UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2004
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------- -------
Commission File Number: 0-19301
COMMUNICATION INTELLIGENCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-2790442
-------------------------- -------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
275 Shoreline Drive, Suite 500, Redwood Shores, CA 94065-1413
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 802-7888
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
-------- --------
Number of shares outstanding of the issuer's Common Stock, as of November 15,
2004: 101,374,876.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page No.
Condensed Consolidated Balance Sheets at
September 30, 2004 (unaudited) and December 31, 2003.................3
Condensed Consolidated Statements of Operations for
the Three and Nine-Month Periods Ended September 30,
2004 and 2003 (unaudited)............................................4
Condensed Consolidated Statements of Changes in
Stockholders' Equity for the Three and Nine-Month
Periods Ended September 30, 2004 (unaudited).........................5
Condensed Consolidated Statements of Cash Flows
for the Nine-Month Periods Ended September 30, 2004
and 2003 (unaudited).................................................6
Notes to Unaudited Condensed Consolidated Financial Statements.......7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations...........15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk..........................................24
Item 4A. Controls and Procedures...................................24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................25
Item 2. Change in Securities and Use of proceeds...................25
Item 3. Defaults Upon Senior Securities............................25
Item 4. Submission of Matters to a Vote of Security Holders........25
Item 5. Other Information..........................................25
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits..........................................25
(b) Reports on Form 8-K...............................25
Signatures..........................................................26
-2-
Communication Intelligence Corporation
and Subsidiary
Condensed Consolidated Balance Sheets
(In thousands)
September 30, December 31,
2004 2003
------------- ------------
Unaudited
Assets
Current assets:
Cash and cash equivalents................. $ 1,549 $ 1,039
Accounts receivable, net of
allowances of $435 and $256 at
September 30, 2004 and
December 31, 2003, respectively.......... 3,863 742
Inventories............................... - 47
Prepaid expenses and other
current assets........................... 302 177
------------ ----------
Total current assets................. 5,714 2,005
Property and equipment, net................... 141 138
Patents and trademarks........................ 4,758 5,042
Deposits ..................................... 30 30
------------ ----------
Total assets......................... $ 10,643 $ 7,215
============ ==========
Liabilities and Stockholders' equity
Current liabilities:
Short-term debt - related party.......... $ 8 $ 3,008
Short-term debt - other.................. 3,537 750
Accounts payable......................... 157 243
Accrued compensation..................... 399 259
Other accrued liabilities................ 362 475
Deferred revenue......................... 507 165
------------ ----------
Total current liabilities............ 4,970 4,900
Long-term debt - related party................ 6 13
Minority interest............................. 100 115
Commitments and contingencies - -
Stockholders' equity:
Common stock............................. 1,014 1,001
Additional paid-in capital............... 84,245 83,528
Accumulated deficit...................... (79,530) (82,164)
Accumulated foreign currency
translation adjustment................... (162) (178)
------------ ----------
Total stockholders' equity........... 5,567 2,187
------------ ----------
Total liabilities and stockholders' equity.. $ 10,643 $ 7,215
============ ==========
The accompanying notes form an integral part of these
Condensed Consolidated Financial Statements
-3-
Communication Intelligence Corporation
and Subsidiary
Condensed Consolidated Statements of Operations
Unaudited
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2004 2003 2004 2003
--------- ------- -------- ------
Revenues:
Online/retail........................ $ 21 $ 54 $ 109 $ 260
Corporate............................ 3,645 480 6,465 1,435
China ............................ 3 402 154 921
------- ------- ------- -------
Total revenues................... 3,669 936 6,728 2,616
Operating costs and expenses:
Cost of sales:
Online/retail..................... - 2 - 3
Corporate......................... 6 4 17 27
China ............................ - 226 33 557
Research and development............. 326 324 918 967
Sales and marketing ................ 394 233 1,031 696
General and administrative ......... 690 569 1,848 1,700
------- ------- -------- ------
Total operating costs and expenses 1,416 1,358 3,847 3,950
------- ------- -------- ------
Income (loss) from operations ........... 2,253 (422) 2,881 (1,334)
Other income (expense)
Interest and other income (expense), 2 (2) - 3
net
Interest expense ................... (117) (46) (262) (143)
Minority interest.................... 7 (2) 15 2
------- ------- ------- ------
Net Income (loss) .............. 2,145 (472) 2,634 (1,472)
======= ======= ======== =======
Basic income (loss) per common share .... $ 0.02 $(0.01) $ 0.03 $(0.02)
======= ======== ======= =======
Diluted income (loss) per common share ... $ 0.02 $(0.01) $ 0.03 $(0.02)
======= ======== ======= =======
Weighted average common shares
outstanding basic 101,368 100,101 100,751 96,537
======= ======= ======= =======
Weighted average common shares
outstanding diluted 101,819 100,101 101,202 96,537
======= ======= ======= ======
The accompanying notes form an integral part of these
Condensed Consolidated Financial Statements
-4-
Communication Intelligence Corporation
and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Unaudited
(In thousands, except share amounts)
Accumulated
Additional Other
Shares Common Paid-In Accumulated Comprehen.
Outstanding Stock Capital Deficit Loss Total
Balances as of December
31, 2003............... 100,102 $ 1,001 $ 83,528 $(82,164) $ (178) $2,187
-----------------------------------------------------
Foreign currency
translation adjustment. - - - - 1 1
Net income for the three
months ended March 31,
2004.................... - - - 1,167 - 1,167
-----------------------------------------------------
Balances as of March 31,
2004................... 100,102 $ 1,001 $ 83,528 $(80,997) $ (177) $3,355
-----------------------------------------------------
Sale of Common shares
through Cornell Capital
net of expenses........ 1,133 11 679 - - 690
Exercise of options for
shares of Common stock... 33 1 9 - - 10
Foreign currency
translation adjustment.. - - - - 2 2
Net loss for the three
months ended June 30,
2004.................... - - - (678) - (678)
-----------------------------------------------------
Balances as of June 30,
2004................... 101,268 $ 1,013 $ 84,216 $(81,675) $ (175) $3,379
=====================================================
Exercise of options for
shares of Common stock. 108 1 29 - - 30
Foreign currency
translation adjustment... - - - - 13 13
Net income for the three
months ended September
30, 2004............... - - - 2,145 - 2,145
-----------------------------------------------------
Balances as of September
30, 2004............... 101,376 $ 1,014 $ 84,245 $(79,530) $ (162) $5,567
=====================================================
The accompanying notes form an integral part of these
Condensed Consolidated Financial Statements
-5-
Communication Intelligence Corporation
and Subsidiary
Condensed Consolidated Statements of Cash Flows
Unaudited
(In thousands)
Nine Months Ended
September 30,
--------------------
2004 2003
------- -------
Cash flows from operating activities:
Net income (loss).........................................$ 2,634 $(1,472)
Adjustments to reconcile net income (loss) to net cash
provided by/ (used for) operating activities:
Depreciation........................................... 39 62
Patent and capitalized software amortization........... 294 284
Provision for doubtful accounts........................ 178 (6)
Loss on disposal of fixed assets....................... 4 8
Changes in operating assets and liabilities:
Accounts receivable, net............................ (3,299) (326)
Inventories......................................... 47 27
Prepaid expenses and other current assets........... (125) 45
Other assets........................................ - (2)
Accounts payable.................................... (86) 7
Accrued compensation................................ 140 12
Other accrued liabilities........................... (128) (92)
Deferred revenue.................................... 342 (76)
-------- --------
Net cash provided by (used for) operating activities.. 40 (1,529)
-------- --------
Cash flows from investing activity:
Acquisition of property and equipment.................. (32) (16)
-------- --------
Net cash used in investing activity................ (32) (16)
-------- --------
Cash flows from financing activities:
Payments on short term debt related party.............. (3,000) -
Payments on long-term debt............................. (7) -
Proceeds from issuance of short-term debt.............. 3,537 -
Proceeds from the exercise of stock options............ 40 -
Proceeds from the issuance of common stock............. - 2,000
Offering costs......................................... (60) (412)
Principal payments on capital lease obligations........ (6) (7)
-------- --------
Net cash provided by financing activities.......... 504 1,581
-------- --------
Effect of exchange rate changes on cash..................... (2) -
-------- --------
Net increase in cash and cash equivalents................... 510 36
Cash and cash equivalents at beginning of period............ 1,039 711
-------- --------
Cash and cash equivalents at end of period..................$ 1,549 $ 747
========= =========
Supplemental Disclosure of Cash Flow Information
Interest Paid.......................................... $ 262 $ 143
Income taxes Paid...................................... 1 1
Pay off of short-term debt through issuance
of common stock....................................... 750 -
The accompanying notes form an integral part of these
Condensed Consolidated Financial Statements
-6-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
1. Interim financial statements and basis of presentation
The financial information contained herein should be read in conjunction
with the Company's consolidated audited financial statements and notes
thereto included in its Annual Report on Form 10-K for the year ended
December 31, 2003.
