs are written off against an allowance for doubtful accounts.
The allowance is established at the time of sale based on our five-year history
of extending EPTAs and revised periodically based on current experience and
information.
The Company also offers its customers, through telemarketing sales following the
workshop, certain products intended to assist the customer in being successful
with their business. These products include a live chat capability for the
customer's own website and web traffic building services. Revenues from these
products are recognized when delivery of the product has occurred. These
products are purchased from independent third party vendors and resold by the
Company to its customers with no continuing obligation on the part of the
Company.
(k) 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.
(l) Per Share Data
Basic earnings (loss) per share is computed by dividing net earnings (loss)
available to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted net earnings (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 1,174,635 shares of the Company's common
stock and unexercised warrants to purchase 435,404 shares of the Company's
common stock were outstanding as of September 30, 2003, of which 555,690 stock
options and 257,795 warrants were included in the diluted per share computation.
Unexercised stock options to purchase 312,015 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 September 30, 2002 of which 0stock options
and 269,643 warrants were included in the diluted per share computation.
(m) Use of Estimates
In the preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America, estimates and
assumptions must be made that affect the reported amounts of assets and
liabilities and disclosure of contingent liabilities, at the date of the balance
sheet, and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. The Company has
estimated that allowances for doubtful accounts for trade receivables should be
$9,189,373 as of September 30, 2003 and $6,603,260 as of June 30, 2003. In
addition, the Company has recorded an allowance for doubtful accounts of
$243,385 as of September 30, 2003 and $319,812 as of June 30, 2003, for
estimated credit card charge-backs relating to the most recent 180 days of
credit card sales.
(n) 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 three months ended September 30, 2003 and 2002 were
approximately $2.1 million and $1.9 million, respectively. As of September 30,
2003 the Company recorded $615,158 of direct response advertising related to
future workshops as an asset as compared to $434,886 as of June 30, 2003.
(o) Recently Issued Accounting Pronouncements
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. During the fiscal year ended June 30, 2001 we had originally
reported an extraordinary item related to gain on extinguishment of debt in its
Statement of Operations of $1,688,956. Based on SFAS No. 145, we have
reclassified $1,688,956 to income before discontinued operations in its
statement of operations included in our annual report.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of FASB Statement No.
123". This statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
amendments to Statement 123 regarding disclosure are effective for financial
statements for fiscal years ending after December 15, 2002. We have adopted the
annual disclosure provisions of SFAS No. 148 in our financial statements for the
year ended June 30, 2003 and for the quarter ended September 30, 2003 and
thereafter. The adoption of this standard involves additional disclosures. Our
adoption of SFAS No. 148 did not have a material impact on our results of
operations, financial position or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has been
issued and requires that they be recorded at fair value. The initial recognition
and measurement provisions of this interpretation are to be applied only on a
prospective basis to guarantees issued or modified after December 31, 2002,
which, for us, is the fiscal year beginning July 1, 2003. The disclosure
requirements of this interpretation are effective for financial statements of
interim or annual periods ending after December 15, 2002. We do not have any
indirect guarantees of indebtedness of others as of September 30, 2003.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." This interpretation addresses the consolidation of
business enterprises (variable interest entities) to which the usual condition
of consolidation does not apply. This interpretation focuses on financial
interests that indicate control. It concludes that in the absence of clear
control through voting interests, a company's exposure (variable interest) to
the economic risks and potential rewards from the variable interest entity's
assets and activities are the best evidence of control. Variable interests are
rights and obligations that convey economic gains or losses from changes in the
values of the variable interest entity's assets and liabilities. Variable
interests may arise from financial instruments, service contracts, nonvoting
ownership interests and other arrangements. If an enterprise holds a majority of
the variable interests of an entity, it would be considered the primary
beneficiary. The primary beneficiary would be required to include assets,
liabilities and the results of operations of the variable interest entity in its
consolidated financial statements. This interpretation applies immediately to
variable interest entities which are created after or for which control is
obtained after January 31, 2003. For variable interest entities created prior to
February 1, 2003, the provisions would be applied effective July 1, 2003. We do
not have an interest in any variable interest entities as of September 30, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" for
contracts entered into or modified after June 30, 2003; for hedging
relationships designated after June 30, 2003. We do not have any derivative
instruments or hedging activities as of September 30, 2003.
(3) 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 three months ended
September 30, 2003 and September 30, 2002, the Company sold contracts totaling
$1,703,759 and $754,751 respectively. The Company maintains approximately a two
percent bad debt allowance for doubtful accounts on all EPTAs that are purchased
by finance companies. The Company sells contracts to three separate finance
companies and continues to seek relationships with other potential purchasers of
these EPTAs.
