NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The accompanying unaudited condensed consolidated financial statements of Internet Commerce Corporation (the “Company” or “ICC”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. In the opinion of management, such statements include all adjustments (consisting only of normal recurring adjustments) necessary for the fair presentation of the Company’s financial position, results of operations and cash flows at the dates and for the periods indicated. Pursuant to the requirements of the Securities and Exchange Commission (the “SEC”) applicable to Quarterly Reports on Form 10-Q, the accompanying financial statements do not include all the disclosures required by GAAP for annual financial statements. While the Company believes that the disclosures presented are adequate to make the information not misleading, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended July 31, 2006. Operating results for the six month period ended January 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending July 31, 2007 or any future period.
1. ORGANIZATION AND NATURE OF BUSINESS
ICC creates, deploys and manages the secure and reliable electronic exchange of essential business documents. With the Company’s value added network (“VAN”), desktop software and hosted applications, managed services, consulting and professional services, ICC is a trusted provider of e-commerce solutions to connect businesses, regardless of size and level of technical sophistication, with their trading communities. Thousands of customers, ranging from sole proprietorships to large corporations, in a variety of industries rely on the value delivered from ICC’s broad line of solutions, expertise and 24x7 customer service to help meet the unique requirements for trading partner compliance, coordination and collaboration.
2. RECENT ACQUISITIONS
STEWART TECHNICAL SERVICES
On January 31, 2007, the Company completed the acquisition of certain assets of Stewart Technical Services, Inc. (“STS”) STS provides EDI services and software and will be included in our EC Solutions segment. In accordance with the Asset Purchase Agreement (“Agreement”), the Company paid $300,000 upon close and has a contingent payment of up to an additional one times revenue for the first year’s revenue less the $300,000 payment made at closing. Additionally, if the first year’s revenues are less than $400,000, then no additional earn-out will be paid. The Company received tangible assets of approximately $49,000, which included accounts receivable of $44,000 and fixed assets of $5,000, and intangible assets of approximately $266,000, which are comprised of internally developed software of $166,000 and customer relationships of $100,000. Under the Agreement, the Company also recorded a liability of $15,000 for transition costs. The fixed assets are estimated to have a useful life of three years and customer relationships and internally developed software are estimated to have useful lives of five and four years, respectively.
ENABLE
On May 9, 2006, the Company acquired all of the outstanding shares of Enable Corp. (“Enable”), a privately held corporation with offices in New York City that provides trading community portals, web based EDI trading tools, and EDI professional services to a variety of industries. Under the terms of the Share Purchase Agreement, the Company paid $4.2 million in cash and issued 686,324 shares of its class A common stock valued at approximately $2.6 million.
The following table sets forth the components of the purchase price for Enable as of January 31, 2007.
Cash on closing | | $ | 4,203,000 | |
ICC class A common stock issued | | 2,632,739 | |
Transaction costs | | 416,208 | |
Additional costs since July 31, 2006 | | 20,551 | |
Total purchase price | | $ | 7,272,498 | |
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The following table provides the estimated fair value of assets acquired and liabilities assumed in the Enable acquisition:
Cash | | $ | 991,747 | |
Accounts receivable | | 705,386 | |
Restricted cash | | 15,000 | |
Other assets | | 14,975 | |
Fixed assets | | 246,520 | |
Intangible assets – acquired technology | | 1,775,000 | |
Intangible assets – trade names | | 250,000 | |
Intangible assets – customer relationships | | 1,500,000 | |
Liabilities | | (510,778 | ) |
| | | |
Fair value of net assets acquired | | $ | 4,987,850 | |
| | | |
Goodwill | | $ | 2,284,648 | |
| | | |
Total purchase price | | $ | 7,272,498 | |
The recorded fixed and other assets are estimated to have a life of two to three years. The acquired technology intangibles are estimated to have a life between one and four years, and the customer relationship and trade names intangibles are estimated to have a life of seven years. We recorded $2,285,000 in goodwill resulting from the Enable acquisition. Revenue from the Enable acquisition includes hosting and transaction fees, administrative fees and professional services, which are part of our EC Solutions segment. Goodwill and intangible assets are deductible for tax purposes. The results of operations of Enable are consolidated with the results of operations of the Company subsequent to the acquisition date. The acquisition of Enable was made to strengthen the Company’s web based trading technology offering and customer base.
3. REPURCHASE OF PREFERRED STOCK
On December 14, 2006, two subsidiaries of 3V Capital LLC (3V Capital Fund Ltd. and Distressed/High Yield Trading Opportunities, Ltd. (collectively, the “3V Entities”)) acquired from Omega Liquidating Trust, the liquidating trust for the bankrupt Cable & Wireless USA, 10,000 shares of the series C preferred stock and 381,111 shares of the class A common stock of Internet Commerce Corporation (“ICC” or the “Company”). Thereafter, on December 20, 2006, ICC entered into a Stock Purchase Agreement with each of the 3V Entities, pursuant to which ICC reacquired a total of 5,000 shares of its series C preferred stock and 190,555 shares of its class A common stock for an aggregate purchase price of $2,875,000. Following this reacquisition of shares by ICC, the 3V Entities together continue to own the remaining 5,000 shares of ICC’s series C preferred stock and 190,556 shares of ICC’s class A common stock. The repurchased shares were subsequently retired during the quarter.
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4. BUSINESS SEGMENT INFORMATION
The Company’s two reportable segments are:
· Electronic Commerce Solutions (“EC Solutions”) segment, which includes ICC.NET VAN services, browser-based and hosted applications, and desktop software; and
· Electronic Commerce Services (“EC Services “) segment, which is comprised of the EC service center, EC outsourcing, mapping and professional services.
The Company changed its reportable segments as of August 1, 2006 to coincide with management’s realignment of the business operations to follow our service and product lines. The EC Solutions segment was formed to consolidate the services and products offered with direct or indirect connections to our VAN. The EC Services segment was formed and consolidates all of our professional, managed and outsourcing services. Specifically, professional service revenue and mapping revenue were moved from the old ICC.NET segment to the EC Services segment. Hosted applications and desktop software were moved to the EC Solutions segment from the old EC Service Bureau segment. The browser-based and hosted applications acquired from Enable were also added to the EC Solutions segment. In addition, the Company will no longer allocate 100% of its operating expenses to the reporting segments. Only those expenses that are directly related to the development and delivery of a reporting segment’s products and services will be allocated. The Company has restated the previous period’s reporting segments for comparability purposes between the periods.
