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: March 31, 2005
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
- ------- THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-19301
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 May 10, 2005:
102,250,065.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page No.
-------------------- --------
Condensed Consolidated Balance Sheets at March 31, 2005 (unaudited)
and December 31, 2004....................................................3
Condensed Consolidated Statements of Operations for the Three-Month
Period Ended March 31, 2005 and 2004 (unaudited).........................4
Condensed Consolidated Statements of Changes in Stockholders' Equity
for the Three-Month Period Ended March 31, 2005 (unaudited)..............5
Condensed Consolidated Statements of Cash Flows for the Three-Month
Period Ended March 31, 2005 and 2004 (unaudited).........................6
Notes to Unaudited Condensed Consolidated Financial Statements.............7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................14
---------------------.
Item 3. Quantitative and Qualitative Disclosures About Market Risk........23
----------------------------------------------------------
Item 4A. Controls and Procedures..........................................23
-----------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................24
-----------------
Item 2. Change in Securities and Use of proceeds..........................24
----------------------------------------
Item 3. Defaults Upon Senior Securities...................................24
-------------------------------
Item 4. Submission of Matters to a Vote of Security Holders...............24
---------------------------------------------------
Item 5. Other Information.................................................24
-----------------
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits..................................................24
Signatures.................................................................26
-2-
Communication Intelligence Corporation
and Subsidiary
Condensed Consolidated Balance Sheets
(In thousands)
March 31, December 31,
2005 2004
----------- -------------
Unaudited
Assets
Current assets:
Cash and cash equivalents..................... $ 3,853 $ 4,736
Accounts receivable, net...................... 465 356
Deferred financing costs - current portion.... 252 272
Prepaid expenses and other current assets..... 98 105
---------- ----------
Total current assets...................... 4,668 5,469
Property and equipment, net........................ 122 123
Patents and trademarks............................. 4,569 4,663
Capitalized software development costs............. 127 32
Deferred financing costs - long term............... 400 502
Other assets....................................... 30 30
---------- ----------
Total assets.............................. $ 9,916 $ 10,819
========== ==========
Liabilities and Stockholders' Equity
Current liabilities:
Short-term debt - related party............... $ 8 $ 8
Short-term debt - other....................... 36 36
Accounts payable.............................. 253 241
Accrued compensation............................... 204 258
Other accrued liabilities..................... 462 400
Deferred revenue.............................. 304 458
--------- ----------
Total current liabilities................. 1,267 1,401
Long-term debt - related party..................... 3 5
Convertible notes, net of unamortized fair value
assigned to the beneficial feature and warrants
of $2,088 and $2,410 at March 31, 2005 and
December 31, 2004, respectively................... 1,723 1,785
Minority interest.................................. 90 97
Commitments and contingencies...................... - -
Stockholders' equity:
Common stock.................................. 1,023 1,014
Additional paid-in capital.................... 87,610 87,231
Accumulated deficit........................... (81,632) (80,544)
Accumulated foreign currency translation
adjustment.................................... (168) (170)
---------- ----------
Total stockholders' equity................ 6,833 7,531
---------- ----------
Total liabilities and stockholders' equity $ 9,916 $ 10,819
========== ==========
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
March 31,
---------------------------
2005 2004
------------ -----------
Revenues:
Online/retail ........................... $ 24 $ 41
Corporate ............................... 554 2,352
China ................................... 1 36
---------- ----------
Total revenues....................... 579 2,429
Operating costs and expenses:
Cost of sales:
eSignature .......................... 21 7
China................................ 1 26
Research and development................. 303 319
Sales and marketing...................... 309 332
General and administrative............... 509 504
---------- ----------
Total operating costs and expenses... 1,143 1,188
---------- ----------
Income (loss) from operations................. (564) 1,241
Other income (expense):
Interest and other income (expense), net. 1 (1)
Interest expense......................... (532) (83)
Minority interest........................ 7 10
---------- ----------
Net Income (loss) ................... $ (1,088) $ 1,167
========== ==========
Basic and diluted income (loss) per share..... $ (0.01) $ 0.01
========== ==========
Weighted average common shares outstanding
basic........................................ 101,682 100,102
========== ==========
Weighted average common shares outstanding
diluted...................................... 101,682 102,618
========== ==========
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 Comprehensive
Outstanding Stock Capital Deficit Loss Total
Balances as of December
31, 2004................. 101,412 $ 1,014 $ 87,231 $(80,544) $ (170) $ 7,531
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Shares issued on
conversion of notes...... 838 9 379 - - 388
Comprehensive loss
Net loss................. - - - (1,088) - (1,088)
Foreign currency
translation adjustment... - - - - 2 2
------------
Total comprehensive loss (1,086)
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Balances as of March 31,
2005..................... 102,250 $ 1,023 $ 87,610 $(81,632) $ (168) $ 6,833
===============================================================================
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)
Three Months Ended
March 31,
-------------------
2005 2004
-------- --------
Cash flows from operating activities:
Net income (loss)........................................ $(1,088) $ 1,167
Adjustments to reconcile net income (loss) to net cash
(used) in operating activities:
Depreciation and amortization........................ 230 113
Discount on long term debt........................... 322 -
Loss on disposal of property and equipment........... 6 -
Changes in operating assets and liabilities:
Accounts receivable, net.......................... (109) (1,953)
Inventories....................................... - 23
Prepaid expenses and other current assets......... 7 16
Other assets...................................... - -
Accounts payable.................................. 12 (158)
Accrued compensation.............................. (54) 53
Other accrued liabilities......................... 62 (108)
Deferred revenue.................................. (154) 204
--------- --------
Net cash used in operating activities............ (766) (643)
--------- --------
Cash flows from investing activities:
Acquisition of property and equipment................. (14) (3)
Capitalized software development costs................ (99) -
--------- -------
Net cash used in investing activities............. (113) (3)
--------- -------
Cash flows from financing activities:
Principal payments on long-term debt.................. (2) (2)
Principal payments on capital lease obligations....... (2) (1)
--------- --------
Net cash used in financing activities............. (4) (3)
--------- --------
Effect of exchange rate changes on cash.................... - -
--------- --------
Net decrease in cash and cash equivalents.................. (883) (649)
Cash and cash equivalents at beginning of period........... 4,736 1,039
--------- --------
Cash and cash equivalents at end of period................. $ 3,853 $ 390
========= ========
Supplemental Non Cash Flow Information
2005 2004
------ --------
Conversion of convertible notes
for 838 common shares $ 387 $ -
The accompanying notes form an integral part of these
Condensed Consolidated Financial Statements
-6-
Communication Intelligence Corporation
and Subsidiary
(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, 2004.