(4) Goodwill and Intangible Assets
As required by Statement of Financial Accounting Standards ("SFAS") 142,
beginning on July 1, 2002 goodwill is no longer amortized but is 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. Prior to July 1, 2002
goodwill was being amortized over a ten-year period. During the quarter ended
December 31, 2002 the Company engaged an independent consulting firm to test the
Company's goodwill for impairment. Based on the appraisal made by the
independent consulting firm management has concluded that the fair market value
of the Company's assets exceeded the carrying value at July 1, 2002 and
determined that there is no goodwill impairment as of that date. As a result, no
change to the carrying value of the goodwill is necessary as of July 1, 2002. As
of September 30, 2003 management continues to believe that the fair market value
of the Company's assets exceeded the carrying value and therefore has determined
that there is no goodwill impairment as of that date. Prior to July 1, 2002
Goodwill was amortized on a straight-line basis over the estimated useful lives
as follows:
Acquired technology....................................5 to 7 years
Goodwill................................................. 10 years
Goodwill as of September 30, 2003 and 2002 is summarized as follows:
------------------------------------
2003 2002
------------------------------------
Goodwill $ 867,003 $ 867,003
Less accumulated amortization (411,826) (411,826)
------------------------------------
$ 455,177 $ 455,177
======== =======
(5) Notes Payable
Notes payable at September 30, 2003 consist of $400,000 of principal to King
William and $60,987 due to Imperial Premium Finance Company. Interest on the
note payable to Imperial Premium Finance Company is recorded at an annual
interest rate of 5.08%. Interest on the note payable to King William is recorded
at an annual interest rate of 8.0% and as of September 30, 2003 totaled $65,753,
and is recorded as accrued interest under current liabilities. Maturities of
notes payable are as follows:
Year ending June 30,
2004 $ 60,987
2005 -
2006 -
2007 -
2008 400,000
Thereafter -
------------
$ 460,987
============
(6) Stockholders' Equity
Quarter ended September 30, 2003
During the three months ended September 30, 2003 the Company issued 210,151
shares of common stock, upon the exercise of options and warrants.
During the three months ended September 30, 2003 the Company recorded an expense
totaling $61,774 related to options granted to consultants prior to and during
the quarter.
Quarter ended September 30, 2002
In July 2002, the Company issued 5,000 shares of common stock at a price of
$3.00 a share relating to the private placement of common stock which closed
during November 2001 for which all necessary paperwork had not previously been
received. The Company had held these funds as a current liability pending the
receipt of all proper paperwork.
(7) Related Entity Transactions
On July 1, 2003 John J. (Jay) Poelman, retired and in connection therewith
resigned as the Company's Chief Executive Officer and as a Director of the
Company. Transactions with Electronic Commerce International, Inc. ("ECI"),
Electronic Marketing Services, LLC. ("EMS") and Simply Splendid, LLC ("Simply
Splendid") which prior to July 1, 2003 were considered related party
transactions, were not considered related entity transactions for the three
months ending September 30, 2003.
John J. Poelman was the sole owner of Electronic Commerce International, Inc.
("ECI") during the three months ended September 30, 2002. During this period,
the Company purchased a merchant account solutions product from ECI that
provided on-line, real-time processing of credit card transactions and resold
this product to its customers. Effective October 1, 2002, Mr. Poelman sold
certain assets and liabilities of ECI, including ECI's corporate name and its
relationship with the Company, to an unrelated third party.
Total revenue generated by the Company from the sale of ECI merchant account
solutions was $1,453,612 for the three months ended September 30, 2002. The cost
to the Company for these products and services totaled $223,716 for the three
months ended September 30, 2002.
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, former
Chief Executive Officer and formerly a director of the Company. The Company's
revenues generated from the above products and services were $1,429,824 for the
three months ended September 30, 2002. The Company paid EMS $278,060 to fulfill
these services during the three months ended September 30, 2002. In addition,
the Company had $92,094 as of June 30, 2003 recorded in accounts payable
relating to the amounts owed to EMS for product and services.
The Company utilizes Simply Splendid to provide complimentary gift packages to
its customers who register to attend the Company's Workshop training sessions.
An additional gift is sent to Workshop attendees who purchase products at the
conclusion of the Workshop. Aftyn Morrison, who owns Simply Splendid, is the
daughter of John J. Poelman, our former Chief Executive Officer, and formerly a
director of the Company. The Company paid Simply Splendid $0 to fulfill these
services during the quarter ended September 30, 2002. In addition, the Company
had $22,831 as of June 30, 2003 recorded in accounts payable relating to the
amounts owed to Simply Splendid for gift packages.
(8) Earnings Per Share
The following data was used in computing earnings per share:
----------------------------------
Three Months Ending September 30,
----------------------------------
2003 2002
----------------------------------
Net earnings available to common shareholders $ 2,152,081 $ 1,083,150
Basic EPS
-----------------------------------------------------------------------------------------
Shares
Common shares outstanding entire period 11,062,290 10,995,774
Weighted average common shares:
Issued during period 90,708 3,704
Canceled during period - -
----------------------------------
Weighted average common shares outstanding
during period 11,152,998 10,999,478
----------------------------------
Earnings per common share - basic $ .19 $ .10
==================================
Diluted EPS
-----------------------------------------------------------------------------------------
Weighted average common shares outstanding
during period - basic 11,152,998 10,999,478
Dilutive effect of stock equivalents 813,485 35,981
----------------------------------
Weighted average common shares outstanding
during period - diluted 11,966,483 11,035,459
----------------------------------
Earnings per common share - diluted $ .18 $ .10
==================================
Item 2. 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 Quarterly Report on Form 10-Q
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 could cause or contribute to such
differences include, but are not limited to, those discussed or referred to in
the Annual Report on Form 10-K for the year ended June 30, 2003, filed on
September 29, 2003, under the heading Information Regarding Forward-Looking
Statements and elsewhere. Investors should review this quarterly report on Form
10-Q in combination with our Annual Report on Form 10-K in order to have a more
complete understanding of the principal risks associated with an investment in
our common stock. This management's discussion and analysis of financial
condition and results of operations should be read in conjunction with our
unaudited condensed consolidated financial statements and related notes included
elsewhere in this document.