The tables below summarize information about operations for the three and six month periods ended January 31, 2007 and 2006.
| | EC Solutions | | EC Services | | Total | |
Three Months – January 31, 2007 | | | | | | | |
Revenues from external customers | | $ | 3,880,022 | | $ | 1,422,446 | | $ | 5,302,468 | |
Segment operating income | | $ | 2,259,701 | | $ | 385,219 | | $ | 2,644,920 | |
The following is a reconciliation of operating segment income to net income for the three month period ending January 31, 2007:
Segment operating income | | $ | 2,644,920 | |
Corporate expenses | | (1,987,501 | ) |
Operating income | | 657,419 | |
Other income (expense), net | | 62,650 | |
Income before income taxes | | 720,069 | |
Income tax expense | | 16,663 | |
Net income | | $ | 703,406 | |
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| | EC Solutions | | EC Services | | Total | |
Six Months – January 31, 2007 | | | | | | | |
Revenues from external customers | | $ | 7,816,663 | | $ | 3,293,533 | | $ | 11,110,196 | |
Segment operating income | | $ | 4,631,303 | | $ | 1,174,530 | | $ | 5,805,833 | |
The following is a reconciliation of operating segment income to net income for the six month period ending January 31, 2007:
Segment operating income | | $ | 5,805,833 | |
Corporate expenses | | (4,545,395 | ) |
Operating income | | 1,260,438 | |
Other income (expense), net | | 101,836 | |
Income before income taxes | | 1,362,274 | |
Income tax expense | | 84,270 | |
Net income | | $ | 1,278,004 | |
| | EC Solutions | | EC Services | | Total | |
Three Months – January 31, 2006 | | | | | | | |
Revenues from external customers | | $ | 3,156,784 | | $ | 1,855,456 | | $ | 5,012,240 | |
Segment operating income | | $ | 2,130,144 | | $ | 874,038 | | $ | 3,004,182 | |
The following is a reconciliation of operating segments income to net income for the three month period ending January 31, 2006:
Segment operating income | | $ | 3,004,182 | |
Corporate expenses | | (2,606,893 | ) |
Operating income | | 397,289 | |
Other income (expense), net | | (32,479 | ) |
Income before income taxes | | 364,810 | |
Income tax (benefit) expense | | (7,093 | ) |
Net income | | $ | 371,903 | |
| | EC Solutions | | EC Services | | Total | |
Six Months – January 31, 2006 | | | | | | | |
Revenues from external customers | | $ | 6,370,747 | | $ | 3,659,326 | | $ | 10,030,073 | |
Segment operating income | | $ | 4,261,777 | | $ | 1,703,328 | | $ | 5,965,105 | |
The following is a reconciliation of operating segments income to net income for the six month period ending January 31, 2006:
Segment operating income | | $ | 5,965,105 | |
Corporate expenses | | (4,827,975 | ) |
Operating income | | 1,137,130 | |
Other income (expense), net | | (25,509 | ) |
Income before income taxes | | 1,111,621 | |
Income tax expense | | 17,172 | |
Net income | | $ | 1,094,449 | |
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5. Recent Accounting proNouncements
In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 describes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 and will be effective for the Company in fiscal 2008. The Company is currently evaluating the impact of this new accounting interpretation on its financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements”. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS No. 157 requires fair value measurements to be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact of adopting SFAS No. 157 on its financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements”. SAB No. 108 provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of assessing materiality. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The Company is currently evaluating the impact of adopting SAB No. 108 on its financial statements.
6. INCOME TAXES
A provision for income taxes has been provided for the three and six months ended January 31, 2007 and 2006 for estimated federal alternative minimum taxes and certain state income taxes, as the Company has sufficient net operating loss carryforwards to offset regular taxable income. As of January 31, 2007, the Company continues to maintain a valuation allowance against the total net deferred tax balance. The Company will continue to evaluate its prospects going forward. If the Company’s operations continue at current levels and future business projections indicate continued profitability, the Company will review the valuation allowance and may reverse, in the near future, a portion of the deferred tax asset valuation reserve.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains a number of “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Specifically, all statements other than statements of historical facts included in this Quarterly Report regarding our financial position, business strategy and plans and objectives of management for future operations are forward-looking statements. These forward-looking statements are based on the beliefs of management, as well as assumptions made by and information currently available to management. When used in this Report, the words “anticipate,” “believe,” “estimate,” “expect,” “may,” “will,” “hope,” “continue” and “intend,” and words or phrases of similar import, as they relate to our financial position, business strategy and plans, or objectives of management, are intended to identify forward-looking statements. These statements reflect our current view with respect to future events and are subject to risks, uncertainties and assumptions related to various factors including, without limitation, those factors discussed in Item 1 (Business) of Part I and Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of Part II of our Annual Report on Form 10-K filed on October 30, 2006, Item 2 and Item 1A of Part II of our Quarterly Reports. You should carefully review those risks, as well as additional risks described in other documents we file from time to time with the Securities and Exchange Commission.
Although we believe that our expectations are reasonable, we cannot assure you that our expectations will prove to be correct. Should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described in this Quarterly Report as anticipated, believed, estimated, expected or intended.
Overview
Internet Commerce Corporation creates, deploys and manages the secure and reliable electronic exchange of essential business documents. With our value added network (“VAN”), desktop software and hosted applications, managed services, consulting and professional services, we are a trusted provider of e-commerce solutions to connect businesses, regardless of their size and level of technical sophistication, with their trading communities. Thousands of customers, ranging from sole proprietorships to large corporations, in a variety of industries rely on the value delivered from ICC’s broad line of solutions, expertise and 24x7 customer service to help meet the unique requirements for trading partner compliance, coordination and collaboration.
We pioneered the use of the Internet for electronic data interchange (“EDI”) business-to-business (B2B) solutions and continue to lead as new technologies and requirements emerge for more efficient business communication. Organizationally, our two segments of business are known as the:
· EC Solutions segment, which includes ICC.NET VAN services, browser-based and hosted applications, and desktop software; and
· EC Services segment, whose operations primarily focus on facilitating the EDI communications of small and mid-sized businesses with their trading partners. The EC Services segment includes the EC service center, EC outsourcing, mapping and professional services.
These segments compliment one another and give us the ability to provide solutions to many different kinds of enterprises, from sole proprietorships to large corporations, operating in a variety of industries.
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Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. We consider certain accounting policies related to revenue recognition, valuation of acquired intangibles and impairment of long-lived assets including goodwill, and valuation of investments to be critical policies due to the estimation process involved in each. Management discusses its estimates and judgments with the Audit Committee of our Board of Directors.
For a more detailed description on the application of these and other accounting policies, see Note 2 of the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2006. Reference is also made to the discussion of the application of these critical accounting policies and estimates contained in Management’s Discussion and Analysis in our Annual Report on Form 10-K for fiscal 2006. During the six months ended January 31, 2007, there were no significant or material changes in the application of critical accounting policies that would require an update to the information provided in the Form 10-K for fiscal 2006.
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Three Months Ended January 31, 2007 Compared with Three Months Ended January 31, 2006.