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)). These 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
(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
March 31, 2005, the Company's accumulated deficit is approximately $81,632
and the Company has working capital of $3,401. The Company filed a
registration statement with the Securities and Exchange Commission that was
declared effective January 2005, pursuant a financing of convertible notes
(see Note 8). 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, 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.
Recent Pronouncements
In December 2004, the FASB issued SFAS No.123 (revised 2004), "Share-Based
Payment". Statement 123(R) will provide investors and other users of
financial statements with more complete and neutral financial information
by requiring that the compensation cost relating to share-based payment
transactions be recognized in financial statements. That cost will be
measured based on the fair value of the equity or liability instruments
issued. Statement 123(R) covers a wide range of share-based compensation
arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights, and employee share
purchase plans. Statement 123(R) replaces FASB Statement No. 123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. Statement 123, as originally
issued in 1995, established as preferable a fair-value-based method of
accounting for share-based payment transactions with employees. However,
that Statement permitted entities the option of continuing to apply the
guidance in Opinion 25, as long as the footnotes to financial statements
disclosed what net income would have been had the preferable
fair-value-based method been used. Public entities (other than those filing
as small business issuers) will be required to apply Statement 123(R) as of
the first interim or annual reporting period that begins after June 15,
2005.
On April 14, 2005, the Securities and Exchange Commission (SEC) announced a
delay of up to six months in the effective date of the option-expensing
requirements set forth in Statement No. 123(R). For public companies with
less than $25 million in revenues, the new effective date for compliance
with FAS 123R is the first quarter of their first fiscal year beginning
after December 15, 2005. The Company is still evaluating the transition
provisions allowed by SFAS 123(R) and the impact of the adoption of the
Statement.
In December 2004 the Financial Accounting Standards Board issued two FASB
Staff Positions - FSP FAS 109-1, Application of FASB Statement No. 109
"Accounting for Income Taxes" to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004, and FSP FAS
109-2, Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of 2004.
Neither of these affected the Company as it does not participate in the
related activities.
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:
March 31, December 31,
2005 2004
--------------------- -- -------------------
Cash in bank $ 828 $ 1,734
Money market 3,025 3,002
--------------------- -------------------
$ 3,853 $ 4,736
===================== ===================
-8-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
3. Accounts receivable concentration
For the three months ended March 31, 2005, one customer accounted for 48%
of net accounts receivable. For the three months ended March 31, 2004, one
customer accounted for 95% of net accounts receivable.
4. Patents
The Company performs intangible asset impairment analyses on a quarterly
basis in accordance with the guidance in Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") and
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long Lived Assets" ("SFAS 144"). The Company uses
SFAS 144 in response to changes in industry and market conditions that
affects its patents; the Company then determines if an impairment of its
assets has occurred. The Company reassesses the lives of its patents and
tests for impairment quarterly in order to determine whether the book value
of each patent exceeds the fair value of each patent. Fair value is
determined by estimating future cash flows from the products that are and
will be protected by the patents and considering the additional factors
listed in Critical Accounting Policies. The Company believes that as of
March 31, 2005 no impairment of the carrying values of the patents existed.
Amortization of patent costs was $95 for each of the three months ended
March 31, 2005 and 2004.
5. Short and Long-term debt - related party
In June 2003, the Company's 90% owned joint venture, Communication
Intelligence Computer Corporation, Ltd., (the " Joint Venture') borrowed
from one of its directors, Tong Ming Sheng, approximately $24 denominated
in U. S. dollars to purchase a replacement van used in the Company's
operations. The note bears interest at the rate of 5% per annum, and is due
in June 2006. Principal payments on long term debt are $2, and $2 for the
three months ended March 31, 2005, and 2004, respectively.