GENERAL
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 effective 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.
Fluctuations in Quarterly Results and Seasonality
In view of the rapidly evolving nature of our business and the market
we serve, we believe that period to period comparisons of our operating results,
including our gross profit and operating expenses as a percentage of revenues
and cash flow, are not necessarily meaningful and should not be relied upon as
in indication of future performance. We experience seasonality in our business.
Our fiscal year ends each June 30. Revenues from our core business during the
first and second fiscal quarters tend to be lower than revenues in our third and
fourth quarters. We believe this to be attributable to summer vacations and the
Thanksgiving and December holiday seasons that occur during our first and second
quarters.
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
("US GAAP") 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. Senior management has discussed the development,
selection and disclosure of these estimates with the Board of Directors and its
Audit Committee. There are currently five members of the Board of Directors,
three of whom make up the Audit Committee. The Board of Directors has determined
that each member of the Audit Committee qualifies as an independent director and
that the chairman of the Audit Committee qualifies as an "audit committee
financial expert" as defined under the rules adopted by the SEC.
A summary of our significant accounting policies is set out in Note 2
to our Financial Statements as found in our Form 10-K for the year ended June
30, 2003. 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.
Valuation of Long-Lived Assets Including Goodwill and Purchased Assets
We review property, equipment, goodwill and purchased intangible assets
for impairment whenever events or changes in circumstances indicate the carrying
value of an asset may not be recoverable. This review is conducted as of
December 31st of each year or more frequently if necessary. Our asset impairment
review assesses the fair value of the assets based on the future cash flows the
assets are expected to generate. An impairment loss is recognized when estimated
undiscounted future cash flows expected to result from the use of the asset plus
net proceeds expected from the disposition of the asset (if any) are less than
the carrying value of the asset. This approach uses our estimates of future
market growth, forecasted revenue and costs, expected period the assets will be
utilized and appropriate discount rates. When an impairment is identified, the
carrying amount of the asset is reduced to its estimated fair value.
Revenue Recognition
Beginning October 1, 2000, the Company has sold a license to use a new
product called the StoresOnline Software ("SOS"). The SOS is a web-based
software product that enables the customer to develop their Internet website
without additional assistance from us. When a customer purchases a SOS license
at one of our Internet training 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. If they choose
to host with 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 it is
paid and recognized during the subsequent 12 months. A separate computer file is
provided to the purchaser at the time of purchase and can be used if the
customer decides to create their website on their own completely without access
to our website and host their site with another hosting service.
The revenue from the sale of the SOS license is recognized when the
product is delivered to the customer. The Company accepts cash and credit cards
as methods of payment and the Company 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 permission for the
Company to independently check their credit and are willing to make an
appropriate down payment. Installment contracts ("EPTAs") are either sold to
third party financial institutions for cash on a discounted basis, or carried on
the Company's books as a receivable. The revenue generated by sales to "EPTA
customers is recognized when the product is delivered to the customer and the
contract is signed. At that same time an allowance for doubtful accounts is
established. This procedure has been in effect for all of fiscal year 2003 and
2004.
The American Institute of Certified Public Accountants Statement of
Position 97-2 ("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 the
Company's order forms and a receipt acknowledging 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. The Company offers customers the option to pay for the SOS
license and merchant account with Extended Payment Term Arrangements ("EPTAs").
The EPTAs generally have a twenty-four month term. The Company has offered its
customers the payment option of a long-term installment contract for more than
five years and has a history of successfully collecting under the original
payment terms without making concessions. During fiscal years ended June 30,
1999 through 2003, the Company has collected or is collecting approximately 70%
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 our
efforts, approximately 47 percent of all EPTAs become uncollectible during the
life of the contract. All uncollectible EPTAs are written off against an
allowance for doubtful accounts. The allowance is established at the time of
sale based on our five-year history of extending EPTAs and revised periodically
based on current experience and information.
The Company also offers its customers, through telemarketing sales
following the workshop, certain products intended to assist the customer in
being successful with their business. These products include a live chat
capability for the customer's own website and web traffic building services.
Revenues from these products are recognized when delivery of the product has
occurred. These products are purchased from independent third party vendors and
resold by the Company to its customers with no continuing obligation on the part
of the Company.
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 $9.2 million and $6.6
million as of September 30, 2003 and June 30, 2003, 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 financial reporting purposes. These differences result in deferred tax
assets and liabilities. Our deferred tax assets consist primarily of net
operating losses carried forward. We record a valuation allowance to reduce our
deferred tax assets to the amount that is more likely than not to be realized.
We have considered historical operations and current earnings trends, future
market growth, forecasted earnings, future taxable income, the mix of earnings
in the jurisdictions in which we operate and prudent and feasible tax planning
strategies in determining the need for a valuation allowance. In the event we
were to determine that we would not be able to realize all or part of our net
deferred tax assets in the future, an adjustment to the deferred tax assets
would be charged to earnings in the period such determination is made. Likewise,
if we later determine that it is more likely than not that the net deferred tax
assets would be realized, the previously provided valuation allowance would be
reversed. For the quarters ended September 30, 2003 and 2002 we have established
a 100% reserve. We intend to reevaluate this reserve requirement upon completion
of the section 382 study and valuation currently in progress.