Results of Operations – EC Solutions
Our EC Solutions segment uses the Internet and our proprietary technology to deliver our customers’ documents and data files to members of their trading communities. The following table summarizes operating results for our EC Solutions services for the three months ended January 31, 2007 and 2006:
| | Three Months Ended | | | | | |
| | January 31, | | Variance | |
| | 2007 | | 2006 | | $ | | % | |
Revenues: | | | | | | | | | |
Services | | $ | 3,880,022 | | $ | 3,156,784 | | 723,238 | | 23 | |
| | | | | | | | | |
Expenses: | | | | | | | | | |
Cost of services | | 1,104,319 | | 830,655 | | 273,664 | | 33 | |
Product development and enhancement | | 438,841 | | 148,458 | | 290,383 | | 196 | |
General and administrative | | 77,161 | | 47,527 | | 29,634 | | 62 | |
Total expenses | | 1,620,321 | | 1,026,640 | | 593,681 | | 58 | |
| | | | | | | | | |
Segment operating income | | $ | 2,259,701 | | $ | 2,130,144 | | 129,557 | | 6 | |
Revenues – EC Solutions – Revenue from EC Solutions segment was 73% of consolidated revenues for the quarter ended January 31, 2007 (“2007 Quarter”) compared to 63% for the quarter ended January 31, 2006 (“2006 Quarter”). EC Solutions revenues increased $723,000 for the 2007 Quarter compared to the 2006 Quarter, principally from the browser-based and hosted services revenue acquired from Enable and an increase in VAN related transaction volume and mailbox fees.
Cost of services – EC Solutions – Cost of services relating to our EC Solutions segment was 28% of revenue from the EC Solutions services for the 2007 Quarter, compared to 26% for the 2006 Quarter. Total cost of services increased $274,000 for the 2007 Quarter compared to the 2006 Quarter. Cost of services consists primarily of salaries and employee benefits, connectivity fees, amortization, allocation of product and development expenses and rent. The increase was primarily related to the increased allocation of product development of $145,000 and an increase in acquired technology and customer list amortization expense of $247,000, offset by a reduction in the cost of our telephone and connectivity fees of $75,000.
Product development and enhancement - EC Solutions - Product development and enhancement costs relating to our EC Solutions segment consist primarily of salaries and employee benefits. Product development and enhancement costs increased $290,000 in the 2007 Quarter compared with the 2006 Quarter. This increase is related to the additional staff, consulting and rent expenses from the Enable operations.
General and administrative - EC Solutions - General and administrative expenses supporting our EC Solutions segment consist primarily of depreciation, telephone, and computer maintenance expenses. General and administrative costs increased $30,000 in the 2007 Quarter compared to the 2006 Quarter. The increase was mainly due to computer maintenance expenses.
Operating Income - EC Solutions - Operating income from EC Solutions increased $129,557, or 6%, for the 2007 Quarter compared with the 2006 Quarter, due to the increased revenue from the Enable acquisition and VAN related transaction volume and mailbox fees, offset principally by the additional staff, consulting and rent expenses from the Enable operations. We expect our EC Solutions segment to remain profitable as we continue to build our browser-based and hosted services customer portfolio.
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Results of Operations – EC Services
Our EC Services operations primarily focus on facilitating the EDI communications of small and mid-sized businesses with their trading partners through our EC Service center, E-Commerce outsourcing and professional services. The following table summarizes operating results for our EC Services segment for the three months ended January 31, 2007 and 2006:
| | Three Months Ended | | | | | |
| | January 31, | | Variance | |
| | 2007 | | 2006 | | $ | | % | |
Revenues: | | | | | | | | | |
Services | | $ | 1,422,446 | | $ | 1,855,456 | | (433,010 | ) | (23 | ) |
| | | | | | | | | |
Expenses: | | | | | | | | | |
Cost of services | | 865,364 | | 919,527 | | (54,163 | ) | (6 | ) |
Product development and enhancement | | 112,402 | | 58,470 | | 53,932 | | 92 | |
General and administrative | | 59,461 | | 3,421 | | 56,040 | | 1,638 | |
Total expenses | | 1,037,227 | | 981,418 | | 55,809 | | 6 | |
| | | | | | | | | |
Segment operating income | | $ | 385,219 | | $ | 874,038 | | (488,819 | ) | (56 | ) |
Revenue – EC Services – Revenue from our EC Services was 27% of consolidated revenues for the 2007 Quarter compared to 37% for the 2006 Quarter. Revenue decreased $433,000 for the 2007 Quarter compared to the 2006 Quarter. Mainly due to customer attrition, revenues decreased at our EC service center approximately $256,000 and our EC outsourcing services approximately $156,000. We believe the attrition from the MEC and Kodiak acquisitions has stabilized and we anticipate that our third and fourth quarter will depict more comparative quarter to quarter results.
Cost of services – EC Services - Cost of services relating to our EC Services segment was 61% of revenue in the 2007 Quarter, compared to 50% in the 2006 Quarter. Cost of services decreased $54,000 for the 2007 Quarter compared to the 2006 Quarter. Cost of services consists primarily of salaries and employee benefits, amortization, connectivity fees and rent. The decrease was mainly a result of lower salary and benefit expense at our EC service center offset by increased amortization expense. We do not anticipate any further significant reductions in salaries and benefits related to our EC Services segment as the increase in the 2006 Quarter was primarily related to the higher levels of staff required to transition the backlog of work from to the MEC acquisition.
Product development and enhancement – EC Services - Product development and enhancement costs consist primarily of salaries and employee benefits. Product development and enhancement costs incurred by our EC Services segment increased $54,000 in the 2007 Quarter compared to the 2006 Quarter. The increase was primarily the result of increased salary and benefits expense of approximately $100,000, offset by a higher allocation of product development to other departments of $47,000.
General and administrative – EC Services - General and administrative expenses relating to our EC Services segment consist primarily of office expenses, depreciation, computer maintenance expense, telephone and rent. General and administrative expenses incurred by our EC Services segment increased $56,000 in the 2007 Quarter compared to the 2006 Quarter. The increase was mainly related to higher depreciation and computer maintenance expenses related to recent investments in capital expenditures.
Operating Income - EC Services - Operating income from EC Services decreased $488,819, or 56%, for the 2007 Quarter compared with the 2006 Quarter, due primarily to the decreased revenue in the segment. We anticipate that future periods will be more comparable due to the stabilization of the customer attrition from the MEC and Kodiak acquisitions.