6. Short-term debt - other
On April 20, 2004, the Company's Joint Venture borrowed the aggregate
equivalent of $36, denominated in Chinese currency, from a Chinese bank.
The unsecured loan bears interest at 5.0% per annum and was paid in April,
2005. The borrowing did not require the Joint Venture to deposit a
compensating balance.
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. Convertible Notes
In November 2004, the Company entered into an unsecured 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 proceeds to the Company were approximately $3,885, net of $310
in commissions and legal expenses. H.C. Wainwright & Co., Inc.
("Wainwright") acted as placement agent. As placement agent for the
Company, at closing Wainwright received $731 in commissions, legal fees and
warrants. The commissions of approximately $285 and legal fees of $25,
mentioned above, were paid in cash. The Company issued warrants to
Wainwright to acquire 1,218 shares of the Company's common stock. Of the
warrants issued, 870 are exercisable at $0.462 and 348 are exercisable at
$0.508. The Company has ascribed the value of $421 to the Wainwright
warrants, which is recorded as deferred financing costs in the balance
sheet. The fair value ascribed to the Wainwright warrants was estimated on
the commitment date using the Black-Scholes pricing model with the
following assumptions: risk-free interest
-9-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
8. Convertible Notes (continued)
rate of 3.21%; expected life of 3 years; expected volatility of 100%; and
expected dividend yield of 0%. The Company is using the proceeds of the
financing for working capital purposes.
Under the terms of the financing, the Company 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. The
Company has ascribed a value of $982 to the investor warrants, which is
recorded as a discount to notes payable in the balance sheet. The fair
value ascribed to the warrants was estimated on the commitment date using
the Black-Scholes pricing model with the following assumptions: risk-free
interest rate of 3.21%; expected life of 3 years; expected volatility of
100%; and expected dividend yield of 0%. In addition to the fair value
ascribed to the warrants, the Company has ascribed $1,569 to the beneficial
conversion feature in the convertible notes, which is recorded as a
discount to notes payable in the balance sheet. The values ascribed to the
warrants and beneficial conversion feature follow the guidance of the EITF
Issue No. 98-5, "Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios", and ETIF
Issue No. 00-27, "Application of Issue No. 98-5 to Certain Convertible
Instruments" of the FASB's Emerging Issues Task Force. The fair value of
the warrants and beneficial conversion feature is amortized to expense over
the life of the convertible notes or upon earlier conversion using the
effective interest method. For the three months ended March 31, 2005, the
Company had amortized to interest expense approximately $532 of the loan
discount and deferred financing costs. The balance due under the
convertible notes is shown net of the remaining unamortized discount on the
accompanying consolidated balance sheet. During the three months ended
March 31, 2005, the investors converted $388 of the notes in exchange for
838 shares of the Company's common stock. If the remaining aggregate
principal amount owing under the notes is converted, the Company will issue
8,242 shares of its common stock. If the notes are not converted, all
remaining 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.
The above 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. Wainwright will be paid approximately $28 in the aggregate if all
of the investor warrants are exercised. The Company will receive proceeds
of approximately $1,845 if all of the warrants are exercised.
The Company also was required to file a registration statement providing
for the resale of the shares that are issuable upon the conversion of the
notes and the exercise of the warrants. The registration statement was
filed on December 22, 2004 and was declared effective on January 26, 2005.
Interest paid during the three months ended March 31, 2005 and 2004 was $1,
and $83, respectively.
9. 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
-10-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
9. Net income (loss) per share (continued)
potential shares outstanding. For the three-month period ended March 31,
2005, 5,871 shares of common stock subject to outstanding options, 8,242
shares issuable upon the conversion of the convertible notes and 4,850
warrants were excluded from the calculation of dilutive earnings per share
because the exercise or conversion price of such options and warrants, was
greater than the average market price of the Company's common stock. For
the three months ended March 31, 2004, 4,813 stock 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.
Three Months Ended
March 31, 2005 March 31, 2004
-------------------------------------- -----------------------------------
Weighted Weighted
Average Per-Share Average Shares Per-Share
Net Shares Amount Net Outstanding Amount
Loss Outstanding Income
Basic income (loss) per share:
Income (loss) available to
stockholders $ (1,088) 101,682 $ (0.01$ 1,167 100,102 $ 0.01
Effect of dilutive securities
Stock options - - - - 529 -
Note payable to Cornell - - - - 1,987 -
----------- -------------- ----------- ---------- --------------- ----------
Diluted income (loss) $ (1,088) 101,682 $(0.01) $ 1,167 102,618 $0.01
=========== ============== =========== ========== =============== ==========
10. 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.
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:
Three Months Ended
-----------------------------
March 31, March 31,
2005 2004
-----------------------------
Net income (loss) available to stockholders:
As reported................................. $ (1,088) $ 1,167
------------------------------
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............... (52) (38)
------------------------------
Pro forma................................. $ (1,140) $ 1,129
==============================
-11-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
10. Common Stock Options (continued)
Basic and diluted net income (loss) per share available to
stockholders:
As reported............................. $ (0.01) $ 0.01
=============================
Pro forma........................... $ (0.01) $ 0.01
=============================
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 3.65% and 2.37% for 2005 and 2004
respectively;
o an expected life of 7 years for 2005, and 6.6 years for 2004;
respectively;
o expected volatility of 52% for 2005 and 100% for 2004; 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.