The accompanying unaudited condensed consolidated financial statements of
Communication Intelligence Corporation and its subsidiary (the "Company" or
"CIC") have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States of America ("GAAP") for complete consolidated
financial statements. In the opinion of management, the unaudited condensed
consolidated financial statements included in this quarterly report reflect
all adjustments (consisting only of normal recurring adjustments) which the
Company considers necessary for a fair presentation of its financial
position at the dates presented and the Company's results of operations and
cash flows for the periods presented. The Company's interim results are not
necessarily indicative of the results to be expected for the entire year.
The Company develops and markets electronic signature software, biometric
verification software for handwritten signatures and handwritten data entry
software solutions aimed at emerging, large potential markets such as
e-commerce, workflow automation, corporate security, smart handheld devices
such as handheld computers & smartphones and the Palm OS aftermarket.
The Company's core software technologies include electronic signature,
biometric signature verification, cryptography, electronic ink recording
tools (SignatureOne(TM)), (InkTools(R)), (Sign-it(R)), (iSign(R)) and
(Sign-On(R)), operating systems extensions that enable pen input (PenX(TM))
and multilingual handwriting recognition systems (Jot(R)) and the
Handwriter(R) Recognition System, referred to as HRS(TM).
Other consumer and original equipment manufacturer ("OEM") products include
electronic notetaking (QuickNotes(R) and InkSnap(R)) and predictive text
input, (WordComplete(R)). CIC's products are designed to increase the ease
of use, functionality and security of electronic devices with a primary
focus on smart handheld devices such as handheld computers and smartphones.
The Company offers a wide range of multi-platform software products that
enable or enhance pen-based computing. The Company's core technologies are
classified into two broad categories: "transaction and communication
enabling technologies" and "natural input technologies".
Transaction and communication enabling technologies have been fundamental
to the Company's development of software for electronic signatures,
handwritten biometric signature verification, data security, data
compression, and electronic ink capture. These technologies are designed to
provide a cost-effective means for securing electronic transactions,
providing network and device access control, and enabling workflow
automation of traditional paper form processing. CIC believes that these
technologies offer more efficient methods for conducting electronic
transactions while providing more functional user authentication,
heightened data security, and increased user productivity.
Natural input technologies are designed to allow users to interact with
handheld devices, including PDA's and smartphones, by using an electronic
pen or "stylus" as the primary input device or in conjunction with a
keyboard. CIC's natural input offerings include multilingual handwriting
recognition systems, software keyboards, and predictive text entry
technologies.
Going Concern
The accompanying condensed consolidated financial statements have been
prepared assuming that the Company will continue as a going concern. The
-7-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
Company has suffered recurring losses from operations that raise a
substantial doubt about its ability to continue as a going concern. At
September 30, 2004, the Company's accumulated deficit was approximately
$79,530 and has working capital of $744. The Company filed a registration
statement with the Securities and Exchange Commission that was declared
effective February 2003, pursuant to the equity line of credit agreement
with Cornell Capital Partners, LP ("Cornell"). However, there can be no
assurance that the Company will have adequate capital resources to fund
planned operations or that additional funds will be available to the
Company when needed under the equity line of credit agreement or otherwise,
or if available, will be available on favorable terms or in amounts
required by the Company. If the Company is unable to obtain adequate
capital resources to fund operations, it may be required to delay, scale
back or eliminate some or all of its operations, which may have a material
adverse effect on the Company's business, results of operations and ability
to operate as a going concern. The accompanying condensed consolidated
financial statements do not include any adjustments that might result from
the outcome of this uncertainty. See "Subsequent events, Note".
2. Cash and cash equivalents
The Company considers all highly liquid investments with original
maturities of up to 90 days to be cash equivalents.
Cash and cash equivalents consist of the following:
September 30, December 31,
2004 2003
--------------------- -- -------------------
Cash in bank $ 82 $ 110
Money market 1,467 929
--------------------- -------------------
$ 1,549 $ 1,039
===================== ===================
3. Account receivable consentration
For the nine months ended September 30, 2004, one customer accounted for
91% of net accounts receivable. The accounts receivable, which accounted
for 91% of net accounts receivable at September 30, 2004, was collected
subsequent to the balance sheet date.
4. Inventories
Inventories are stated at the lower of cost or market, cost being
determined using the first-in, first-out (FIFO) method. Inventories
consisted primarily of finished goods and are fully reserved at September
30, 2004.
5. Short-term debt - other
On April 20, 2004, the Company's 90% owned Joint Venture borrowed the
aggregate equivalent of $37, denominated in Chinese currency, from a
Chinese bank. The unsecured loan bears interest at 5.0% per annum and is
due April 20, 2005. The borrowing did not require the Joint Venture to
deposit a compensating balance. The note can be repaid at any time without
penalty.
On December 19, 2003, the Company borrowed $750 from Cornell Capital
Partners, LP. The proceeds of the loan were used for working capital
purposes. The loan was secured by 4,621 shares of the Company's common
stock held in escrow. The promissory note was due and payable in seven
installments, commencing January 19, 2004 and ending on March 1, 2004, and
could have been paid in cash or shares of the Company's common stock. The
Company exercised its option, provided in the note, to delay the
commencement of the installment payments by paying the 2% fee, which was
$38 in the aggregate for the six months ended June 30, 2004. The Company
chose to delay commencement of the installment payments in anticipation of
an increase in the price of the Company's stock based upon a projection of
profitable first quarter results. Under the equity line of credit, the
higher the market value of the Company's stock the fewer number of shares
are required to repay amounts drawn on the line. The Company had repaid the
$750,000 loan through the issuance of 1,133 shares of common stock as of
June 30, 2004. Due to the delay in commencement of the due date, The
Company had issued approximately 21 fewer shares than it would have if it
had not exercised its option to defer the due date. The company wrote off
approximately $60 in unamortized deferred financing costs associated with
the $750 loan against equity.
-8-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
5. Short-term debt - other (continued)
On August 4, 2004 the Company borrowed an additional $3,500 from Cornell,
the proceeds of which were used to extinguish short-term debt with a
related party. See Note 6, "Short-term debt - Related Party Transaction".