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Corporate Expenses
Our Corporate expenses represent the general, administrative, corporate and executive expenses not directly related to our EC Solutions or EC Services segments. The following table summarizes operating expenses for our corporate expenses for the three months ended January 31, 2007 and 2006:
| | Three Months Ended | | | | | |
| | January 31, | | Variance | |
| | 2007 | | 2006 | | $ | | % | |
Expenses: | | | | | | | | | |
Product development and enhancement | | $ | 34,454 | | $ | — | | 34,454 | | — | |
Selling and marketing | | 369,359 | | 577,301 | | (207,942 | ) | (36 | ) |
General and administrative | | 1,583,688 | | 2,029,592 | | (445,904 | ) | (22 | ) |
Total expenses | | $ | 1,987,501 | | $ | 2,606,893 | | (619,392 | ) | 24 | |
Product development and enhancement – Corporate – Product development and enhancement costs included in our Corporate expenses consist primarily of salaries and employee benefits. Product development and enhancement costs increased $34,000 in the 2007 Quarter compared to the 2006 Quarter. The increase is primarily a result of unallocable salary and benefit costs not directly related to the EC Solutions or EC Services segments.
Selling and marketing – Corporate - Selling and marketing costs included in our Corporate expenses consist primarily of salaries and employee benefits and amortization. Selling and marketing expenses decreased $208,000 in the 2007 Quarter compared to the 2006 Quarter primarily due to the lower salary, benefits and commission expense of approximately $110,000 and the reclassification of ECS, MEC and Kodiak customer list amortization of $68,000 to cost of sales in the EC Services segment.
General and administrative – Corporate – General and administrative costs included in our Corporate expenses consist primarily of salaries and employee benefits, office expenses, legal and accounting expenses, depreciation, computer maintenance expenses, telephone and rent. General and administrative expenses decreased $446,000 in the 2007 Quarter compared to the 2006 Quarter. The decrease is primarily related to the reduction of office rent of $163,000 due to the closing of our Cary, North Carolina and Charlottesville, Virginia offices, a reduction of bad debt expense of $131,000 due to stronger collection activity and a reduction of $113,000 in option related non-cash compensation.
Six Months Ended January 31, 2007 Compared with Six Months Ended January 31, 2006.
Results of Operations – EC Solutions
Our EC Solutions segment uses the Internet and our proprietary technology to deliver our customers’ documents and data files to members of their trading communities. The following table summarizes operating results for our EC Solutions services for the six months ended January 31, 2007 and 2006:
| | Six Months Ended | | | | | |
| | January 31, | | Variance | |
| | 2007 | | 2006 | | $ | | % | |
Revenues: | | | | | | | | | |
Services | | $ | 7,816,663 | | $ | 6,370,747 | | 1,445,916 | | 23 | |
| | | | | | | | | |
Expenses: | | | | | | | | | |
Cost of services | | 2,055,951 | | 1,838,214 | | 217,737 | | 12 | |
Product development and enhancement | | 990,738 | | 179,288 | | 811,450 | | 453 | |
General and administrative | | 138,671 | | 91,468 | | 47,203 | | 52 | |
Total expenses | | 3,185,360 | | 2,108,970 | | 1,076,390 | | 51 | |
| | | | | | | | | |
Segment operating income | | $ | 4,631,303 | | $ | 4,261,777 | | 369,526 | | 9 | |
Revenues – EC Solutions – Revenue from EC Solutions segment was 70% of consolidated revenues for the six months ended January 31, 2007 (“2007 Six Months”) compared to 64% for the six months ended January 31, 2006 (“2006 Six Months”). EC Solutions revenues increased $1,446,000 for the 2007 Six Months compared to the
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2006 Six Months, principally from the browser-based and hosted services revenue acquired from Enable and an increase in VAN transaction volume.
Cost of services – EC Solutions – Cost of services relating to our EC Solutions segment was 26% of revenue from the EC Solutions services for the 2007 Six Months, compared to 29% for the 2006 Six Months. Total cost of services increased $218,000 for the 2007 Six Months compared to the 2006 Six Months. Cost of services consists primarily of salaries and employee benefits, connectivity fees, amortization, allocation of product and development expenses and rent. The increase was primarily the result of approximately a $250,000 net increase in acquired technology and customer list amortization expense related to the Enable acquisition and a $121,000 increase in product development expense allocation offset by a $154,000 reduction in telephone and connectivity fees.
Product development and enhancement - EC Solutions - Product development and enhancement costs relating to our EC Solutions segment consist primarily of salaries and employee benefits. Product development and enhancement costs increased $811,000 in the 2007 Six Months compared with the 2006 Six Months. This increase is related to the additional staff, consulting and rent expenses from the Enable operations.
General and administrative - EC Solutions - General and administrative expenses supporting our EC Solutions segment consist primarily of depreciation, telephone, and computer maintenance expenses. General and administrative costs increased $47,000 in the 2007 Six Months compared to the 2006 Six Months. The increase was mainly due to higher computer maintenance expenses.
Operating Income - EC Solutions - Operating income from EC Solutions increased $369,526, or 9%, for the 2007 Six Months compared with the 2006 Six Months, due to the increased revenue from the Enable acquisition and VAN related transaction volume, offset principally by the additional staff, consulting and rent expenses from the Enable operations. We expect our EC Solutions segment to remain profitable as we continue to build our browser-based and hosted services customer portfolio.
Results of Operations – EC Services
Our EC Services operations primarily focus on facilitating the EDI communications of small and mid-sized businesses with their trading partners through our EC service center, E-Commerce outsourcing and professional services. The following table summarizes operating results for our EC Services segment for the six months ended January 31, 2007 and 2006:
| | Six Months Ended | | | | | |
| | January 31, | | Variance | |
| | 2007 | | 2006 | | $ | | % | |
Revenues: | | | | | | | | | |
Services | | $ | 3,293,533 | | $ | 3,659,326 | | (365,793 | ) | (10 | ) |
| | | | | | | | | |
Expenses: | | | | | | | | | |
Cost of services | | 1,773,024 | | 1,817,365 | | (44,341 | ) | 2 | |
Product development and enhancement | | 231,672 | | 130,623 | | 101,049 | | 77 | |
General and administrative | | 114,307 | | 8,010 | | 106,297 | | 1,327 | |
Total expenses | | 2,119,003 | | 1,955,998 | | 163,005 | | 8 | |
| | | | | | | | | |
Segment operating income | | $ | 1,174,530 | | $ | 1,703,328 | | (528,798 | ) | (31 | ) |
Revenue – EC Services – Revenue from our EC Services was 30% of consolidated revenues for the 2007 Six Months compared to 36% for the 2006 Six Months. The revenue decreased $366,000 for the 2007 Six Months compared to the 2006 Six Months. The decrease was a primarily a result of reduced revenue from our EC service center of approximately $756,000 due to year over year customer attrition, offset by increased revenue of $202,000 from our EC outsourcing and $191,000 from professional services. We believe the customer attrition from the MEC and Kodiak acquisitions has stabilized and we anticipate that our third and fourth quarter will depict more comparative quarter to quarter results.