11. Comprehensive income (loss)
Total comprehensive income (loss) was as follows:
-------------------------------
Three Months Ended
March 31,
--------------- ---------------
2005 2004
--------------- ---------------
Net income (loss) $ (1,088) $ 1,167
Other comprehensive income:
Cumulative translation adjustment 2 1
--------------- ---------------
Total comprehensive income (loss) $ (1,086) $ 1,168
=============== ===============
12. 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 two revenue categories;
online/retail, corporate, which includes eSignature and natural
input/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.
-12-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
12. Segment Information
The tables below present information about reporting segments for the
periods indicated:
Three Months Ended March 31,
2005 2004
------------------------------------------- ---------------------------------------------
Handwriting Systems Handwriting Systems
Recognition Integration Total Recognition Integration Total
-------------- --------------- ------------ ---------------- --------------- ------------
Revenues $ 579 $ - $ 579 $ 2,398 $ 31 $ 2,429
Income (loss) from
Operations $ (564) $ - $ (564) $ 1,286 $ (45) $ 1,241
Significant change
in total long
lived assets from
year end $ - $ - $ - $ - $ - $ -
For the three months ended March 31, 2005, one customer accounted for 35%
of total handwriting recognition segment revenue. For the three months
ended March 31, 2004, one customer accounted for 83% of total handwriting
recognition segment revenue.
For the three months ended March 31, 2005 there were no system integration
revenues recorded. For the three months ended March 31, 2004, one customer
accounted for 47% of system integration revenues.
13. Commitments and contingencies
In February of 2005, Valyd, Inc. filed a complaint against the Company
seeking a declaratory judgment that Valyd is not infringing certain of the
Company's patents, that such patents are invalid or unenforceable, and that
the Company tortiously interfered with a contract between Valyd, Inc. and
Interlink Electronics, Inc. by delivering an infringement notice to
Interlink Electronics, Inc. The complaint also alleged unfair competition
under California law. No specific monetary claim is set forth in the
complaint. On March 3, 2005, the Company responded to the complaint,
denying all allegations, and filed counterclaims against Valyd, Inc. The
counterclaims assert that Valyd, Inc. is infringing certain of the
Company's patents and asked for treble damages, alleging that the
infringement is willful, deliberate and in conscious disregard of CIC's
rights. 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-
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, 2004.
Overview
The Company was 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, 2004, operating losses aggregated approximately $7,792 and at
December 31, 2004 the Company's accumulated deficit was approximately $80,544.
At March 31, 2005, the Company's accumulated deficit was approximately $81,632.
Total revenue of $579 for the quarter ended March 31, 2005 decreased 76%
compared to revenues of $2,429 in the corresponding quarter of the prior year.
Revenue in the first quarter of last year was dominated by a single $2.0 million
eSignature order from Wells Fargo. The first quarter 2005 revenue reflects the
continuing realities of an unpredictable economic recovery, mergers and
acquisition and other factors over which we have no control that negatively
impact sustained IT spending in the financial services segment, and the
challenges associated with the new and emerging applications upon which we are
dependent to ramp up and produce viable revenue streams.
Net loss for the three months ended March 31, 2005 was $1,088, on
significantly lower sales, compared with a net income of $1,167 in the
corresponding prior year period. Operating expenses decreased approximately 3%,
or $34, to $1,121 for the three months ended March 31, 2005, compared to $1,155
in the prior year period. The decrease in operating expenses primarily reflects
a decrease in commission expense due to lower sales volumes in the first quarter
compared to last year.
Our ability to predict quarterly sales continues to be challenged by the
emerging market realities of our eSignature business. Despite concerns about a
slowing in the economic recovery and reports of weakness in first quarter
enterprise IT spending, we believe that the benefits of risk mitigation, both
legal and compliance related, together with the ROI potential afforded by our
solutions are recognized by our pilot and proof of concept customers. Hence
although the IT spending required for full follow-on deployments of our
technology by large financial institutions is impacted by the economic
environment, there is increasing awareness among these customers that to achieve
the full ROI potential of document management and paperless operations, and to
recoup their extensive past expenditures, they must address the sixty percent of
their documents that are signature dependent. It is recognition of this message
at our installed base of large financial institutions that is leading us to
believe that there is potential for near term rollouts by more of these
customers. Although we believe there is a direct correlation between economic
recovery, IT expenditures and deployment of our technology in the financial
services industry, we believe other vertical markets on which we focus, have
recognized the significant benefits and ROI potential afforded by our products.
Many of these potential customers possess the capital to fund deployments
notwithstanding a less than robust economy.
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.
-14-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
Revenue Recognition. 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 Bulletin
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.
We recognize revenue from software license agreements 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.
We recognize revenue from system integration activities 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 March 31, 2005.
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. During the
quarter ended March 31, 2005, $99 in engineering costs were capitalized. The
Company expects that capitalization of engineering costs will increase over
prior period amounts to reflect new product development and enhancements. As of
March 31, 2004, such costs were insignificant.