Our net operating loss carry forward ("NOL"), which was approximately
$43 million prior to the application of our estimated FY 2003 taxable income of
approximately $8.2 million, represents the losses reported for income tax
purposes from the inception of the Company through June 30, 2002. FY 2003 was
the first year in our history that generated taxable income. Section 382 of the
Internal Revenue Code ("Section 382") imposes limitations on a corporation's
ability to utilize its NOLs if it experiences an "ownership change". In general
terms, an ownership change results from transactions increasing the ownership of
certain stockholders in the stock of a corporation by more than 50 percentage
points over a three-year period. Since our formation, we have issued a
significant number of shares, and purchasers of those shares have sold some of
them, with the result that two changes of control as defined by Section 382 have
occurred. As a result of the most recent ownership change, utilization of our
NOLs is subject to an annual limitation under Section 382 determined by
multiplying the value of our stock at the time of the ownership change by the
applicable long-term tax-exempt rate resulting in an annual limitation amount of
approximately $127,000. Any unused annual limitation may be carried over to
later years, and the amount of the limitation may under certain circumstances be
increased by the "recognized built-in gains" that occur during the five-year
period after the ownership change (the "recognition period"). We believe that we
will have significant recognized built-in gains and that during the recognition
period the limitation will be increased by approximately $15 million based on an
independent valuation of the Company as of April 2, 2002. We also believe that
based on a valuation of the Company as of June 25, 2000, which is currently
underway, the earlier ownership change will also have significant recognized
built-in gains and that during the recognition period the limitation will be
further increased by approximately $28 million thus allowing the Company to
utilize its entire NOL. Significant management judgment was required in
estimating the amount of the recognized built in gain. If it is determined that
the actual amount of recognized built in gain is less than our estimate, we may
be required to make a cash payment for taxes due on our income for fiscal year
2003, plus related interest, which could materially adversely impact our
financial position.
RELATED PARTY TRANSACTIONS
On July 1, 2003 John J. (Jay) Poelman, retired and in connection
therewith resigned as the Company's Chief Executive Officer and as a Director of
the Company. Transactions with Electronic Commerce International, Inc. ("ECI"),
Electronic Marketing Services, LLC. ("EMS") and Simply Splendid, LLC ("Simply
Splendid") which prior to July 1, 2003 were considered related party
transactions, were not considered related entity transactions for the three
months ending September 30, 2003.
John J. Poelman was the sole owner of Electronic Commerce
International, Inc. ("ECI") during the three months ended September 30, 2002.
During this period, the Company purchased a merchant account solutions product
from ECI that provided on-line, real-time processing of credit card transactions
and resold this product to its customers. Effective October 1, 2002, Mr. Poelman
sold certain assets and liabilities of ECI, including ECI's corporate name and
its relationship with the Company, to an unrelated third party.
Total revenue generated by the Company from the sale of ECI merchant
account solutions was $1,453,612 for the three months ended September 30, 2002.
The cost to the Company for these products and services totaled $223,716 for the
three months ended September 30, 2002.
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, our former Chief Executive Officer and formerly a director of the
Company. The Company's revenues generated from the above products and services
were $1,429,824 for the three months ended September 30, 2002. The Company paid
EMS $278,060 to fulfill these services during the three months ended September
30, 2002. In addition, the Company had $92,094 as of June 30, 2003 recorded in
accounts payable relating to the amounts owed to EMS for product and services.
The Company utilizes Simply Splendid to provide complimentary gift
packages to its customers who register to attend the Company's Workshop training
sessions. An additional gift is sent to Workshop attendees who purchase products
at the conclusion of the Workshop. Aftyn Morrison, who owns Simply Splendid, is
the daughter of John J. Poelman, our former Chief Executive Officer, and
formerly a director of the Company. The Company paid Simply Splendid $0 to
fulfill these services during the quarter ended September 30, 2002. In addition,
the Company had $22,831 as of June 30, 2003 recorded in accounts payable
relating to the amounts owed to Simply Splendid for gift packages.
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
Three-month period ended September 30, 2003 compared to the three-month
period ended September 30, 2002
Revenue
Our fiscal year ends on June 30 of each year. Revenues for the
three-month period ended September 30, 2003 increased to $20,545,136 from
$11,283,849 in the three-month period ended September 30, 2002, an increase of
82%. Revenues generated at our Internet training workshops for the periods in
both fiscal years were from the sale of the SOS product as described in Critical
Accounting Policies and Estimates above. Revenues also include fees charged to
attend the workshop, web traffic building products, mentoring, consulting
services and access to credit card transaction processing interfaces. We expect
future, operating revenue to be generated principally following a business model
similar to the one used in our fiscal year that ended June 30, 2003. 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.