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Cost of services – EC Services - Cost of services relating to our EC Services segment was 54% of revenue in the 2007 Six Months, compared to 50% in the 2006 Six Months. Cost of services decreased $44,000 for the 2007 Quarter compared to the 2006 Quarter. Cost of services consists primarily of salaries and employee benefits, amortization, connectivity fees and rent. The decrease was mainly a result of lower salary and benefit expense at our EC service center offset by increased amortization expense.
Product development and enhancement – EC Services - Product development and enhancement costs consist primarily of salaries and employee benefits. Product development and enhancement costs incurred by our EC Services segment increased $101,000 in the 2007 Six Months compared to the 2006 Six Months. The increase was primarily the result of increased salary and benefits expense of approximately $189,000, offset by a higher allocation of product development to other departments of $88,000.
General and administrative – EC Services - General and administrative expenses relating to our EC Services segment consist primarily of office expenses, depreciation, computer maintenance expense, telephone and rent. General and administrative expenses incurred by our EC Services segment increased $106,000 in the 2007 Six Months compared to the 2006 Six Months. The increase was mainly related to higher depreciation and computer maintenance expenses related to recent investments in capital expenditures.
Operating Income - EC Services - Operating income from EC Services decreased $528,798, or 31%, for the 2007 Six Months compared with the 2006 Six Months, due primarily to the decreased revenue in the segment. We anticipate that future periods will be more comparable due to the stabilization of the customer attrition from our MEC and Kodiak acquisitions.
Corporate Expenses
Our Corporate expenses represent the general, administrative, corporate and executive expenses not directly related to our EC Solutions or EC Services segments. The following table summarizes operating expenses for our corporate expenses for the six months ended January 31, 2007 and 2006:
| | Six Months Ended | | | | | |
| | January 31, | | Variance | |
| | 2007 | | 2006 | | $ | | % | |
Expenses: | | | | | | | | | |
Product development and enhancement | | $ | 79,931 | | $ | — | | 79,931 | | — | |
Selling and marketing | | 889,316 | | 992,658 | | (103,342 | ) | 10 | |
General and administrative | | 3,576,148 | | 3,835,317 | | (259,169 | ) | (7 | ) |
Total expenses | | $ | 4,545,395 | | $ | 4,827,975 | | (282,580 | ) | (7 | ) |
Product development and enhancement – Corporate – Product development and enhancement costs included in our Corporate expenses consist primarily of salaries and employee benefits. Product development and enhancement costs increased $80,000 in the 2007 Six Months compared to the 2006 Six Months. The increase is primarily a result of unallocable salary and benefit costs not directly related to the EC Solutions or EC Services segments.
Selling and marketing – Corporate - Selling and marketing costs included in our Corporate expenses consist primarily of salaries and employee benefits and amortization. Selling and marketing expenses decreased $103,000 in the 2007 Six Months compared to the 2006 Six Months primarily related to the reclassification of amortization expenses related to the Kodiak and MEC customer lists to the EC Services segment cost of sales.
General and administrative – Corporate – General and administrative costs included in our Corporate expenses consist primarily of salaries and employee benefits, office expenses, legal and accounting expenses, depreciation, computer maintenance expenses, telephone and rent. General and administrative expenses decreased $259,000 in the 2007 Six Months compared to the 2006 Six Months. The decrease is primarily a result of a reduction in bad debt expense of $177,000 due to stronger collection activity, a reduction of $73,000 in general office expenses and a $50,000 reduction in repairs and maintenance costs, offset by an increase of $52,000 in salary and benefit expenses.
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Liquidity and Capital Resources
Our principal sources of liquidity, which consist of unrestricted cash and cash equivalents, decreased to $6,095,000 as of January 31, 2007 from $6,989,000 as of July 31, 2006. We believe these resources will provide us with sufficient liquidity for the short term and long term requirements of the company.
The principal uses of cash for the six month period ended January 31, 2007 were for the repurchase of our series C preferred stock of $2,261,000 and our class A common stock of $614,000. On December 14, 2006, two subsidiaries of 3V Capital LLC (3V Capital Fund Ltd. and Distressed/High Yield Trading Opportunities, Ltd. (collectively, the “3V Entities”)) acquired from Omega Liquidating Trust, the liquidating trust for the bankrupt Cable & Wireless USA, 10,000 shares of the series C preferred stock and 381,111 shares of the class A common stock of Internet Commerce Corporation (“ICC” or the “Company”). Thereafter, on December 20, 2006, ICC entered into a Stock Purchase Agreement with each of the 3V Entities, pursuant to which ICC reacquired a total of 5,000 shares of its series C preferred stock and 190,555 shares of its class A common stock for an aggregate purchase price of $2,875,000. Following this reacquisition of shares by ICC, the 3V Entities together continue to own the remaining 5,000 shares of ICC’s series C preferred stock and 190,556 shares of ICC’s class A common stock. The repurchased shares were subsequently retired during the quarter.
Additionally during the period, we used $300,000 for the acquisition of certain assets of Stewart Technical Services, Inc. and $208,000 in capital expenditures to upgrade and relocate the equipment from our Enable data center.
The principal sources of cash during the period were cash generated from continued operations of $2,328,000 and proceeds from the exercise of 71,200 warrants that were originally issued in a private placement that closed in October 2004 of $248,000.
The Company has net operating loss carryforwards for tax purposes of approximately $71.0 million as of January 31, 2007. These carryforwards expire from 2011 to 2024.
The Internal Revenue Code and Income Tax Regulations contain provisions which limit the use of available net operating loss carryforwards in any given year should significant changes (greater than 50%) in ownership interests occur. Due to the private placement of series A preferred stock in April 1999, the net operating loss carryover of approximately $19.6 million incurred prior to the private placement is subject to an annual limitation of approximately $1.4 million until that portion of the net operating loss is utilized or expires. Due to a 100% ownership change of an acquired company in November 2000, the purchased net operating loss of approximately $6.5 million incurred prior to the ownership change is subject to an annual limitation of approximately $1.1 million until that portion of the net operating loss is utilized or expires. Additionally, this transaction created an ownership change for the Company as defined by IRC Section 382. As such, its net operating loss of approximately $49.4 million incurred prior to the ownership change is subject to an annual limitation of approximately $2.8 million until that portion of the net operating loss is utilized or expires. Finally, due to a 100% ownership change of an acquired company in June 2004, the purchased net operating loss of approximately $1.2 million incurred prior to the ownership change is subject to an annual limitation of approximately $128,000 until that portion of the net operating loss is utilized or expires.
Off Balance Sheet Arrangements
We provide indemnifications of varying scope and amount to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and services. We evaluate estimated losses for such indemnification under Statement of Financial Accounting Standards No. 5, Accounting for Contingencies, as interpreted by Financial Accounting Standards Board Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. We consider factors such as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. To date, we have not encountered material costs as a result of such obligations and have not accrued any material liabilities related to such indemnifications in our financial statements.