The Cornell short-term debt accrues interest at the rate of 5% per annum
and is scheduled to be paid, in ten equal installments with the first
installment due December 6, 2004 and the last on February 7, 2005. The
Company had the option to repay the note by issuing shares of the Company's
common stock. The Cornell debt was repaid in full, in cash, on November 8,
2004. See Note 13 - "Subsequent events".
6. Short-term debt - Related Party Transactions
On June 19, 2001, the Company consummated a three-year $3,000 financing
(the "Loan") with a charitable remainder annuity trust of which a former
director and officer of the Company is a trustee (the "Trust"). The
proceeds of the Loan were used to refinance $1,500 of indebtedness
outstanding to the Trust pursuant to a loan made by the Trust to the
Company in October 1999, and for working capital purposes. The Loan bore
interest at the rate of 2% over the prime rate publicly announced by
Citibank N.A. from time to time, and was due June 18, 2004. The Company
received a sixty day extension to pay the $3,000 Loan to the Trust in
exchange for thirty days worth of interest ($15) calculated according to
the terms of the note. The extended due date was August 18, 2004. All other
provisions of the Loan remained unchanged.
On August 5, 2004, CIC paid the $3,000 note due August 18, 2004, to the
Trust. The funds to retire the debt were obtained from Cornell on August 4,
2004, (See Note 5 - "Short-term debt - other"). The Cornell debt was repaid
on November 8, 2004, See Note 13, "Subsequent events".
Interest paid during the three and nine months ended September 30, 2004 was
$117, and $262, respectively, and for the three and nine months ended
September 30, 2003, $46 and $143, respectively. Interest payments for the
three and nine months ended September 30, 2004 include $84 paid to the
Trust representing interest accrued at March 31, 2004 and interest accrued
through June 18, 2004 of $69, plus the $15 loan extension fee.
7. Deferred revenue
Deferred revenue is recorded for post-contract support and is recognized as
revenue when costs are incurred or over the support period, generally
twelve months, whichever is longer.
8. Net income (loss) per share
The Company calculates net income (loss) per share under the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("SFAS 128"). SFAS 128 requires the disclosure of both basic net income
(loss) per share, which is based on the weighted average number of shares
outstanding, and diluted income (loss) per share, which is based on the
weighted average number of shares and dilutive potential shares
outstanding. For the three-month period ended September 30, 2004, 4,937
shares of common stock subject to outstanding options, were excluded from
the calculation of dilutive earnings per share because the exercise price
of such options was greater than the average market price of the Company's
common stock. For the three-month period ended September 30, 2003, 5,856
shares of common stock subject to outstanding options were excluded from
the calculation of dilutive earnings per share as the effect of these
options is not dilutive.
-9-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
8. Net income (loss) per share (continued)
Three Months Ended
September 30, 2004 September 30, 2003
------------------------- -----------------------
Weighted Weighted
Average Per Average Per
Net Shares Share Net Shares Share
Income Outstanding Amount Loss Outstanding Amount
Basic income (loss) per share:
Income available to
stockholders $2,145 101,368 $ 0.02 $ (472) 100,101 $0.01)
Effect of dilutive securities
Stock options - 451 - - - -
------ --------- ------- ------- -------- ------
Diluted income (loss) $2,145 101,819 $0.02 $ (472) 100,101 $(0.01)
====== ======= ====== ======= ======= ======
For the nine-month periods ended September 30, 2004 and 2003, the
computation for basic and diluted weighted average shares outstanding is as
follows:
Three Months Ended
September 30, 2004 September 30, 2003
------------------------- -----------------------
Weighted Weighted
Average Per Average Per
Net Shares Share Net Shares Share
Income Outstanding Amount Loss Outstanding Amount
Basic income (loss) per share:
Income available to
stockholders $2,634 100,751 $ 0.03 $ (1,472) 96,537 $0.02)
Effect of dilutive securities
Stock options - 451 - - - -
------ --------- ------- ------- -------- ------
Diluted income (loss) $2,634 101,202 $0.03 $(1,472) 96,537 $(0.02)
====== ======= ===== ======== ====== =======
For the nine months ended September 30, 2004, 4,937 shares of common stock
subject to outstanding options, were excluded from the calculation of
dilutive earnings per share because the exercise price of such options was
greater than the average market price of the Company's common stock. For
the nine months ended September 30, 2003, stock options of 5,856 were
excluded from the calculation of diluted earnings per share as the effect
of these options is not dilutive.
9. Common Stock Options
The Company has adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123") as amended by
Financial Accounting Standards Board Statement No. 148. The Company has
elected to continue to use the intrinsic value based method of Accounting
Principles Board Opinion No. 25, as allowed under SFAS 123, to account for
its employee stock-based compensation plans. No stock based employee
compensation expense is reflected in the consolidated statement of
operations as all options granted had an exercise price equal to the market
value of the Company's common stock on the date of grant. The Company
complies with the disclosure provisions of SFAS 123.
-10-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
9. Common Stock Options (continued)
Had compensation cost for the Company's option plans been determined based
on the fair value of the options at the date of grant, as prescribed by
SFAS 123, the Company's net income (loss) available to common stockholders
and basic and diluted net income (loss) per share available to stockholders
would have been as follows:
Nine Months Ended
-------------------------------
September 30, September 30,
2004 2003
-------------------------------
Net income (loss) available to stockholders:
As reported................................... $ 2,634 $ (1,472)
---------------------------
Add: Stock-based employee compensation expense
included in reported results of operations,
net of related tax effect - -
Deduct: Total stock based employee
compensation expense determined under fair
value based method, net of tax................ (219) (306)
--------------------------
Pro forma................................. $ 2,415 $ (1,778)
===========================
Basic and diluted net income (loss) per
share available to stockholders:
As reported........................... $ 0.03 $ (0.02)
===========================
===========================
Pro forma........................... $ 0.02 $ (0.02)
===========================
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants during the applicable periods:
o risk-free interest rate of 2.93% and 2.11% for 2004 and 2003;
o an expected life of 6.2 years for 2004, 6.4 years for 2003; respectively;
o expected volatility of 100% for all periods; and
o dividend yield of 0% for all periods.
The Company expects to make additional option grants. The Company believes the
above pro forma disclosures may not be representative of the pro forma effects
on reported results of operations to be expected in future periods due to
changes in interest rates, expected lives of current and future option grants
and changes in the volatility of the price of the Company's common stock in the
market.
10. Comprehensive income (loss)
Total comprehensive income (loss) was as follows:
------------------ ------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------- --------- --------- ---------
2004 2003 2004 2003
--------- --------- --------- ---------
Net income (loss) $ 2,145 $ ( 472 ) $ 2,634 $ (1,472)
Other comprehensive income:
Cumulative translation adjustment 13 2 16 6
--------- --------- --------- ---------
Total comprehensive income (loss) $ 2,158 $ (470) $ 2,650 $ (1,466)
========= ========= ========= ========
-11-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
11. Segment Information
The Company identifies reportable segments by classifying revenues into two
categories: handwriting recognition and system integration. Handwriting
recognition software is an aggregate of three revenue categories;
online/retail, enterprise and original equipment manufacturers ("OEM"). All
handwriting recognition software is developed around the Company's core
technology. System integration represents the sale and installation of
third party computer equipment and systems that utilize the Company's
products. All sales represent sales to external customers.
The accounting policies followed by the segments are the same as those
described in the "Critical Accounting Policies." Segment data includes
revenues and allocated costs charged to each of the operating segments.
The tables below present information about reporting segments for the
periods indicated:
Three Months Ended September 30,
2004 2003
----------------------------- ------------------------------
Handwriting Systems Handwriting Systems
Recognition Integration Total Recognition Integration Total
----------- ----------- ------ ----------- ----------- -----
Revenues $ 3,669 $ - $ 3,669 $ 731 $ 205 $ 936
Income (loss) from
Operations $ 2,253 $ - $ 2,253 $ (437) $ 15 $ (422)
Significant change
in total long
lived assets from
year end $ - $ - $ - $ 41 $ - $ 41
Nine Months Ended September 30,
2004 2003
----------------------------- ------------------------------
Handwriting Systems Handwriting Systems
Recognition Integration Total Recognition Integration Total
----------- ----------- ------ ----------- ----------- -----
Revenues $ 6,691 $ 37 $ 6,728 $ 2,015 $ 601 $ 2,616
Income (loss) from
Operations $ 2,873 $ 8 $ 2,881 $(1,325) $ (9) $(1,134)
Significant change
in total long
lived assets from
year end $ - $ - $ - $ 5 $ - $ 5
For the three months ended September 30, 2004, one customer accounted for
96% of total handwriting recognition segment revenue. For the three months
ended September 30, 2003, one customer accounted for 35% of total
handwriting recognition segment revenue. For the nine months ended
September 30, 2004 and 2003, one customer accounted for 49% and 22% of
total handwriting recognition segment revenue, respectively.