Research and Development. Research and development costs are charged to
expense as incurred.
-15-
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 months ended March 31, 2005 and 2004, 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 March 31,
2005 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 eSignature and natural input/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 (see
discussion under revenues - Handwriting recognition). 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. The system integration
business has become highly competitive with a low barrier to entry. It is
increasingly comprised of small Chinese owned businesses with virtually no
differentiation in service offerings and primarily competing on price and
relationships. The Company made the decision in late 2003 not to continue in or
expand this low margin, labor intensive business, which would require
significant increases in base costs to provide turn-key capabilities.
-16-
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
March 31,
2005 2004
------------ ------------
Segment revenues:
Handwriting recognition
Online/retail $ 24 $ 41
Corporate 554 2,352
China 1 5
------------ ------------
Total Handwriting recognition $ 579 $ 2,398
Systems integration
China - 31
------------ ------------
Total revenues $ 579 $ 2,429
------------ ------------
Cost of Sales
Handwriting recognition $ 22 $ 7
Systems integration - 26
------------ ------------
Total cost of sales $ 22 $ 33
------------ ------------
Other operating cost and expenses
Research and development $ 303 $ 319
Sales and Marketing 309 332
General and administrative 509 504
------------ ------------
Total other operating costs and expenses $ 1,121 $ 1,155
------------ ------------
Interest and other income (expense) net $ (524) $ (74)
------------ ------------
Net income (loss) $ (1,088) $ 1,167
============ ============
Amortization of intangible assets
Cost of sales $ 3 $ 3
General and administrative 95 95
------------ ------------
Total amortization of intangible assets $ 98 $ 98
============ ============
Revenues
Handwriting recognition.
Handwriting recognition segment revenues include online/retail, corporate
and China software sales. Handwriting recognition segment revenues decreased
76%, or $1,819, to $579 for the three months ended March 31, 2005, compared to
$2,398 in the prior year period as discussed below.
Online/retail revenues decreased 41%, or $17, to $24 for the three months
ended March 31, 2005, compared to $41 in the prior year period. In early 2003,
PalmSource announced that it had licensed CIC's Jot(R) handwriting recognition
software to replace Graffiti(R) as the standard and only handwriting software on
all new Palm Powered(R) devices. The embedding of Jot on Palm related devices
had a negative impact on the online/retail sales by limiting the number of units
that would be upgraded to older units. The transition to Jot based PalmSource
operating systems by OEM's was completed in the third quarter of 2004 and the
-17-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
Company no longer offers its products through online/retail outlets. CIC has
phased out the consumer offering of its Palm OS products. Jot continues to be
the de facto standard, embedded in the PalmSource OS that is used by many
leading handheld computer and smartphones suppliers. In addition, major device
manufacturers, such as Sony-Ericsson, continue to embed Jot in their products.
These events dramatically reduced the demand for our text entry products sold
directly to end users via retail and online outlets. Corporate revenues, which
includes eSignature and natural input sales, decreased 76%, or $1,798, to $554
for the three months ended March 31, 2005, compared to $2,352 in the prior year
period. Natural input OEM and channel partner sales decreased 19%, or $53, to
$225 for the three months ended March 31, 2005, compared to $278 in the prior
year period. The decrease in natural input channel partner and OEM sales was due
primarily to lower royalties from the shipment by PalmSource of its operating
system containing the Company' Jot software. The Company expects natural input
channel partner and OEM sales to increase in the future as new customers are
identified and new agreements are signed. eSignature sales decreased 84%, or
$1,745, to $329 compared to $2,074 in the prior year period. In the first
quarter ended March 31, 2004, the Company sold $2,000 of its eSignature products
to Wells Fargo Bank. The absence of a similarly large order during the three
months ended March 31, 2005 was the primary reason for the decline. The Company
continues working with other customers that are developing internal applications
that utilize the Company's eSignature products. The Company believes that the
sales of these smaller pilot deployments to large national eSignature customers
will lead to greater sales in future periods as the customers roll out their
applications on a wider scale. 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.
Software sales in China decreased 80%, or $4, to $1 for the three months
ended March 31, 2005, compared to $5 in the prior year. This decline represents
both the impact of delays in rolling out our Joint Venture's channel strategy as
well as the passage of China's E-Sign Law in August of 2004. Achieving
accelerated and sustained sales growth in China by leveraging resellers to
provide China-wide market coverage requires investment in both time and
resources. Training resellers' sales forces and committing the upfront
engineering resources required to embed our eSignature software into partners'
total solutions was anticipated and fundamental to achieving China-wide sales
coverage. The anticipation and final passage of China's E-Sign Law, however,
significantly dampened sales results as both resellers and end user customers
awaited the implications of the law on product functionality. We believe passage
of this law is an overall positive event in that it provides the framework for
product functionality and standards required to accelerate acceptance and growth
for our technology in China. It does, however, require new market validation
studies and considerable engineering effort to localize our newer technologies
to meet the China market requirements. This has led to our current strategy of
identifying and focusing on fewer strategic partners/resellers in
China-specifically, those capable of both market validation and possessing a
high level of engineering competence and effective selling to target market
applications.