The increase in revenues from our first fiscal quarter ended September
30, 2003 compared to the three-month period ended September 30, 2002 can be
attributed to various factors. There was an increase in the number of Internet
training workshops conducted during the current fiscal quarter. The number
increased to 118 for the first quarter of the current fiscal year ("FY 2004")
from 67 in the first quarter of FY 2003. The average number of "buying units" in
attendance at our workshops during the period decreased to 92 from 100 in the
comparable period in the prior fiscal year. Persons who pay an enrollment fee to
attend our workshops are allowed to bring a guest at no additional charge, and
that individual and his/her guest constitute one buying unit. If the person
attends alone that single person also counts as one buying unit. Approximately
37% of the buying units made a purchase at the workshops in the first quarter of
FY 2003 compared to 28% in the first quarter of FY 2002. The average revenue per
workshop purchase of $4,231during the current quarter remained approximately the
same as in the comparable quarter of the prior fiscal year. We will seek to
increase the number of workshops held in the future including some in English
speaking countries outside of the United States of America.
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 three-month ended September 30, 2003
increased to $16,183,434 from $8,825,417 for the same three-month period in the
prior year. The increase in gross profit primarily reflects the increased
revenue during the period.
Gross profit as a percent of revenue for quarter ended September 30,
2003 was 79% compared to 78% for the quarter ended September 31, 2002.
Cost of revenues includes related party transactions of $0 in the
three-month period ended September 30, 2003 and $223,716 in the comparable
period of the prior fiscal year. These related party transactions are more fully
described in the notes to the consolidated financial statements as Note 7. 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 this related party is at least as favorable to us as
would be available from an independent third party.
Research and Development
Research and development expenses consist primarily of payroll and
related expenses. Research and development expenses in the current fiscal
quarter were $76,694 compared to $76,810 in the quarter ended September 30,
2002. In both periods these expenses consisted of work on the StoresOnline,
version 4, product that is used in the StoresOnline Software sold at our
Internet training workshops and the improvement of our internal database used by
management to control operations.
We intend to make enhancements to our technology as new methods and
business opportunities present themselves. 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 quarter ended September 30, 2003 increased to
$6,223,131 from $4,521,348 in the quarter ended September 30, 2002. The increase
in selling and marketing expenses is primarily attributable to the increase in
the number of workshops held during the current year and the associated expenses
including advertising and promotional expenses necessary to attract the
attendees. Advertising expenses for the three-month period ended September 30,
2003 were approximately $2.1 million compared to approximately $1.9 million in
the three-month period ended September 30, 2002. Commissions paid to independent
contract telemarketing companies increased to $1.7 million in the current fiscal
quarter from $1.3 million in the comparable quarter of the prior fiscal year.
Selling and marketing expenses as a percentage of sales were 30% of revenues for
the first quarter of FY2003 compared to 40% in the first quarter of FY 2002.
Selling and marketing expenses include related party transactions of
$0 and $278,060 in the three-month periods ended September 30, 2003 and 2002,
respectively. These are more fully described in the notes to the condensed
consolidated financial statements as Note 7. 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
this related party is 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, finance company discounts and other general corporate expenses.
General and administrative expenses for the three-month period ended September
30, 2003 increased to $1,758,275 from $857,608 in the comparable period of the
previous fiscal year. This increase is attributable to increases in finance
company discounts, salaries and fringe benefits, and legal, accounting and other
professional services. Finance company discounts arise in connection with our
practice of accepting 24-month installment contracts from our customers as one
of several methods of payment. Some of these contracts are subsequently sold to
finance companies at a discount. The discounts, which generally range between
15% and 25% depending upon the credit worthiness of our customer, amounted to
$484,973 in the three- month period ended September 30, 2003 and $266,753 in the
three-month period ended September 30, 2002.
General and administrative expenses as a percentage of revenues
increased during the quarter ended September 30, 2003 to 9% from 8% in the same
quarter of the prior fiscal year. We anticipate that general and administrative
expenses will increase in future years as our business grows, and may also
increase if we are not able to achieve a negotiated resolution of the litigation
and regulatory matters currently pending against us.
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 for our
customers, 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 of from 5% to 10% of the purchase price. These
installment contracts are sometimes sold to 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 low marginal cost associated with these sales and that
the down payment received by us at the time the contract is entered into exceeds
the cost of the delivered products. Since all other expenses relating to the
sale, such as salaries, advertising, meeting room expense, travel, etc., have
already been incurred, we believe there is a good business reason for extending
credit on these terms.
Bad debt expense was $6,220,234 in the first quarter of FY 2004
compared to $2,287,733 in the comparable period of the prior fiscal year. This
significant increase is due to an increase in the number of installment
contracts entered into, an increase in the number of contracts carried by us,
and our recent collection experience. During FY 2003 we wrote off approximately
$2.4 million of installment contracts that originated in FY 2002 and 2001. We
provided for bad debts as of June 30, 2002 based on the best information
available at the time, including historical write-off patterns. We have begun to
have access to much more detailed information from the finance companies that
service the installment contracts, and we have also had more historical data
with which to estimate the appropriate bad debt reserve. We believe that bad
debt expense in future years will decline as a percentage of revenues since we
have resolved all known contract losses during FY 2003. We believe the allowance
for doubtful accounts of approximately $9.2 million at September 30, 2003 is
adequate to cover all future losses associated with the contracts in our
accounts receivable as of September 30, 2003.