-12-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
11. Segment Information (continued)
For the three months ended September 30, 2004 there were no system
integration revenues recorded. For the three months ended September 30,
2003, one customer accounted for 37% of system integration revenues. For
the nine months ended September 30, 2004 and 2003, one customer accounted
for 40% and 25% of system integration revenues, respectively.
12. Commitments and contingencies
On June 7, 2004, (amended July 7, 2004) Topaz Systems, Inc. ("Topaz") filed
a complaint, against the Company, with the United States District Court
Northern District of California San Francisco Division alleging breach of
contract, breach of covenant of good faith and fair dealing and asking for
a declaratory judgment that it had not breached the September 29, 2000
License agreement between it and the Company (the "License"), that Topaz
had not infringed certain of the Company's patents and that such patents
were invalid and/or unenforceable. No monetary damages were specified. The
Company believes that the complaint is without merit and intends to
vigorously defend against the claims. On July 26, 2004, the Company
responded to the complaint and filed counterclaims against Topaz alleging
that Topaz had breached the License, had infringed certain of the Company's
patents and was engaging in unfair competition. On July, 22, 2004, Topaz
filed a complaint against the Company with the United States District Court
Central District of California Western Division requesting declaratory
judgment that it did not infringe certain of CIC's patents (not included in
the other complaint) and that such patents were invalid and/or
unenforceable. The Company believes that the complaint is without merit and
intends to vigorously defend against the claims. The ultimate outcome of
this litigation cannot presently be determined. However, in management's
opinion, the likelihood of a material adverse outcome is remote and any
liability that might be incurred would not have a material adverse effect
on the Company's financial position or its results of operations.
Accordingly, adjustments, if any, that might result from the resolution of
this matter have not been reflected in the financial statements.
13. Subsequent Events:
$4.2 Million Financing
On November 1, 2004, the Company entered into a Note and Warrant Purchase
Agreement (the "Purchase Agreement") and a Registration Rights Agreement
(the "Registration Rights Agreement, each dated as of October 28, 2004).
The financing, a combination of debt and equity, closed November 2, 2004.
The Company raised approximately $4 million, net of commissions and legal
expenses, in the financing. H.C. Wainwright & Co., Inc. ("Wainwright")
acted as the Company's exclusive placement agent in connection with the
financing. The Company expects to use the proceeds of the financing for
additional working capital as it continues to further strengthen its
leadership position.
Under the terms of the financing, the Company has issued to certain
accredited investors convertible promissory notes in the aggregate
principal amount of $4,195 and warrants to acquire 3,632, shares of the
Company's common stock at an exercise price of $0.508 per share. The notes
accrue interest at the rate of 7% per annum, payable semi-annually, and are
convertible into shares of the Company's common stock at the rate of $0.462
per share. If the aggregate principal amount owing under the notes is
converted, the Company will issue 9,080, shares of its common stock. If the
notes are not converted, all principal and accrued but unpaid interest will
be due October 28, 2007. The Company may pay accrued interest in cash or in
shares of Company common stock, issued at the market price for the common
stock calculated prior to the interest payment. The Company does not
currently intend to pay accrued interest with shares of its common stock.
-13-
Communication Intelligence Corporation
And Subsidiary
Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except per share amounts)
Form 10-Q
13. Subsequent Events (continued):
$4.2 Million Financing (continued)
The warrants expire on October 28, 2009. The Company may call the warrants
if the Company's common stock trades at $1.00 or above for 20 consecutive
trading days after the date that is 20 days following the effectiveness of
a registration statement providing for the resale of the shares issued upon
the conversion of the notes and exercise of the warrants.
As placement agent for the Company, at closing Wainwright was paid a cash
commission of approximately $281 and issued warrants to acquire 1,233
shares of the Company's common stock at $0.508 per share. These warrants
expire on October 28, 2009. In addition, Wainwright will be paid
approximately $28 in the aggregate if all of the investor warrants are
exercised.
The Company also is required to file a registration statement providing for
the resale of the shares issued upon the conversion of the notes and the
exercise of the warrants.
Payment of $3.5 Million outstanding short-term debt
On November 8, 2004, the Company paid $3.5 million to Cornell Capital
Partners LLC in satisfaction of a note in the same amount. The payment was
required under certain provisions of a Note and Warrant Purchase Agreement
between the Company and the Purchasers identified therein. (See $4.2
million financing note above).
-14-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with
the Company's unaudited condensed consolidated financial statements and
notes thereto included in Part 1, Item 1 of this quarterly report on Form
10-Q and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" set fourth in the Company's Annual report on Form
10-K for the fiscal year ended December 31, 2003.
Overview
The Company was initially incorporated in Delaware in October 1986. In each
year since its inception, the Company has incurred losses. For the
five-year period ended December 31, 2003, operating losses aggregated
approximately $13,000 and at December 31, 2003, the Company's accumulated
deficit was approximately $82,000. At September 30, 2004, the Company's
accumulative deficit was approximately $79,500.
Total revenue of $3,669 for the quarter ended September 30, 2004 increased
391% compared to revenues of $936 in the corresponding quarter of the prior
year. The third quarter of 2004, and the first nine months of 2004, were
the most profitable in the history of the Company. Total revenues of $6,728
for the nine months ended September 30, 2004, increased 257% compared to
revenues of $2,616 in the corresponding nine months of the prior year.
Total revenue for eSignature solutions of $5,935 for the nine months ended
September 30, 2004, more than tripled (354%) compared to eSignature revenue
of $ 1,678 in the corresponding nine months of the prior year. The Company
believes the revenue growth reflects the positive impact of increasing
adoption of its eSignature solutions in target markets and is primarily
attributable to Wells Fargo, a large national insurance company, and
revenues from Charles Schwab, Duncan Management, IA Systems, Misys
Healthcare, PalmSource, Prudential, Saytek and TVA., The increasing focus
on corporate accountability, including a growing demand for auditable
business approval processes, is driving many enterprises to add
eTransactions to their priority deployments in 2004.
The net income for the quarter ended September 30, 2004 was $2,145, on
significantly higher sales, compared with a net loss of $472 in the
corresponding prior year period. Operating expenses increased approximately
4% ($58) from $1,358 to $1,416 for the quarter ended September 30, 2004,
compared to the prior year period. The increase primarily reflects the
required investment in selling expenses to insure future revenue growth.
Net income of $2,634 for the nine months ended September 30, 2004,
represents an increase of $4,106 compared to the net loss of $1,472
incurred in the corresponding nine months of the prior year.
Key growth drivers have merged to accelerate the deployment of electronic
transactions worldwide, including the increasing awareness and reality of
the significant benefits of the paperless environment, increasing
competitive and cost pressures on companies and government agencies, and
most recently, the emerging economic recovery increasing pent-up IT
expenditures. The intuitively obvious, non-intrusive nature of handwritten
eSignatures has emerged as a key factor in achieving the significant
benefits that can be derived from secure, signature dependent, legally
binding eTransactions in the financial services industry and is beginning
to penetrate healthcare, ePrescriptions and other industry segments. The
introduction of SignatureOne and updated Sign-it products, in the first
quarter of 2004, significantly expands CIC `s market coverage providing
unique and patented technology that supports a wide range of electronic
signing methods including other biometric verification alternatives.