Systems Integration.
System integration segment revenue declined 100%, or $31, to $0 for the
three months ended March 31, 2005, compared to $31 in the prior year. The
decline in system integration revenue reflects the decision made in late 2003
not to continue in or expand this low margin, labor intensive business, which
would require significant increases in base costs to provide turn-key
capabilities. The system integration business has become highly competitive with
a low barrier to entry. It is increasingly comprised of small Chinese owned
businesses with virtually no differentiation in service offerings and primarily
competing on price and relationships. Our focus in China is on the emerging high
potential workflow/office automation market leveraging our eSignature technology
and strategic channel partners.
Cost of Sales
Handwriting recognition segment.
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 increased 214%,
or $15, to $22 for the three months ended March 31, 2005, compared to $7 in the
-18-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
prior year. The increase was primarily due to the sale of third party hardware
with the Company's software products and engineering costs associated with
development contract revenue. Cost of sales may vary in the future depending on
the customers decision to purchase its software solution and third party
hardware as a complete package, from the Company, rather than buying individual
components from separate vendors.
Online/retail cost of sales remain insignificant for the three months ended
March 31, 2005 and 2004, respectively. The sales are generated by third party
resellers on their respective web sites and the Company receives a percentage of
each sale. The Company does not anticipate a material increase in costs
associated with the online/retail sales. CIC has phased out the consumer
offering of its Palm OS products. Jot continues to be the de facto standard,
embedded in the PalmSource OS that is used by many leading handheld computer and
smartphones suppliers. In addition, major device manufacturers, such as
Sony-Ericsson, continue to embed Jot in their products. These events
dramatically reduced the demand for our text entry products sold directly to end
users via retail and online outlets.
eSignature and natural input channel partner and OEM cost of sales
increased 200%, or $14, to $21 for the three months ended March 31, 2005,
compared to $7 in the prior year. The increase was due to the higher volume of
third party hardware sales and engineering development costs compared to the
prior year. 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, and engineering costs associated with development contracts and
increased amortization of software development costs capitalized in future
periods associated with enhancements and new product development.
China software cost of sales increased 100%, or $1, to $1 for the three
months ended March 31, 2005, compared to $0 in the prior year. The increase was
due to hardware costs sold with the software solution. It is expected that cost
of sales will remain low for the foreseeable future as the current focus is the
sale of software solutions through channel partners.
Systems Integration.
China Systems integration segment cost of sales decreased 100%, or $26, to
$0 for the three months ended March 31, 2005, compared to $26 in the prior year.
The decrease in costs was due primarily to the reduction in sales during the
three months ended March 31, 2005 as compared to the prior year. The Company
expects that system integration cost of sales will be eliminated in future
periods as the Company had decided not to pursue system integration revenues
beyond 2004, but rather to continue to increase its focus on the emerging high
potential eSignature/office automation market in China.
Operating expenses
Research and Development Expenses. Research and Development expense
decreased 5%, or $16, to $303 for the three months ended March 31, 2005, as
compared to $319 in the prior year period. Engineering expenses consists
primarily of salaries and related costs, outside engineering, maintenance items,
and allocated facilities expenses. Salaries and related expense increased 14%,
or $30, to $249 for the three months ended March 31, 2005, as compared to $219
in the prior year period, due primarily to the increase of two engineers
compared to the prior year period. Outside engineering cost and expenses
increased 100%, or $54, to $54 for the three months ended March 31, 2005,
compared to $0 in the prior year period. The increase was due primarily to the
utilization of outside engineering services to complete several projects
compared to the prior year. The Company maintains a relationship with an outside
engineering group familiar with its products and may draw on their services, as
required, which could have a material effect on the amount of outside
engineering expense reported. Facilities allocation increased 27%, or $15, to
$70 for the three months ended March 31, 2005, compared to $55 in the prior year
period. Increased engineering head count is the primary reason for the increase.
Other engineering expenses decreased 11%, or $5, to $40 for the three months
ended March 31, 2005 as compared to $45 in the prior year period. The decrease
was primarily due to lower maintenance and depreciation expense, compared to the
-19-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
prior year period. Capitalized software development costs increased 100%, or
$99, as compared to $0 in the prior year period. The increase in capitalized
software development was due to new product development and significant upgrades
and enhancements being made to the Company's natural input and eSignature
products. Capitalization of software development costs is expected to be
consistent with the increased amounts for the foreseeable future. Engineering
costs transferred to cost of sales increased 100%, or $11, to $11 for the three
months ended March 31, 2005, compared to $0 in the prior year period. The
increase is due to development services purchased by a customer in the current
period.