During the first quarter of FY 2004 workshop sales financed by
installment contracts were approximately $10.5 million compared to approximately
$4.4 million in the first quarter of the prior fiscal year. As a percentage of
workshop sales, installment contracts were 61% in the first quarter of FY 2004
compared to 55% in the first quarter of FY 2003. During the three-month period
ended September 30, 2003 contracts carried by us, before any adjustment for an
allowance for doubtful accounts, increased by approximately $4.6 million to
approximately $18.4 million. The balance carried at September 30, 2003 net of
the allowance for doubtful accounts was approximately $9.3 million. The
allowance for doubtful accounts as of September 30, 2003 related to installment
contracts was 49.8% of gross accounts receivable compared to 47.8% at June 30,
2003. These factors and other non-installment contract receivables required us
to increase our total allowance for doubtful accounts by approximately $2.5
million during the current quarter. The table below shows the activity in our
total allowance for doubtful accounts during the three-month period ended
September 30, 2003.
Allowance balance June 30, 2003 $7,203,855
Plus provision for doubtful accounts 6,040,233
Less accounts written off (3,789,384)
Plus collections on accounts previously written off 78,837
Allowance balance September 30, 2003 $ 9,533,541
===========
Interest Income
Interest income is derived from the installment contracts carried by
the Company. Our contracts have an 18% simple interest rate and interest income
for the three-month period ended September 30, 2003 was $275,244 compared to
$155,764 in the comparable period of the prior fiscal year. In the future as our
cash position strengthens we may be able to carry more installment contracts
rather than selling them at a discount to finance companies. If we were able to
carry more of these contracts it would increase interest income and reduce
administrative expenses. The discounts are included in administrative expenses,
as discussed above.
Income Taxes
We have made no provision for income taxes in our Statement of
Operations for the three-month period ended September 30, 2003, because we
believe our net operating loss carry forward ("NOL") will offset our entire
earnings before income taxes during that period. Our NOL, which is approximately
$43 million, represents the losses reported for income tax purposes from our
inception through June 30, 2002. FY 2003 was the first year in our history that
generated taxable income. Section 382 of the Internal Revenue Code ("Section
382") imposes limitations on a corporation's ability to utilize its NOLs if it
experiences an "ownership change". In general terms, an ownership change results
from transactions increasing the ownership of certain stockholders in the stock
of a corporation by more than 50 percentage points over a three-year period.
Since our formation, we have issued a significant number of shares, and
purchasers of those shares have sold some of them, with the result that two
changes of control as defined by Section 382 have occurred. As a result of the
most recent ownership change, utilization of our NOLs is subject to an annual
limitation under Section 382 determined by multiplying the value of our stock at
the time of the ownership change by the applicable long-term tax-exempt rate
resulting in an annual limitation amount of approximately $127,000. Any unused
annual limitation may be carried over to later years, and the amount of the
limitation may under certain circumstances be increased by the "recognized
built-in gains" that occur during the five-year period after the ownership
change (the "recognition period"). We believe that we will have significant
recognized built-in gains and that during the recognition period the limitation
will be increased by approximately $15 million based on an independent valuation
of our company as of April 3, 2002. We also believe that based on a valuation of
our company as of June 25, 2000, which evaluation is currently underway, the
earlier ownership change will also have significant recognized built-in gains
and that during the recognition period the limitation will be further increased
by approximately $28 million thus allowing us to utilize our entire NOL.
Significant management judgment was required in estimating the amount of the
recognized built in gain. If it is determined that the actual amount of
recognized built in gain is less than our estimate, we may be required to make a
cash payment for taxes due on our income for fiscal year 2003, plus related
interest, which could materially adversely impact our financial position.
LIQUIDITY AND CAPITAL RESOURCES
At the close of the quarter ended September 30, 2003, we had working
capital of $6,980,064 compared to $5,562,926 at June 30, 2003. Our shareholders
equity was $10,440,613 at September 30, 2003 compared to $8,103,047 at June 30,
2003. We generated revenues of $20,545,136 for the three-month period ended
September 30, 2003 compared to $11,283,849 for the comparable period of the
prior fiscal year. For the quarter ended September 30, 2003 we generated net
earnings of $2,152,081 compared to $1,083,150 for the quarter ended September
30, 2002. For the quarter ended September 30, 2003, we recorded positive cash
flows from operating activities of $119,171 compared to negative cash flows of
$151,347 in the comparable period of the prior fiscal year.
Although we had historically incurred losses during our first several
years of operations, we became Profitable in FY 2002 and continued our
profitability in FY 2003 and in the first quarter of FY 2004. Our historical
losses, however, have resulted in a cumulative net loss of $62,334,308 through
September 30, 2003. We have historically relied upon private placements of our
stock and the issuance of debt to generate funds to meet our operating needs.
However in FY 2003 we had positive cash flow from operations of $2,080,778, and
during the quarter ended September 30, 2003 we had positive cash flows from
operations of $119,171. We may in the future seek to raise additional debt or
equity capital to further increase our growth potential and take advantage of
strategic opportunities. However, there can be no assurance that additional
financing will be available on acceptable terms, if at all.
Cash
At September 30, 2003, we had $2,444,115 cash on hand compared to
$2,319,618 at June 30, 2003. Cash provided by operating activities was $119,173
for the quarter ended September 30, 2003. Net cash provided by operations was
mainly net earnings of $2,152,081 and a provision for bad debts of $6,220,234,
but partially offset by an increase in trade receivables of $8,199,145. The
increase in trade receivables occurred because our increase in revenues
generated additional installment contracts. See the discussion of Bad Debt
Expense in the Results of Operations for a detailed discussion.