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Contractual Obligations
Our contractual obligations are comprised of future minimum rental payments due under non-cancelable operating leases. The following table is a summary of our contractual obligations as of January 31, 2007:
Fiscal
Year | | Amount | |
2007 | | $ | 794,797 | |
2008 | | $ | 1,524,649 | |
2009 | | $ | 1,429,073 | |
2010 | | $ | 1,188,485 | |
2011 | | $ | 335,924 | |
The minimum future rental payments have not been reduced by $2,718,336 of sublease rentals to be received in the future under non-cancelable subleases.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We may invest our cash in a variety of financial instruments. If invested, we account for our investment instruments in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”). All of the cash equivalents and investments are treated as available-for-sale under SFAS No. 115. Investments that are classified as cash and cash equivalents have original maturities of three months or less. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may vary widely due to changes in interest rates, or we may suffer losses in principal if forced to sell securities that have seen a decline in market value due to changes in interest rates. For the quarter ended January 31, 2007, our cash investments consisted entirely of overnight cash sweep accounts invested in a fund composed primarily of triple A rated commercial paper and government agency bonds. As of January 31, 2007, the interest rate for this investment was 4.62%.
Item 4. Controls and Procedures
Our management, including our chief executive officer and chief financial officer, has carried out an evaluation of the effectiveness of our disclosure controls and procedures as of January 31, 2007, as required by paragraph (b) of Exchange Act Rules 13(a)-15 and 15(d)-15. Based upon that evaluation, our chief executive officer and chief financial officer have concluded that as of such date, our disclosure controls and procedures are effective. There was no change in our internal control over financial reporting during the quarter ended January 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On January 6, 2006 we filed a complaint for declaratory judgment in the United States Bankruptcy Court (the “Court”) naming Omega Liquidating Trust (“Omega”), the liquidating trust for the bankrupt Cable & Wireless USA (C&W USA), and Cable & Wireless PLC (C&W) as defendants (together the “Defendants”). We sought to have Omega declared the rightful owner of our series C preferred stock and of any of our shares of class A common stock that have been issued but not distributed as dividends of the series C preferred stock. On October 19, 2006, the Defendants filed a motion to have the suit dismissed as the result of a compromise settlement having been reached between the Defendants. The compromise names defendant Omega as owner of the disputed shares, but splits the proceeds from any sale of our stock fifty-fifty between the Defendants. An order approving the settlement was signed by the Court on November 7, 2006.
We are party to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these matters cannot be predicted with certainty, we do not believe that the outcome of any of these claims or any of the above mentioned legal matters will have a material adverse effect on our consolidated financial position, results of operations or cash flow.
Item 1A. Risk Factors
The following Risk Factor disclosure updates the risk factors as disclosed in our 2006 Annual Report on Form 10-K previously filed with the Securities and Exchange Commission.
Risks Relating to Our Company
We may not remain profitable in the future. We have incurred significant losses since the Company was founded in 1991, and, as of January 31, 2007, we had an accumulated deficit of approximately $81.4 million. We realized profitability and have done so for the past 8 consecutive quarters. However, there can be no assurances that we may not incur losses again in the future.
We must continue to grow our business in order to remain competitive. Over the past year, the VAN business has remained significantly price competitive. Our major competitors appear to be restructuring their VAN operations to reduce their overhead and other costs to better compete against Internet-based networks such as our ICC.NET service. While we have been successful in maintaining our margins and we have increased the volume of data transmitted through our VAN, we have experienced price erosion in competing for larger customers. Although we expect to continue to add new customers and increase the volume of data transmitted through our service, we do not expect our revenue from VAN services to continue to grow rapidly as in the past. If our revenues grow at a slower rate than we anticipate, or decrease and we are unable to adjust spending in a timely manner or if our expenses increase without commensurate increases in revenues, our operating results will suffer and we may again report losses.
If we are not successful in selling our products and services, our results of operations will suffer. While our primary focus in the past has been on growing our ICC.NET VAN service, we have attempted to diversify by acquiring Electronic Commerce Systems in June 2004, the MEC operations of Inovis International, Inc. in March 2005 and Enable Corp. in May 2006. However, the success of our services depends to a large extent on the future of business-to-business electronic commerce and our ability to effectively compete in the marketplace. In particular, our success depends on the number of customers that subscribe to our services, the volume of the data, documents or other information they send or retrieve and the price we are able to charge for these services in light of competitive pressures. In connection with the assimilation of our new customers acquired from the MEC operation and the Enable acquisition, we expect to see attrition to these newly acquired customer bases due to the seasonal trends, integration difficulties, and customer defections to alternative EDI solutions. As a result, a portion of our revenues may be adversely affected. While we are learning to manage these new customers, there is no assurance that we will accurately assess the trends of these new customers. Accordingly, the value of these new customers, the volume of our services subscribed by them and the possibility of payment collection may differ materially from our
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current expectation. Further, since our operating expense levels are based significantly on our expectations of future revenue, our inability to assess the trends may render us vulnerable in the case of a significant shortfall in revenues or orders from these new customers, in which case we may not be able to reduce our operating expenses quickly in response. Therefore, any significant shortfall in revenue or orders could have an immediate adverse effect on our operating results.
We may not be successful in competing against our competitors. We face a significant number of competitors, ranging from very large enterprises or divisions of very large companies to a number of relatively small organizations. These competitors are diverse in terms of their histories, business models, corporate strategies, financial strength, name recognition, company reputation, customer base and breadth of offerings. Many of our large competitors have more history, significantly greater financial resources, larger customer bases and more easily recognized names than we do. As a result, our competitors may be able to respond more quickly to changing technology and changes in customer requirements or be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to potential customers and employees, or be able to devote greater resources to the development, promotion and sale of their services than we can. New competition is emerging in the form of web services networks, collaborative applications, application service providers, e-marketplaces and integration broker suites. We have enhanced our technologies to communicate with these web-based technologies. However, there can be no assurance that our product and service offerings will compete effectively and generate any significant revenues. We believe that the high cost of implementation and the ongoing costs of supporting a company’s trading partners may be a barrier to the wider acceptance of our new product offerings in the marketplace. As a result, we may not be successful in competing against our competitors.
If we are unable to maintain or replace our existing interconnect arrangements, our results of operations would suffer. We rely on many of our competitors to interconnect with our service to promote an “open community” so all businesses can take advantage of the efficiencies of EDI, no matter what network they choose as their provider. Although we have interconnect agreements with the major VAN providers, there can be no assurances that these agreements will not be terminated or will continue with acceptable terms. If terminated, we would have to find an acceptable alternative. If available, such an alternative could add significant operating costs to our business.