Sales and Marketing Expenses. Sales and marketing expenses decreased 7%, or
$23, to $309 for the three months ended March 31, 2005, compared to $332 in the
prior year period. Sales and marketing expenses consists of salaries,
commissions and related expenses, professional services, advertising and
promotion, general office and allocated facilities expenses. Salaries and
related expenses increased 14%, or $16, to $130 for the three months ended March
31, 2005, compared to $114 in the prior year period. The increase in salaries
and related expense was due primarily to the increase of two sales employees
and, to a lesser extent, increases in employee salaries. Recruiting expense
increased 240%, or $48, to $68 for the three months ended March 31, 2005,
compared to $20 in the prior year period. Professional services increased 100%,
or $20, to $20 for the three months ended March 31, 2005, compared to $0 in the
prior year period. The increase is due to the organization of health care focus
groups for the eSignature market. Commission expense decreased 90%, or $103, to
$11 for the three months ended December 31, 2005, compared to $114 in the prior
year period. The decrease in commission expense was due primarily to the
decrease in revenues compared to the prior year. Other expense, including
general office and allocated facilities expenses declined 5%, or $4, to $80 for
the three months ended March 31, 2005, compared to $84 in the prior year period.
The Company anticipates that sales and marketing expenses will continue to
increase in the near term as the Company strengthens its sales efforts through
increasing headcount to pursue new opportunities in the eSignature market space.
The Company continues to pursue a channel strategy for its eSignature products.
The Company believes the channel strategy, along with its current and potential
partners, will produce increasing revenues in the near term.
General and Administrative Expenses. General and administrative expenses
increased 1%, or $5, to $509, for the three months ended March 31, 2005,
compared to $504 in the prior year period. General and administrative expense
consists of salaries, professional fees, investor relations expenses, patent
amortization and office and allocated facilities costs. Salaries and wages
increased 3%, or $6, to $184 for the three months ended March 31, 2005, compared
to $178 in the prior year period. The increase was due primarily to increases in
employee salaries. Professional service expenses, which include consulting,
legal and outside accounting fees, increased 128%, or $77, to $137 for the three
months ended March 31, 2005, compared to $60 in the prior year period. The
increase was due primarily to an increase in legal fees associated with the
infringement litigation incurred by the Company in protecting its patented
intellectual property during the three months ended March 31, 2005, compared to
the prior year. The Company decreased its expense for bad debts 100%, or $6, to
$0 for the three months ended March 31, 2005, compared to $6 in the prior year
period. The decrease was due to adequate coverage at December 31, 2004 for the
slow payment cycle of channel partner receivables of the Joint Venture. At this
time, the Company believes that its provision for bad debts is adequate.
Insurance expense decreased 33%, or $12, to $24 for the three months ended March
31, 2005, compared to $36 in the prior year period. Other administrative
expenses decreased 27%, or $60, to $164 for the year ended December 31, 2004,
compared to $224 in the prior year period. The decrease was due primarily to
spending reductions. The Company believes that its General and Administrative
expenses will remain fairly stable for the near term.
Interest and other income (expense), net
Interest and other income (expense), net increased $2, for the three months
ended March 31, 2005, compared to the same prior year period. The increase was
due to higher cash balances earning interest than in the prior year period.
Interest expense
Interest expense increased 541%, or $449, to $532 for the three months
ended March 31, 2005, compared to $83 in the prior year period. The increase was
primarily due to non-cash charges for the accrual of interest and the
amortization of prepaid financing costs, and warrant and beneficial conversion
feature cost associated with the convertible notes (See Note 7 of the condensed
consolidated financial statements).
-20-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
Liquidity and Capital Resources
At March 31, 2005, cash and cash equivalents totaled $3,853 compared to
cash and cash equivalents of $4,736 at December 31, 2004. The decrease in cash
was primarily due to cash used in operating activities of $766, acquisition of
property and equipment amounting to $14, capitalization of software development
costs of $99 and payments of long term debt and capital lease obligations of $4.
Total current assets were $4,668 at March 31, 2005, compared to $5,469 at
December 31, 2004. As of March 31, 2005, the Company's principal sources of
funds included its cash and cash equivalents aggregating $3,853.
Accounts receivable increased $109 for the three months ended March 31,
2005 compared to the December 31, 2004 balance, due primarily to the increase in
recurring maintenance billings and sales compared to the prior quarter. The
Company expects 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.
Prepaid expenses and other current assets declined by $7 for the three
months ended March 31, 2005, compared to December 31, 2004, due to annual fees
or maintenance and support costs added to prepaids over the three months ended
March 31, 2005 being approximately equal to the quarterly amortization amounts.
Generally, annual insurance premiums and maintenance and support fees are
prepaid in December and June of each year and, therefore, the balances typically
begin to decrease in the first and third quarters as the prepaid balances are
amortized.
Accounts payable increased $12 for the three months ended March 31, 2005,
compared to December 31, 2004, due to increased professional fees for
engineering and recruiting utilized during the quarter. 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 decreased
$54 due to the payment of deferred salaries during the three months ended March
31, 2005, compared to the prior year period.
Current liabilities, which include deferred revenue, were $1,267 at March
31, 2005, compared to $1,401 at December 31, 2004. Deferred revenue, totaling
$304 at March 31, 2005, compared to $458 at December 31, 2004, 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.
In November 2004, the Company entered into an unsecured 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 proceeds to the Company were approximately $3,885, net of $310 in
commissions and legal expenses. H.C. Wainwright & Co., Inc. ("Wainwright") acted
as placement agent. As placement agent for the Company, at closing Wainwright
received $731 in commissions, legal fees and warrants. The commissions of
approximately $285 and legal fees of $25, mentioned above, were paid in cash.