Trade Receivables
Trade receivables, carried as a current asset, net of allowance for
doubtful accounts, were $6,240,549 at September 30, 2003 compared to $4,965,769
at June 30, 2003. Trade receivables, carried as a long-term asset, net of
allowance for doubtful accounts, were $3,023,826 at September 30, 2003 compared
to $2,254,969 at June 30, 2003. 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 period are carried as long-term trade
receivables. During the quarter ended September 30, 2003 workshop sales financed
by installment contracts were approximately $10.5 million compared to
approximately $4.4 million in the quarter ended September 30, 2002.
We sell, on a discounted basis, a portion of these installment
contracts to third party financial institutions for cash. Currently we sell
these installment contracts to three separate financial institutions with
different recourse rights. When contracts are sold the discount varies between
15% and 25% depending on the credit quality of the customer involved. During the
current quarter our cash position was strong enough to retain some of the
contracts we otherwise would have sold. Contracts with customers whose credit
rating would have allowed us to sell them and having an original principal
balance of $235,642 were retained by the Company. The savings in discount by not
selling the contracts was approximately $42,000. During the quarter ending
December 31, 2003 we expect to retain additional contracts.
Accounts Payable
Accounts payable at September 30, 2003, totaled $1,816,381, compared to
$1,528,037 at June 30, 2003. Our accounts payable as of September 30, 2003 were
generally within our vendor's terms of payment.
Stockholders' Equity
Stockholders' equity at September 30, 2003 was $10,440,613 compared to
$8,103,047 at June 30, 2003. The increase was mainly due to profitable
operations for the first fiscal quarter. Net earnings during the quarter were
$2,152,081.
Financing Arrangements
We accept payment for the sales made at our Internet training workshops
by cash, credit card, or installment contract. 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. See "Liquidity and Capital Resources - Accounts
Receivable," for further information.
NASDAQ Application
On June 6, 2003 we filed an application for a listing on the NASDAQ
Small Cap Market. Our application is subject to review and approval by the
NASDAQ. Since filing, we have received and answered a series of questions from
NASDAQ. We believe that because we are seeking to be listed other than in the
context of an underwritten public offering and also because we had previously
been delisted in January of 2001 and the level and nature of complaints and
inquiries from customers and regulators about certain of our business practices
NASDAQ is conducting a more complete and lengthy review of us than is normally
conducted in connection with a listing application. We were invited to meet
members of NASDAQ's staff on October 28 and that was a positive and fruitful
meeting. Following that meeting NASDAQ requested additional information and a
number of documents for their files which we are in the process of providing to
them. We continue to feel confident that we meet all of the criteria and the
standards of NASDAQ and are hopeful that our application will be accepted.
Impact of Recent Accounting Pronouncements
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 145 are effective for transactions
occurring after May 15, 2002 while other are effective for fiscal years
beginning after May 15, 2002. During the fiscal year ended June 30, 2001 we had
originally reported an extraordinary item related to gain on extinguishment of
debt in its Statement of Operations of $1,688,956. Based on SFAS No. 145, we
have reclassified $1,688,956 to income before discontinued operations in its
statement of operations included in our annual report on Form 10-K for the
fiscal year ended June 30, 2003.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of FASB
Statement No. 123". This statement amends FASB Statement No. 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
amendments to Statement 123 regarding disclosure are effective for financial
statements for fiscal years ending after December 15, 2002. We have adopted the
annual disclosure provisions of SFAS No. 148 in our financial statements for the
year ended June 30, 2003 and for the quarter ended September 30, 2003 and
thereafter. The adoption of this standard involves additional disclosures. Our
adoption of SFAS No. 148 did not have a material impact on our results of
operations, financial position or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has been issued and requires that they be recorded at fair value. The initial
recognition and measurement provisions of this interpretation are to be applied
only on a prospective basis to guarantees issued or modified after December 31,
2002, which, for us, is the fiscal year beginning July 1, 2003. The disclosure
requirements of this interpretation are effective for financial statements of
interim or annual periods ending after December 15, 2002. We do not have any
indirect guarantees of indebtedness of others as of September 30, 2003.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities." This interpretation addresses the consolidation
of business enterprises (variable interest entities) to which the usual
condition of consolidation does not apply. This interpretation focuses on
financial interests that indicate control. It concludes that in the absence of
clear control through voting interests, a company's exposure (variable interest)
to the economic risks and potential rewards from the variable interest entity's
assets and activities are the best evidence of control. Variable interests are
rights and obligations that convey economic gains or losses from changes in the
values of the variable interest entity's assets and liabilities. Variable
interests may arise from financial instruments, service contracts, nonvoting
ownership interests and other arrangements. If an enterprise holds a majority of
the variable interests of an entity, it would be considered the primary
beneficiary. The primary beneficiary would be required to include assets,
liabilities and the results of operations of the variable interest entity in its
consolidated financial statements. This interpretation applies immediately to
variable interest entities which are created after or for which control is
obtained after January 31, 2003. For variable interest entities created prior to
February 1, 2003, the provisions would be applied effective July 1, 2003. We do
not have an interest in any variable interest entities as of September 30, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" for
contracts entered into or modified after June 30, 2003; for hedging
relationships designated after June 30, 2003. We do not have any derivative
instruments or hedging activities as of September 30, 2003.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
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.