We must continue to develop new products and services. If we do not keep pace with rapid technological changes, customer demands and intense competition, we will not be successful. Our market is characterized by rapidly changing technology, customer demands and intense competition. The satisfactory performance, reliability and availability of our network infrastructure, customer support and document delivery systems and our web site are critical to our reputation and our ability to attract customers and maintain adequate customer service levels. If we cannot keep pace with these changes and maintain the performance and reliability of our network and customer service levels, our business will suffer. The intense competition in our industry requires us to continue to develop strategic business and Internet solutions that enhance and improve the customer service features, functions and responsiveness of our products and services and we must constantly keep pace with continuing changes in information technology and customer requirements. While we actively search for ways to expand our business and our products and services to keep pace with the rapidly changing technology, customer demands and intense competition, there can be no assurance that we will be able to keep pace with these changes. If we are not successful in developing and marketing enhancements to our products and services that respond to technological change or customer demands, our business will suffer.
We may need to obtain additional financing on satisfactory terms to continue to compete successfully. If we are unable to obtain necessary future capital, our business will suffer. We may need to raise additional funds if competitive pressures or technological changes are greater than anticipated, if we are unable to increase revenue at anticipated rates, if our expenses increase significantly or if our customers delay payment of our receivables or if we identify a suitable acquisition candidate that requires a cash outlay in order to complete the transaction. We cannot assure you that any additional financing will be available on reasonable terms or at all. Raising additional funds in the future by issuing securities could adversely affect our stockholders and negatively impact our publicly traded share price. If we raise additional funds through the issuance of debt securities, the holders of the debt securities will have a claim to our assets that will have priority over any claim of our stockholders. The interest on these debt securities would increase our costs and negatively impact our operating results. If we raise additional funds through the issuance of common stock or securities convertible into or exchangeable for common stock, the percentage ownership of our then-existing stockholders will decrease and they may experience additional and substantial dilution. In addition, any convertible or exchangeable securities may have rights, preferences and privileges more favorable to the holders than those of the common stock.
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Failure of our third-party providers to provide adequate Internet and telecommunications service could result in significant losses of revenue. Our operations depend upon third parties for Internet access and telecommunications service. Frequent or prolonged interruptions of these services could result in significant losses of revenues. We have experienced outages in the past and could experience outages, delays and other difficulties due to system failures unrelated to our internal activities in the future. These types of occurrences could also cause users to perceive our services as not functioning properly and therefore cause them to use other methods to deliver and receive information. We have limited control over these third parties and cannot assure you that we will be able to maintain satisfactory relationships with any of them on acceptable commercial terms or that the quality of services that they provide will remain at the levels needed to enable us to conduct our business effectively.
We may suffer systems failures and business interruptions that would harm our business. Our success depends in part on the efficient and uninterrupted operation of our VAN service and Enable’s web hosting sites. Almost all of our network operating systems are located in third party co-location facilities. Although these facilities are designed to prevent operational interrupts, our systems are vulnerable to events such as damage from fire, power loss, telecommunications failures, break-ins and earthquakes. This could lead to interruptions or delays in our service, loss of data or the inability to accept, transmit and confirm customer documents and data. Although we have implemented network security measures, our servers may be vulnerable to computer viruses, electronic break-ins, attempts by third parties deliberately to exceed the capacity of our systems and similar disruptions.
If we are unable to successfully integrate acquisitions, our financial results will suffer. Our ability to implement our business plan successfully requires effective planning and strong execution skills. If we cannot manage the integration of anticipated acquisitions, our business and financial results will suffer. We expect that we will need to continue to manage and to expand multiple relationships with customers, Internet service providers and other third parties. We also expect that we will need to continually improve our financial systems, procedures and controls and will need to expand, train and manage our workforce, particularly our information technology and sales and marketing staffs.
If we lose our net operating loss carryforward of approximately $71.0 million, our financial results will suffer. Section 382 of the Internal Revenue Code contains rules designed to discourage persons from buying and selling the net operating losses of companies. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the common stock of a company or any change in ownership arising from a new issuance of stock by a company. In general, the rules limit the ability of a company to utilize net operating losses after a change of ownership of more than 50% of its common stock over a three-year period. Purchases of our class A common stock in amounts greater than specified levels could create a limitation on our ability to utilize our net operating losses for tax purposes in the future. We are currently subject to certain limitations on the utilization of portions of our net operating loss carryforward.
If we cannot hire and retain highly qualified employees, our business and financial results will suffer. We are substantially dependent on the continued services and performance of our executive officers and other key employees. If we are unable to attract, assimilate and retain highly qualified employees, our management may not be able to effectively manage our business, exploit opportunities and respond to competitive challenges and our business and financial results will suffer. Many of our competitors may be able to offer more lucrative compensation packages and higher-profile employment opportunities than we can.
We depend on our intellectual property, which may be difficult and costly to protect. If we fail to adequately protect our proprietary rights, competitors could offer similar products relying on technologies we developed, potentially harming our competitive position and decreasing our revenues. We attempt to protect our intellectual property rights by limiting access to the distribution of our software, documentation and other proprietary information and by relying on a combination of copyright, trademark and trade secret laws. In addition, we enter into confidentiality agreements with our employees and certain customers, vendors and strategic partners. In some circumstances, however, we may, if required by a business relationship, provide our licensees with access to our data model and other proprietary information underlying our licensed applications. Despite the precautions we take, it may be possible for unauthorized third parties to copy aspects of our current or future products or to obtain and use information that we regard as proprietary. Policing unauthorized use of software is difficult, and some foreign laws do not protect proprietary rights to the same extent as United States laws. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others, any of which could be costly and adversely affect our operating results.
Intellectual property infringement claims against us could harm our business. It is possible our products and service may infringe upon the proprietary rights of others and other parties may assert infringement claims
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against us. Any such claims and any resulting litigation could subject us to significant liability for damages and could invalidate our proprietary rights. We could be required to enter into royalty and licensing agreements, which may be costly or otherwise burdensome or which may not be available on terms acceptable to us.
We must comply in the future with new and costly reporting requirements. Under current Securities and Exchange Commission (“SEC”) regulations, we are considered a non-accelerated filer as our market capitalization as of January 31, 2007 was under $75 million. We will have to be compliant with Section 404(a), management’s assertion portion of the Sarbanes-Oxley Act of 2002 (“SOX”) by July 31, 2008 and compliant with Section 404(b), the independent audit requirement of SOX by July 31, 2009. The costs of implementing the requirements of the SOX have ranged from approximately $500,000 to over $1 million for smaller companies. Although we began our SOX compliance efforts, there can be no assurance that we can be in full compliance when required for reasonable costs.
Risks Relating to the Internet and Online Commerce Aspects of Our Business
If Internet usage does not continue to grow or if its infrastructure fails, our business will suffer. We cannot be certain that the infrastructure or complementary services necessary to maintain the Internet as a useful and easy means of transferring documents and data will continue to develop. The Internet infrastructure may not support the demands that growth may place on it and the performance and reliability of the Internet may decline.