The Company issued warrants to Wainwright to acquire 1,218 shares of the
Company's common stock. Of the warrants issued, 870 are exercisable at $0.462
and 348 are exercisable at $0.508. The Company has ascribed the value of $421 to
the Wainwright warrants, which is recorded as deferred financing costs in the
balance sheet. The fair value ascribed to the Wainwright warrants was estimated
on the commitment date using the Black-Scholes pricing model with the following
assumptions: risk-free interest rate of 3.21%; expected life of 3 years;
expected volatility of 100%; and expected dividend yield of 0%. The Company is
using the proceeds of the financing for working capital purposes.
Under the terms of the financing, the Company 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. The Company has ascribed
a value of $982 to the investor warrants, which is recorded as a discount to
notes payable in the balance sheet. The fair value ascribed to the warrants was
estimated on the commitment date using the Black-Scholes pricing model with the
following assumptions: risk-free interest rate of 3.21%; expected life of 3
years; expected volatility of 100%; and expected dividend yield of 0%. In
-21-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
addition to the fair value ascribed to the warrants, the Company has ascribed
$1,569 to the beneficial conversion feature in the convertible notes, which is
recorded as a discount to notes payable in the balance sheet. The values
ascribed to the warrants and beneficial conversion feature follow the guidance
of the EITF Issue No. 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios",
and ETIF Issue No. 00-27, "Application of Issue No. 98-5 to Certain Convertible
Instruments" of the FASB's Emerging Issues Task Force. The fair value of the
warrants and beneficial conversion feature is amortized to expense over the life
of the convertible notes or upon earlier conversion using the effective interest
method. For the three months ended March 31, 2005, the Company had amortized to
interest expense approximately $532 of the loan discount and deferred financing
costs. The balance due under the convertible notes is shown net of the remaining
unamortized discount on the accompanying consolidated balance sheet. During the
three months ended March 31, 2005, the investors converted $388 of the notes in
exchange for 838 shares of the Company's common stock. If the remaining
aggregate principal amount owing under the notes is converted, the Company will
issue 8,242 shares of its common stock. If the notes are not converted, all
remaining 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.
The above 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. Wainwright
will be paid approximately $28 in the aggregate if all of the investor warrants
are exercised. The Company will receive proceeds of approximately $1,845 if all
of the warrants are exercised.
The Company also was required to file a registration statement providing
for the resale of the shares that are issuable upon the conversion of the notes
and the exercise of the warrants. The registration statement was filed on
December 22, 2004 and was declared effective on January 26, 2005.
We have the following material commitments as of March 31, 2005:
Payments due by periods
-------------------------------------- --------------------------------------------------------------------------
Less than One to Four to After five
Contractual obligations Total One year three years five years years
-------------------------------------- ----------- ----------- ------------- ----------- ------------
Short-term debt related party 8 8 - - -
Short term debt - other 36 36
Long-term debt - related party 3 - 3 - -
Long-term debt (1) 1,723 - 1,723 - -
Operating lease commitments (2) 642 380 262 - -
----------- -- ----------- -- ------------- -- ----------- -- ------------
----------- -- ----------- -- ------------- -- ----------- -- ------------
Total contractual cash obligations $ 2,412 $ 424 $ 1,988 $ - $ -
=========== == =========== == ============= == =========== == ============
1. Long-term debt is net of approximately $2,088 in discounts
representing the fair value of warrants issued to the investors and
the beneficial conversion feature associated with the convertible
notes.
2. The operating lease commenced on November 1, 2002. The cost of the
lease will increase approximately 3% per annum over the term of the
lease, which expires on October 31, 2006.
The Company has suffered recurring losses from operations that raise a
substantial doubt about its ability to continue as a going concern. There
can be no assurance that the Company will 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.
-22-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
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,
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 fourth in
the Company's Annual Report on Form 10-K for the year ended December 31, 2004
and 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 months ended March 31, 2005.
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, 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 4. 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
-23-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except per share amounts)
FORM 10-Q
13a-14(c) as of the end of the period covered by 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.
Part II-Other Information
Item 1. Legal Proceedings
In February of 2005, Valyd, Inc. filed a complaint against the Company
seeking a declaratory judgment that Valyd is not infringing certain of the
Company's patents, that such patents are invalid or unenforceable, and that the
Company tortiously interfered with a contract between Valyd, Inc. and Interlink
Electronics, Inc. by delivering an infringement notice to Interlink Electronics,
Inc. The complaint also alleged unfair competition under California law. No
specific monetary claim is set forth in the complaint. On March 3, 2005, the
Company responded to the complaint, denying all allegations, and filed
counterclaims against Valyd, Inc. The counterclaim asserted that Valyd, Inc. is
infringing certain of the Company's patents and asked for treble damages,
alleging that the infringement is willful, deliberate and in conscious disregard
of CIC's rights. 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
(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.
-24-
Communication Intelligence Corporation
and Subsidiary
(In thousands, except share and 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
May 10, 2005 /s/ Francis V. Dane
- ------------------------------- -----------------------------------------------
Date Francis V. Dane
(Principal Financial Officer and Officer Duly
Authorized to Sign on Behalf of the Registrant)
-25-