Item 4. Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer, after conducting
an evaluation, together with other members of our management of the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this report, have concluded
that our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in our reports filed or submitted
under the Securities Exchange Act of 1934 ("Exchange Act") is recorded,
processed, summarized, and reported within the time periods specified in the
rules and forms of the SEC. There were no significant changes in our internal
controls or in other factors that could significantly affect these controls
subsequent to that evaluation, and there were no significant deficiencies or
material weaknesses in such controls requiring corrective actions.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
On August 12, 2002, the Office of the District Attorney of San Mateo
County, California, notified us that it was investigating whether we were
operating in violation of the California Seminar Sales Act (California Civil
Code ss. 1689.20-1693)), the Seller Assisted Marketing Plans Act (California
Civil Code ss. 1812.200-1812.221), and California's Unfair Competition Act
(California Business & Professions Code ss. 17200 et. seq.). The Seminar Sales
Act provides customers a three day right of rescission in connection with
purchases made in a seminar setting (as defined by that Act). The Seller
Assisted Marketing Plan Act is California's business opportunity sales law and
it requires that persons who sell business opportunities (as defined in the that
act) to register with the state and make certain pre-sale disclosures to
purchasers. The Unfair Competition Act prohibits deceptive acts and practices
generally in all industries. After receiving this notice, we reviewed the
customer complaints that the District Attorney's office provided to us and have
been able to resolve many of those complaints. We have also worked with that
office to resolve the regulatory compliance issues raised by it. During the
course of our efforts to resolve these issues we determined that because a
settlement with the office of the San Mateo district attorney would not be
binding on the state of California or the district attorney's of other counties
that we would voluntarily submit our proposed resolution of the matter to the
state of California in an effort to obtain closure on this matter at a statewide
level.
On October 3, 2003, the state indicated that it was not willing to
approve our proposed resolution of the matter. That communication indicated that
neither the state nor the San Mateo District Attorney's office was willing to
enter into a settlement unless the settlement included (i) compliance by the
company with the Seminar Sales Act and the Seller Assisted Marketing Plan Act,
(ii) a consent decree barring future violations of the above mentioned statutory
provisions, (iii) an agreement to provide a full refund to each of the customers
who had previously complained to the state of California or the office of the
San Mateo District Attorney, including those customers with whom we had
previously entered into a settlement and agreement and release and provided a
partial refund, (iv) an agreement to provide a full refund to each California
customer who sought a refund within the 60 days following the execution of the
settlement, and (v) the payment of a civil penalty in the amount of $50,000. The
communication indicated that the office of the San Mateo district attorney was
willing to enter into a settlement agreement on a stand alone basis without
requiring us to register under the Seller Assisted Marketing Plan Act and would
require the payment of a civil penalty of $35,000 and that if we accepted that
offer the state of California would not be prohibited from bringing an
enforcement action against us. That communication also stated that if the matter
was not resolved that the state and the office of the San Mateo district
attorney would bring an enforcement action against us. We continue to believe
that our business is not subject to regulation under the Seller Assisted
Marketing Plan Act or the Seminar Sales Act and believe that we have meritorious
defenses to those claims. Although we are continuing to work to resolve this
matter through a negotiated settlement with the state we are prepared to
vigorously defend any action brought by either the office of the San Mateo
District Attorney or the Attorney General of the state of California. If an
enforcement action is brought against us and we are not able to prevail on the
merits or if we are prevented from conducting operations in California during
the pendency of the proceedings our business would likely be materially
adversely affected.
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
During the period July 29 through September 8, 2003, we issued an
aggregate of 158,443 restricted shares of our common stock pursuant to the
"cashless" exercise of outstanding warrants. In our opinion, the issuance of
these shares was exempt by virtue of Section 4(2) of the Securities Act and the
rules promulgated thereunder.
In October 2003 we issued an aggregate of 27,425 restricted shares of
our common stock pursuant to the exercise of outstanding warrants. In our
opinion, the issuance of these shares was exempt by virtue of Section 4(2) of
the Securities Act and the rules promulgated there under.
On October 11, 2003 we issued 9,853 shares of our common stock at a
deemed price of $6.10 per share in payment of interest due on a note payable to
King William LLC. In our opinion, the issuance of these shares was exempt by
virtue of Section 4(2) of the Securities Act and the rules promulgated there
under.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31.1 Certification of the Chief Executive Officer
31.2 Certification of the Chief Financial Officer
32.1 Certification of the Chief Executive Officer
32.2 Certification of the Chief Financial Officer
(b) Reports on Form 8 K
1. We filed a Current Report on Form 8-K on July 8, 2003 announcing the
retirement and resignation of our Chief Executive Officer and the
appointment of Thomas Scheiner to our Board of Directors.
2. We filed a Current Report o Form 8-K on September 16, 2003 announcing
our earnings for the fiscal year ended June 30, 2003.
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/ Donald L. Danks
November 13, 2003 Donald L. Danks
Chief Executive Officer
November 13, 2003 By: /s/ Frank C. Heyman
Frank C. Heyman
Chief Financial Officer