Deploying and maintaining the worldwide market presence and sales coverage
necessary to achieve sustained sales and earnings growth is the company's
primary challenge.
Critical Accounting Policies
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United
States of America requires management to make judgments, assumptions and
estimates that affect the amounts reported in our consolidated financial
statements and the accompanying notes. The amounts of assets and
liabilities reported in our balance sheets and the amounts of revenues and
expenses reported for each period presented are affected by these estimates
and assumptions which are used for, but not limited to, accounting for
product returns, allowance for doubtful accounts, intangible asset
impairments, and inventory. Actual results may differ from these estimates.
The following critical accounting policies are significantly affected by
judgments, assumptions and estimates used by our management in the
preparation of the consolidated financial statements.
-15-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Revenue is recognized when earned in accordance with applicable accounting
standards, including AICPA Statement of Position ("SOP") No. 97-2, Software
Revenue Recognition, as amended, Staff Accounting Bulletins 104 ("SAB 104")
and the interpretive guidance issued by the Securities and Exchange
Commission and EITF issue 00-21 of the FASB Emerging Issues Task Force. We
recognize revenues from sales of software products upon shipment, provided
that persuasive evidence of an arrangement exists, collection is determined
to be probable and no significant obligations remain. Revenue from service
subscriptions is recognized as costs are incurred or over the service
period, whichever is longer.
In December 2003, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." The
adoption of SAB 104 did not impact the Company's consolidated financial
statements.
Revenue from software license agreements is recognized upon delivery of the
software provided that persuasive evidence of an arrangement exists,
collection is determined to be probable and no significant obligations
remain. Deferred revenue is recorded for post-contract support and is
recognized as costs are incurred or over the support period whichever is
longer. Vendor specific objective evidence of the fair value of the
elements contained in these software license agreements is based on the
price determined by management having the relevant authority when the
element is not yet sold separately.
Revenue from system integration activities is recognized upon installation
provided that persuasive evidence of an arrangement exists, no significant
obligations remain and the collection of the resulting receivable is
probable.
The allowance for doubtful accounts is based on our assessment of the
collectibility of specific customer accounts and an assessment of
international, political and economic risk as well as the aging of the
accounts receivable. If there is a change in actual defaults from our
historical experience, our estimates of recoverability of amounts due us
could be affected and we will adjust the allowance accordingly.
We perform intangible asset impairment analysis on a quarterly basis in
accordance with the guidance in Statement of Financial Accounting Standard
No. 142, Goodwill and Other Intangible Assets ("SFAS No. 142") and
Financial Accounting Standard No. 144, Accounting for the Impairment or
Disposal of Long Lived Assets ("SFAS No. 144"). We use SFAS 144 in response
to changes in industry and market conditions that affect our patents, we
then determine if an impairment of our assets has occurred. Based on the
impairment analysis of the intangible assets, no impairment existed as of
September 30, 2004.
Sources of Revenues. To date, the Company's revenues have been derived
principally from end-users, manufacturers, retailers and distributors of
computer products in North America, Europe and the Pacific Rim. The Company
performs periodic credit evaluations of its customers and does not require
collateral. The Company maintains reserves for potential credit losses.
Historically, such losses have been insignificant and within management's
expectations.
Software Development Costs. Software development costs are accounted for in
accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed" ("SFAS 86"). Under SFAS 86, capitalization of software
development costs begins upon the establishment of technological
feasibility, subject to net realizable value considerations. In the
Company's case, capitalization commences upon the completion of a working
model and generally ends upon the release of the product. The capitalized
costs are amortized to cost of sales on a straight line basis over the
estimated life of the product, generally three years. As of September 30,
2004 and 2003, such costs were insignificant.
Research and Development. Research and development costs are charged to
expense as incurred.
-16-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Foreign Currency Translation. We consider the functional currency of the
Joint Venture to be the respective local currency and, accordingly, gains
and losses from the translation of the local foreign currency financial
statements are included as a component of "accumulated other comprehensive
loss" in our consolidated balance sheets. Foreign currency assets and
liabilities are translated into U.S. dollars at exchange rates prevailing
at the end of the period, except for non-monetary assets and liabilities
that are translated at historical exchange rates. Revenues and expenses are
translated at the average exchange rates in effect during each period,
except for those expenses included in balance sheet accounts, which are
translated at historical exchange rates.
Net foreign currency transaction gains and losses are included as
components of "interest income and other income (expense), net" in the
Company's consolidated statements of operations. Due to the stability of
the currency in China, net foreign currency transaction gains and losses
were not material for the three and nine months ended September 30, 2004
and 2003, respectively.
Net Operating Loss Carryforwards. Utilization of the Company's net
operating losses may be subject to an annual limitation due to the
ownership change limitations provided by the Internal Revenue Code of 1986
and similar state provisions. As a result, a portion of the Company's net
operating loss carryforwards may not be available to offset future taxable
income. The Company has provided a full valuation allowance for deferred
tax assets at September 30, 2004 based upon the Company's history of
losses.
Segments
We report in two segments: handwriting recognition and systems integration.
Handwriting recognition includes online/retail revenues and corporate
sales, including enterprise and original equipment manufacturers ("OEM")
revenues. Handwriting recognition represents the sale of software for
electronic signatures, handwritten biometric signature verification, data
security, data compression, and electronic ink capture. It also includes
the sale of natural input technologies that are designed to allow users to
interact with handheld devices. All handwriting recognition software is
developed around our core technology. Handwriting recognition product
revenues are generated through our web site and a direct sales force to
individual or enterprise end users. We also license a version of our
handwriting recognition software to OEM's. The handwriting recognition
software is included as part of the OEM's product offering. From time to
time, we are required to develop an interface (port) for our software to
run on a new customer's hardware platform or within the customer's software
operating system. The development contract revenues are included in the
handwriting recognition segment.
System integration represents the sale and installation of third party
computer equipment and systems that utilize our products. System
integration sales are derived through a direct sales force which then
develops a system to utilize our software based on the customers
requirements. Systems integration sales are accomplished solely through our
Joint Venture.
-17-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Results of Operations
The following table provides unaudited financial information for each of
our two segments.
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------- -------- -------- -------
Segment revenues:
Handwriting recognition
Online/retail $ 21 $ 54 $ 109 $ 260
Corporate 3,645 480 6,465 1,435
China 3 197 117 320
-------- -------- -------- ---------
Total handwriting recognition $ 3,669 $ 731 $ 6,691 $ 2,015
Systems integration - 205 37 601
-------- -------- -------- ---------
Total revenues $ 3,669 $ 936 $ 6,728 $ 2,616
-------- -------- -------- ---------
Cost of Sales
Handwriting recognition $ 6 $ 51 $ 21 $ 88
Systems integration - 181 29 499
-------- -------- -------- ---------
Total cost of sales $ 6 $ 232 $ 50 $ 587
-------- -------- -------- ---------
Operating cost and expenses
Research and development $ 326 $ 324 $ 918 $ 967
Sales and Marketing 394 233 1,031 696
General and administrative 690 569 1,848 1,700
-------- -------- -------- ---------
Total operating costs
and expenses $ 1,410 $ 1,126 $ 3,797 $ 3,363
-------- -------- -------- ---------
Minority interest, interest
and other income (expense), net $ 9 $ (4) $ 15 $ 5
Interest expense (117) (46) (262) (143)
-------- -------- -------- ---------
Net income (loss) $ 2,145 $ (472) $ 2,634 $ (1,472)
======== ======== ======== =========
Amortization of intangible assets
Cost of sales $ 9 $ 3 $ 9 $ 10
General and administrative 95 95 284 284
-------- -------- -------- ---------
Total amortization of
intangible assets $ 104 $ 98 $ 293 $ 294
========= ======== ======== =========
Revenues
Handwriting recognition.