Privacy concerns may prevent customers from using our services. Concerns about the security of online transactions and the privacy of users may inhibit the growth of the Internet as a means of delivering business documents and data. We may need to incur significant expenses to protect against the threat of security breaches or to alleviate problems caused by security breaches. We rely upon encryption and authentication technology to provide secure transmission of confidential information. If our security measures do not prevent security breaches, we could suffer operating losses, damage to our reputation, litigation and possible liability. Advances in computer capabilities, new discoveries in the field of cryptography or other developments that render current encryption technology outdated may result in a breach of our encryption and authentication technology and could enable an outside party to steal proprietary information or interrupt our operations.
Government regulation and legal uncertainties relating to the Internet could harm our business. Changes in the regulatory environment in the United States and other countries could decrease our revenues and increase our costs. The Internet is largely unregulated and the laws governing the Internet remain unsettled. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy and taxation apply to the Internet. In addition, because of increasing popularity and use of the Internet, any number of laws and regulations may be adopted in the United States and other countries relating to the Internet or other online services covering issues such as user privacy, security, pricing and taxation, contents and distribution.
The cost of transmitting documents and data over the Internet could increase. We may not be able to increase our prices to cover these rising costs. Also, foreign and state laws and regulations relating to the provision of services over the Internet are still developing. If individual states or foreign countries impose taxes or laws that negatively impact services provided over the Internet, our cost of providing our ICC.NET and other services may increase.
Risks Relating to Our Class A Common Stock
The market price of our class A common stock is likely to be highly volatile. The market price of our class A common stock has been very volatile in the past, ranging from a low of $2.30 to a high of $3.98 during fiscal 2007 and is likely to fluctuate substantially in the future. If our class A common stock falls under $1.00 per share and fails to maintain a minimum bid price of $1.00 for 30 consecutive trading days, it may no longer be eligible for trading in the Nasdaq Capital Market, which would adversely affect the ability of investors to sell their shares of our class A common stock.
Shares eligible for future sale by our existing stockholders may adversely affect our stock price making it difficult to sell class A common stock. Between January 1, 2003 and May 2006, we registered the resale under the Securities Act of 1933 of an aggregate of 10,676,141 shares of our class A common stock, which includes 3,016,917 shares of class A common stock issuable upon the exercise of warrants to purchase shares of class A common stock and 192,307 shares of class A common stock issuable upon conversion of our series D preferred. The market price of our class A common stock could be materially and adversely affected by sales of even a small percentage of these shares or the perception that these sales could occur.
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The market for our class A common stock on the Nasdaq Capital Market may be illiquid, which would restrict the ability to sell shares of class A common stock and could result in increased volatility in the trading prices for our class A common stock. The price at which our class A common stock will trade in the future cannot be predicted and will be determined by the market. The price may be influenced by many factors, including investors’ perceptions of our business, our financial condition, operating results and prospects, the use of the Internet for business purposes and general economic and market conditions.
Our Board of Directors can issue preferred stock with rights adverse to the holders of class A common stock. Our Board of Directors is authorized, without further stockholder approval, to determine the provisions of and to issue up to 4,994,750 shares of preferred stock. Issuance of preferred shares with rights to dividends and other distributions, voting rights or other rights superior to the class A common stock could be adverse to the holders of class A common stock. In addition, issuance of preferred shares could have the effect of delaying, deterring or preventing an unsolicited change in control of our company, or could impose various procedural and other requirements that could make it more difficult for holders of our class A common stock to effect certain corporate actions, including the replacement of incumbent directors and the completion of transactions opposed by the incumbent Board of Directors. The rights of the holders of our class A common stock would be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future.
We may have to use significant resources indemnifying our officers and directors or paying for damages caused by their conduct. The Delaware General Corporation Law provides for broad indemnification by corporations of their officers and directors and permits a corporation to exculpate its directors from liability for their actions. Our bylaws and certificate of incorporation implement this indemnification and exculpation to the fullest extent permitted under this law as it currently exists or as it may be amended in the future. Consequently, subject to this law and to some limited exceptions in our certificate of incorporation, none of our directors will be liable to us or to our stockholders for monetary damages resulting from conduct as a director.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the quarter ending January 31, 2007, 71,200 warrants that were originally issued in a private placement that closed in October 2004, were exercised at $2.22 resulting in the issuance of the same number of shares of our class A common stock for which we received $158,064.
The Company intends to use the proceeds for general corporate purposes. The Company relied on the exemptions from registration requirements provided by Section 4(2) and Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended, for the issuance and sale of the shares of class A common stock upon the exercise of the warrants.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
(a) Our 2006 Annual Meeting of Stockholders (the “Annual Meeting”) was held on January 4, 2007. There were present at the Annual Meeting, in person or by proxy, holders of 18,597,603 shares (or 83.15%) of the common stock entitled to vote.
(b) The following directors were elected to hold office until the next annual meeting of stockholders or until their successors are elected and qualified, with the vote for each director being reflected below:
Name | | Votes For | | Votes Withheld |
Richard J. Berman | | 17,631,882 | | 965,721 |
Kim D. Cooke | | 18,108,888 | | 488,715 |
Donald R. Harkleroad | | 18,389,606 | | 207,997 |
Paul D. Lapides | | 18,485,346 | | 112,257 |
Arthur R. Medici | | 18,146,518 | | 451,085 |
Matthew W. Shaw | | 18,390,606 | | 206,997 |
John S. Simon | | 18,390,606 | | 206,997 |
Thomas J. Stallings | | 18,388,606 | | 208,997 |
The affirmative vote of the holders of a plurality of the outstanding shares of common stock represented at the Annual Meeting was required to elect each director.
(c) The appointment of Tauber & Balser, P.C. as independent public auditors to audit the consolidated financial statements of the Company and its subsidiaries for the year ending July 31, 2007, was ratified with 18,425,016 affirmative votes cast, 148,593 negative votes cast and 23,994 abstentions. The affirmative vote of the holders of a majority of the outstanding shares of common stock voting on the proposal at the Annual Meeting was required to ratify the appointment of Tauber & Balser, P.C.
Item 5. Other Information
None.
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Item 6. Exhibits
31.1 | | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
31.2 | | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
32.1 | | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
*In accordance with Release No. 34-47986, this Exhibit is hereby furnished to the SEC as an accompanying document and is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: March 15, 2007
| INTERNET COMMERCE CORPORATION |
| | |
| | |
| By: | /s/ Thomas J. Stallings |
| | Thomas J. Stallings |
| | Chief Executive Officer |
| | |
| | |
| By: | /s/ Glen E. Shipley |
| | Glen E. Shipley |
| | Chief Financial Officer |
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EXHIBIT INDEX
Exhibit No. | | Document |
| | |
Exhibit 31.1 | | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
Exhibit 31.2 | | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
Exhibit 32.1 | | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* |
*In accordance with Release No. 34-47986, this Exhibit is hereby furnished to the SEC as an accompanying document and is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933.
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