Handwriting recognition segment revenues include online/retail, corporate
and China software sales. Handwriting recognition segment revenues increased
402% ($2,938) and 232% ($4,676), to $3,669 and $6,691, from $731 and $2015,
respectively, for the three and nine months ended September 30, 2004, as
compared to the same prior year periods.
Online/retail revenues decreased 61% ($33) and 58% ($151), from $54 and
$260 to $21 and $109, for the three and nine months ended September 30, 2004, as
-18-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
compared to the same prior year periods. The Company expects that online/retail
sales from the internet will continue to decline as the shipments of the
PalmSource operating system embedded with the Company's Jot software increase.
The Company believes the increases in PalmSource OS shipments and the resulting
increased royalties, included in Corporate revenues, will offset the declines
experienced in online/retail internet sales.
Corporate revenues increased 657% ($3,165) and 351% ($5,030), to $3,645 and
$6,465 from $480 and $1,435 for the three and nine months ended September 30,
2004, as compared to the same prior year periods.
OEM and channel partner sales included in corporate revenues, decreased 35%
($136) for the three-month period ended September 30, 2004, from $387 to $251.
The decrease in OEM and channel partner sales for the three months ended
September 30, 2004, is due primarily to a larger order from one customer
received in the third quarter of the prior year. Royalties from the shipment by
PalmSource of its operating system containing the Company' Jot software
increased 250% ($148) which helped to offset a non repetitive order. For the
nine months ended September 30, 2004, OEM and channel partner sales increased
38% ($218) to $786, as compared to $568 in the same prior year period. The
Company expects channel partner and OEM sales to increase in the future as new
channel partners and OEM customers are identified and new agreements are signed.
eSignature included in corporate sales increased for the three and nine months
ended September 30, 2004 by 3473% ($3,299) and 554% ($4,810), to $3,394 and
$5,679 from $95 and $869, as compared to the same prior year periods. The
increase in sales for the three months ended September 30, 2004 was due
primarily to a sale to a large national insurance company. The increase in
revenue for the three and nine months ended September 30, 2004 was primarily
attributable to sales to large national customers in the insurance and banking
industries. The Company believes that the sales of smaller pilot deployments to
large national customers, of its products, will lead to greater sales in future
periods as the customers roll out their applications on a wider scale. The
Company believes that corporate eSignature revenues will increase in the near
term as the customers begin their roll out and corporate IT spending increases
as the economy strengthens. However the timing of customer product roll out is
difficult to project due to many factors beyond the Company's control. The
Company views eSignature as a high potential revenue market and intends to
continue to place increasing focus on this market.
China software sales declined $192 (98%) to $3 during the three months
ended September 30, 2004 compared to $195 in the prior year period. For the nine
months ended September 30, 2004, China software sales declined $203 (63%) to
$117 compared to $320 in the prior year period. This decrease reflects the
unpredictable nature of revenue generation while establishing a channel
strategy, which began in the second quarter of 2003, aimed at achieving
accelerated and sustained sales growth by leveraging channel partners to gain
China-wide market coverage. The channel strategy involves training the partners'
sales forces and CIC Chinas' engineering efforts to embed CIC eSignature
software into the partners' total application solutions. A second factor
expected to impact near term revenue is the passing, in August, of the
Electronic Signature Law in China. This is overall a very positive event in that
it provides an impetus for our technology by providing a framework for product
functionality and standards that are required for accelerated market growth. It
has, however, necessitated the need to focus engineering effort on developing
product functionality that is consistent with the new guidelines thereby
delaying further our sales efforts with channel partners. The Company believes
the channel partner strategy, coupled with the passing of the new eSignature
Law, provides the framework for increasing and sustained sales growth in China,
however, attaining predictable and sustained revenue growth on a quarter to
quarter basis may not occur until the first half of 2005 and beyond.
Systems Integration.
System integration segment revenue declined 100% ($205) and 94% ($564), to
$0 and $37 from $205 and $601, for the three and nine months ended September 30,
2004, as compared to the prior year periods. Over the prior two years, CIC China
had emerged as the leading supplier in Jiangsu Province to a fast-growing mobile
industry application for regulated goods, with an estimated 70% market share.
However the decision not to expand this business to other provinces, which would
require significant increases in base costs to provide turn-key capabilities,
but rather to focus on the emerging high potential eSignature/office automation
market in China, leveraging channel partners capabilities resulted in the
decline in system integration revenue. System integration revenues are expected
to continue to be below the prior year amounts in future quarters.
-19-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Cost of Sales
Handwriting recognition.
Handwriting recognition segment cost of sales includes online/retail,
corporate and China software sales costs. Such costs are comprised of royalty
and import tax payments, third party hardware costs, direct mail costs,
engineering direct costs and amortization of intangible assets excluding
patents. Cost of sales for the handwriting recognition segment decreased 88%
($45) and 76% ($67), to $6 and $21, for the three and nine months ended
September 30, 2004, as compared to $51 and $88 in the same prior year periods.
The decline is primarily due to the sale of less third party hardware along with
the Company's software products. Cost of sales may increase in the future
depending on the customers decision to purchase from the Company its software
solution and third party hardware as a complete package rather than buying
individual components from separate vendors.
Online/retail cost of sales decreased 100% ($2) and 100% ($3), to $0 during
the three and nine months ended September 30, 2004 compared to $2 and $3 the
prior year periods, respectively. The Company does not anticipate a material
increase in costs associated with the online/retail sales.
Enterprise and OEM cost of sales increased 50% ($2) to $6 for the three
months ended September 30, 2004, from $4 in the prior year period. For the nine
months ended September 30, 2004, enterprise and OEM cost of sales decreased 37%
($10), to $17 compared to $27 in the prior year period. The decrease was due to
the lower volume of third party hardware sales and engineering development costs
over the comparable three and nine month periods of the prior year. Any
increases in corporate cost of sales in the future will be driven by the amount
of third party hardware that is sold with the Company's software solutions.
China handwriting recognition segment has no cost for the three months
ended September 30, 2004 compared to $45 in the prior year period. For the nine
months ended September 30 2004, China handwriting recognition segment cost of
sales decreased 93% ($54) to $4 compared to $58 in the prior year period. The
decrease is due to the reduction in revenues over the three and nine months
ended September 30, 2004 compared to the prior year periods. It is expected that
cost of sales will remain low for the foreseeable future as the current trend
has been in the sale of software solutions through channel partners with little
third party hardware costs.
Systems Integration.
China Systems integration segment has no cost for the three months ended
September 30, 2004 compared to $181 in the prior year period. For the nine
months ended September 30, 2004 system integration segment revenues decreased
94% ($470) to $29 compared to $499 in the prior year period. The decrease in
costs was due primarily to the reduction in sales during the three and nine
month periods ended September 30, 2004 compared to the prior year periods. The
Company expects that system integration cost of sales will decrease over time as
the Company continues to increase its focus on the emerging high potential
eSignature/office automation market in China.
Operating expenses
Research and development expenses. Research and development expenses for
the three months ended September 30, 2004, increased 1% ($2), to $326 from $324
in the prior year period. For the nine months ended September 30, 2004
engineering expenses decreased 5% ($49) to $918 from $967 in the prior year
period. Engineering expenses consist primarily of salaries and related costs,
outside engineering, maintenance items, and allocated facilities expenses. These
expenses are offset by the capitalization of software development costs and
direct costs associated with nonrecurring engineering contracts charged to cost
of sales. Salaries and related expenses increased 9% ($18) and 5% ($29), for the
three and nine months ended September 30, 2004, compared to the prior year
periods. The increase is due primarily to the salary increases for the
engineering staff in the US. Other engineering administrative costs including
allocated facilities expenses declined 13% ($16) and 22% ($78), respectively,
during the three and nine months ended September 30, 2004, compared to the prior
year periods. The reduction in other costs occurred primarily in the Joint
venture in China due to the curtailment of the SI segment. Currently the Company
-20-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
does not anticipate reductions in personnel nor does it anticipate an increase
in personnel as the Company maintains its relationship with an outside
engineering group familiar with its products and, if required, can engage them
on an as-needed basis to fill future engineering requirements. In addition the
Company draws on the engineering capabilities of the Joint Venture as required.
This reliance on the Joint Venture and outside parties allows the Company to
maintain lower base costs and to increase engineering cost on a temporary basis
in response to specific revenue opportunities.
Sales and marketing expenses. Sales and marketing expenses increased 69%
($161) and 49% ($335), to $394 and $1,031, respectively, for the three and nine
months ended September 30, 2004 as compared to $233 and $696, in the prior year
periods. Sales and marketing expenses consist of salaries, commissions and
related expenses, professional services, advertising and promotion, general
office and allocated facilities expenses. Salaries and related expenses
increased 77% ($51) and 49% ($124), respectively, for the three and nine month
periods ended September 30, 2004, compared to the prior year periods. The
increase in salaries and related expense is primarily due to an increase in the
headcount by one in the Sales department after the second quarter of 2004.
Recruiting expense decreased 100% ($20) for the three months ended September 30,
2004 compared to the prior year period. For the nine months ended September 30,
2004, recruiting expense increased 72% ($14) compared to the prior year period.
The increase is due to the hiring of one sales person of executive level in the
second fiscal quarter of 2004. Commissions expense increased 303% ($133) and
248% ($218), respectively, in the three and nine months ended September 30,
2004, compared to the prior year periods. The increase in commission expense in
comparable periods is due to the increase in revenues. Other expenses including
facilities and other office related expenses decreased 3% ($3) and 6% ($21),
respectively, for the three and nine months ended September 30, 2004, compared
to the prior year periods. These decreases in other expenses were realized in
both the US and China operations and were primarily related to travel expenses,
depreciation and allocated facility costs. The Company expects these costs may
increase at such time in the future as the sales force is expanded to respond to
increasing revenue opportunities. The Company believes that the current cost
structure can support significantly higher revenue without significant increases
in base costs.
General and Administrative Expenses. General and administrative expenses
increased 21% ($121) and 9% ($148), to $690 and $1,848,respectively, for the
three and nine months ended September 30, 2004, compared to $569 and $1,700 in
the prior year periods. General and administrative expense consists of salaries,
professional fees, investor relations expenses, patent amortization and office
and allocated facilities costs. Salaries and wages increased 9% ($15) and 4%
($20), respectively, for the three and nine month periods ended September 30,
2004, compared to the prior year periods. These increases are due primarily to
salary increases. Professional service expenses which include consulting, legal
and outside accounting fees increased 27% ($33) during the three months ended
September 30, 2004, primarily due to legal fees associated with the pending
contract litigation. Professional services expense decreased 2% ($8) for the
nine months ended September 30, 2004 compared to the prior year period. The
decrease was primarily due to lower legal and accounting fees over the nine
months ended September 30, 2004, compared to the prior year periods. The Company
anticipates that legal fees may increase in future quarters due to pending
contract litigation. Bad debt expenses increased $150 and $178, respectively,
for the three and nine months periods ended September 30, 2004, compared to the
prior year period. The increase in bad debt expense was primarily due to
provisions made to cover the aged receivables of the CIC Joint Venture. The
Company believes that its accounts receivable are adequately reserved at
September 30, 2004 and does not anticipate further provisions in the future.
Other administrative expenses decreased 28% ($77) and 5% ($42), respectively,
for the three and nine months ended September 30, 2004, compared to the prior
year periods. The increases are primarily due to an increase in allocated
expenses compared to the prior year periods. The Company believes that the
increase in the expenses allocated to administration will continue at the higher
rate through the end of the next quarter.
Interest and other income (expense), net
Interest and other income (expense), net, increased $13 and $10 for the
three and nine months ended September 30, 2004, respectively, compared to the
prior year periods. The increase is primarily due to the change in minority
interest due to the operating losses incurred by the Company's Joint Venture.
-21-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Interest expense
Interest expense increased 154% ($71) and 83% ($119), to $117 and $262 from
$46 and $143 for the three and nine months ended September 30, 2004,
respectively, compared to the prior year periods. The increase in interest
expense for the three months ended September 30, 2004 is due to the interest
paid on the $3,500 Loan and the interest paid on the $3,000 loan through August
18, 2004. The increase in interest expense over the nine months ended September
30, 2004 was primarily due to interest paid to Cornell Capital Partners, LC
associated with the $750 in short-term debt, the amounts paid associated with
the $3,000 loan to the Trust, and the $3,500 loan to Cornell Capital Partners,
LP, (See Note 5 of the condensed consolidated financial statements).
Liquidity and Capital Resources
At September 30, 2004, cash and cash equivalents totaled $1,549 compared to
cash and cash equivalents of $1,039 at December 31, 2003. The increase in cash
was primarily due to cash provided by operating activities of $40 and cash
provided financing activities of $502. These cash inflows were offset by the
acquisition of property and equipment amounting to $32. Total current assets
were $5,714 at September 30, 2004, compared to $2,005 at December 31, 2003. As
of September 30, 2004, the Company's principal sources of funds included its
cash and cash equivalents aggregating $1,549, its accounts receivable of $3,863
and the Equity Line of Credit through Cornell Capital Partners LP. On November
2, 2004, the Company received approximately $4,000 in proceeds from a
debt warrant financing. See Note 13 to Condensed Consolidated Financial
Statements - "Subsequent events."
Accounts receivable increased $3,121, net of $435 provided for potentially
uncollectable accounts, for the nine months ended September 30, 2004 compared to
December 31, 2003, due primarily to the a large order received late in the
quarter. The Company expects that the development of the eSignature market will
result in more consistent revenue on a quarter to quarter basis and therefore,
less fluctuation in accounts receivable from quarter to quarter. For the nine
months ended September 30, 2004, one customer accounted for 91% of net accounts
receivable. The account receivable accounting for 91% of net accounts receivable
was collected subsequent to the balance sheet date.
Prepaid expenses and other current assets increased by $125 for the nine
months ended September 30, 2004, compared to December 31, 2003. The increase is
primarily due to the prepaid interest on the $3,500 short term note secured
through Cornell Capital Partners LP in August 2004, offset by the non cash
reduction in prepaid financing and other prepaids associated with the operations
of the Company. Prepaid expenses generally fluctuate due to the timing of annual
insurance premiums and maintenance and support fees which are prepaid in
December and June of each year.
During the second quarter of, 2004, the Company received a sixty day
extension to pay the $3,000 note that was due June 18, 2004, to the charitable
remainder annuity trust of which a former director and officer of the Company is
a trustee (the "Trust"). In exchange for this sixty day extension, the Company
paid the Trust thirty days worth of interest ($15) calculated according to the
terms of the note. All other provisions of the note remained unchanged. On
August 5, 2004, the Company paid all amounts due under the note with proceeds
from a loan from Cornell Capital Partners LP. The Cornel loan was repaid on
November 8, 2004.
On April 20, 2004, the Joint Venture borrowed the aggregate equivalent of
$37, denominated in Chinese currency, from a Chinese bank. The proceeds of the
loan are to be used for working capital purposes until the channel sales
strategy is fully implemented and sales increase. The loan bears interest at
5.0% per annum and is due April 20, 2005. The borrowing did not require the
Joint Venture to deposit a compensating balance. The note can be repaid at any
time with out penalty.
During the nine months ended September 30, 2004, the Company repaid $750 to
Cornell Capital Partners, LP through the issuance of approximately 1,133 shares
of its common stock. Under the terms of a debt-warrant financing that closed on
November 2, 2004, the Company is prohibited from borrowing any additional funds
under the Cornell Equity Line. (See Note 13 to the Condensed Consolidated
Financial Statements - "Subsequent events"). The Company intends to terminate
the Equity Line within the next 30 days.
-22-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Accounts payable decreased $86 for the nine months ended September 30,
2004, compared to December 31, 2003, due to fewer materials purchased and used
by the Joint Venture in cost of sales. Accounts payable balances typically
increase in the second and fourth quarters when the insurance and annual
maintenance and support fees are incurred. Materials used in cost of sales may
impact accounts payable depending on the amount of third party hardware sold as
part of the software solution. Accrued compensation increased $140 due primarily
to the accrual in the third quarter ended September 30, 2004 of commissions.
Commissions are paid after customer payment of the receivable amount.
Current liabilities, which include deferred revenue, were $4,970 at
September 30, 2004 compared to $4,900 at December 31, 2003. Deferred revenue,
was $507 at September 30, 2004, compared to $165 at December 31, 2003. This
increase primarily reflects advance payments for products and maintenance fees
from the Company's licensees, which are generally recognized as revenue by the
Company when all obligations are met or over the term of the maintenance
agreement.
The Company has suffered recurring losses from operations that raise a
substantial doubt about its ability to continue as a going concern. The
Company's accumulated deficit was approximately $79,500 at September 30, 2004
compared to approximately $82,000 at December 31, 2003. There can be no
assurance that the Company will continue to reduce the accumulated deficit or
have adequate capital resources to fund planned operations or that any
additional funds will be available to it when needed, or if available, will be
available on favorable terms or in amounts required by it. If the Company is
unable to obtain adequate capital resources to fund operations, it may be
required to delay, scale back or eliminate some or all of its operations, which
may have a material adverse effect on its business, results of operations and
ability to operate as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
CIC believes the cash provided from operations, and or other potential
sources of financing, will be sufficient to meet its capital requirements for
the foreseeable future. If the Company is unable to secure sufficient funds
through financing, or is unable to sustain the increase in funds generated from
operations, the Company may not be able to continue its operations in their
current form and may not be a viable company on a going forward basis without
significant changes in its operations. Since February 2002, the Company has
raised, net of costs and expenses, approximately $2,300 and borrowed, net of
costs and expenses approximately $3,273 from the Equity Line of Credit. The
Company believes it will be able to raise the necessary funds under the Equity
Line of Credit, through February 2005, and or other alternate financing, and
from operations. The Company has not formulated specific plans to change its
operations. Possible changes could include reduced personnel expenses to better
match its revenue streams.
The following are material commitments as of September 30, 2004:
Payments due by periods
-------------------------------- -------------------------------------------
Less
than One to Four to After
one three five five
Contractual obligations Total year years years years
-------------------------------- ------- ------ ----- ------ -----
Short-term debt related party $ 8 $ 8 $ - $ - $ -
Short-term debt, other 3,537 3,537 - - -
Long-term debt related party 6 6 - -
Capital Lease Obligations 24 24 - - -
Operating lease commitments (1) 879 419 460 - -
--------- ------- ------- ----- ------
Total contractual cash obligations $ 4,454 $ 3,988 $ 466 $ - $ -
========= ======== ======= ===== ======
1. The operating lease commenced on November 1, 2001. The cost of the lease
will increase approximately 3% per annum over the term of the lease, which
expires on October 31, 2006.
Forward Looking Statements
Certain statements contained in this quarterly report on Form 10-Q,
including without limitation, statements containing the words "believes",
"anticipates", "hopes", "intends", "expects", and other words of similar import,
-23-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
constitute "forward looking" statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Such statements involve known and
unknown risks, uncertainties and other factors which may cause actual events to
differ materially from expectations. Such factors include those set forth in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003 and
are delineated as follows:
o Technological, engineering, manufacturing, quality control or other
circumstances which could delay the sale or shipment of products;
o Economic, business, market and competitive conditions in the software
industry and technological innovations which could affect the Company's
business;
o The Company's inability to protect its trade secrets or other proprietary
rights, operate without infringing upon the proprietary rights of others
and prevent others from infringing on the proprietary rights of the
Company; and
o General economic and business conditions and the availability of sufficient
financing.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, as a result of new information, future events or
otherwise.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
The Company has an investment portfolio of fixed income securities that are
classified as cash equivalents. These securities, like all fixed income
instruments, are subject to interest rate risk and will fall in value if the
market interest rates increase. The Company attempts to limit this exposure by
investing primarily in short term securities. The Company did not enter into any
short-term security investments during the three and nine months ended September
30, 2004.
Foreign Currency Risk
From time to time, the Company makes certain capital equipment or other
purchases denominated in foreign currencies. As a result, the Company's cash
flows and earnings are exposed to fluctuations in interest rates and foreign
currency exchange rates. The Company attempts to limit these exposures through
operational strategies and generally has not hedged currency exposures.
Future Results and Stock Price Risk
The Company's stock price may be subject to significant volatility. The
public stock markets have experienced significant volatility in stock prices in
recent years. The stock prices of technology companies have experienced
particularly high volatility, including, at times, severe price changes that are
unrelated or disproportionate to the operating performance of such companies.
The trading price of the Company's common stock could be subject to wide
fluctuations in response to, among other factors, quarter-to-quarter variations
in operating results, announcements of technological innovations or new products
by the Company or its competitors, announcements of new strategic relationships
by the Company or its competitors, general conditions in the computer industry
or the global economy in general, or market volatility unrelated to the
Company's business and operating results.
Item 4A. Controls and Procedures
Under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, the Company has evaluated the effectiveness of the design and operation
of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15
within 90 days of the filing date of this quarterly report. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that these disclosure controls and procedures are effective. There
were no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of their evaluation.
-24-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
Part II-Other Information
Item 1. Legal Proceedings
On June 7, 2004, (amended July 7, 2004) Topaz Systems, Inc. ("Topaz") filed
a complaint, against the Company, with the United States District Court Northern
District of California San Francisco Division alleging breach of contract,
breach of covenant of good faith and fair dealing and asking for a declaratory
judgment that it had not breached the September 29, 2000 License agreement
between it and the Company (the "License"), that Topaz had not infringed certain
of the Company's patents and that such patents were invalid and/or
unenforceable. No monetary damages were specified. The Company believes that the
complaint is without merit and intends to vigorously defend against the claims.
On July 26, 2004, the Company responded to the complaint and filed counterclaims
against Topaz alleging that Topaz had breached the License, had infringed
certain of the Company's patents and was engaging in unfair competition. On
July, 22, 2004, Topaz filed a complaint against the Company with the United
States District Court Central District of California Western Division requesting
declaratory judgment that it did not infringe certain of the Company's patents
(not included in the other complaint) and that such patents were invalid and/or
unenforceable. The Company believes that the complaint is without merit and
intends to vigorously defend against the claims. The ultimate outcome of this
litigation cannot presently be determined. However, in management's opinion, the
likelihood of a material adverse outcome is remote and any liability that might
be incurred would not have a material adverse effect on the Company's financial
position or its results of operations. Accordingly, adjustments, if any, that
might result from the resolution of this matter have not been reflected in the
financial statements.
Item 2. Change in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT 31 - Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
EXHIBIT 32 - Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 18 USC Section 1750, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
1. Current Report on Form 8-K, Items 7, 9 and 12, dated August 11,
2004, with respect to the Company's second quarter 2004 financial
results.
-25-
Communication Intelligence Corporation
And Subsidiary
(In thousands, except per share amounts)
Form 10-Q
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.
COMMUNICATION INTELLIGENCE CORPORATION
----------------------------------------------
Registrant
November 15, 2004 /s/ Francis V. Dane
- -------------------------- ------------------------------------------
Date Francis V. Dane
(Principal Financial Officer and Officer Duly
Authorized to Sign on Behalf of the Registrant)
-26-