Exhibit 99.2
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This annual report on form 10-K contains a number of "forward-looking
statements" within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. Specifically, all statements other than statements of
historical facts included in this annual report regarding our financial
position, business strategy and plans and objectives of management for future
operations are forward-looking statements. These forward-looking statements are
based on the beliefs of management, as well as assumptions made by and
information currently available to management. When used in this Report, the
words "anticipate," "believe," "estimate," "expect," "may," "will," "continue"
and "intend," and words or phrases of similar import, as they relate to our
financial position, business strategy and plans, or objectives of management,
are intended to identify forward-looking statements. These statements reflect
our current view with respect to future events and are subject to risks,
uncertainties and assumptions related to various factors including, without
limitation, those described below the heading "Overview", those described
starting on page 32 of this annual report under the heading "Risk Factors" and
in our registration statements and periodic reports filed with the SEC under the
Securities Act and the Exchange Act.
Although we believe that our expectations are reasonable, we cannot assure
you that our expectations will prove to be correct. Should any one or more of
these risks or uncertainties materialize, or should any underlying assumptions
prove incorrect, actual results may vary materially from those described in this
annual report as anticipated, believed, estimated, expected or intended.
Overview
We are in the e-commerce business-to-business communication services
market providing complete EC infrastructure solutions. Our business operates in
two segments: namely, our ICC.NET service and our Service Bureau.
ICC.NET includes the Company's global Internet-based value added network
or VAN, which uses the Internet and our proprietary technology to deliver our
customers' documents and data files to members of their trading communities,
many of which may have incompatible systems, by translating the documents and
data files into any format required by the receiver. We believe that our ICC.NET
service has significant advantages over traditional VANs, email-based and other
Internet-based software systems, because our service is provided at a low cost,
with greater transmission speed in nearly real-time and offers more features.
Professional Services facilitates the development and operations of
comprehensive business-to-business e-commerce solutions.
Our Service Bureau manages and translates the data of small and mid-sized
companies that exchange EDI data with large companies.
Through July 2000, our business was entirely focused on our ICC.NET
service. During fiscal 2001 we made two acquisitions that enable us to offer a
more complete range of services to allow our customers to expand their
e-commerce trading communities and bridge their legacy systems to the Internet.
In August 2000, we acquired IDC, an EDI service bureau. IDC delivers
business-to-business EDI standards-based documents for companies that do not
have EDI departments.
In November 2000, we acquired RTCI, thereby expanding our professional
services capability. RTCI was an e-commerce infrastructure solutions company
serving the business-to-business e-commerce market. RTCI assists its clients to
conduct business electronically through a continuum of services including
eConsulting, data transformation mapping (EDI, EAI, XML) and internetworking.
RTCI developed a business model that offered remote service delivery, fixed and
value-based pricing and reusable solutions. Subsequent to the acquisition in
fiscal 2001, due to a reduction of the workforce of RTCI, a steep decline in
value of companies similar to RTCI, continued operating losses and a significant
reduction in the forecasted future operating profits of our professional
services reporting unit, management determined that triggering events had
occurred related to certain intangible assets. Projected cash flow analysis
related to those assets determined that the assets had been impaired. These
intangible assets were written down to fair value during the fourth quarter of
2001 based on the related discounted expected future cash flows.
During the fourth quarter of fiscal 2003 the goodwill of the Service
Bureau was tested for impairment due to a significant decline in revenues and
operating income resulting primarily from the bankruptcy of its largest
customer. An impairment loss of $982,142 was recognized as a result of this
evaluation. The fair value of the Service Bureau reporting unit was estimated
using the net present value of expected future cash flows.
Due to a continued decline in its revenues throughout the course of 2002,
continued operating losses and a significant reduction in forecasted future
operating profits, the Professional Services reporting unit was tested for
impairment during the fourth quarter of fiscal 2002. An impairment loss of
$1,710,617 was recognized as a result of this evaluation. The fair value of the
Professional Services reporting unit was estimated using the net present value
of expected future cash flows.
We rely on many of our competitors to interconnect, at reasonable cost,
with our service. We have interconnection arrangements with more than 65
business-to-business networks for the benefit of our customers. Two of the
largest networks, Global eXchange Services ("GXS") and Sterling Commerce, which
we believe to account for approximately 60% of the estimated EDI users,
discontinued their interconnect arrangements with the Company. GXS discontinued
its interconnection with our service in September 2001 and Sterling Commerce
discontinued its interconnection with our service in April 2002. We have entered
into arrangements with Inovis, Inc. (formerly a division of Peregrine Systems,
Inc. and now an idependent company) and IBM Corporation so our customers can
continue to communicate through us with their trading communities. As a result
of these interconnection arrangements, we will continue to incur additional
costs and may lose existing customers if the arrangements we have provided are
inadequate for their business purposes. We believe, however, that the
arrangements we have made satisfy our existing customers.
Critical Accounting Policies and Significant Use of Estimates in Financial
Statements
Critical accounting policies are those policies that require application
of management's most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain and may change in subsequent periods.
The following list of critical accounting policies is not intended to be a
comprehensive list of all of our accounting policies. Our significant accounting
policies are more fully described in note 2 of the notes to the consolidated
financial statements included elsewhere in this annual report on Form 10-K for
the year ended July 31, 2003. In many cases, the accounting treatment of a
particular transaction is specifically dictated by generally accepted accounting
principles with no need for management's judgment in their application. There
are also areas in which management's judgment in selecting any available
alternative would not produce a materially different result. We have identified
the following to be critical accounting policies of the Company:
Revenue Recognition: The Company derives revenue from subscriptions to its
ICC.NET service, which includes transaction, mailbox and fax transmission fees.
The subscription fees are comprised of both fixed and usage-based fees. Fixed
subscription fees are recognized on a pro-rata basis over the subscription
period, generally three to six months. Usage fees are recognized in the period
the services are rendered. The Company also derives revenue through
implementation fees, interconnection fees and by providing data mapping services
to its customers. Implementation fees are recognized over the life of the
subscription period. Interconnection fees are fees charged to connect to another
VAN service and are recognized when the data is transmitted to the connected
service. Revenue from data mapping services is recognized when the map has been
completed and delivered to the customer. The Company has a limited number of
fixed fee data mapping services contracts. Under these arrangements the Company
is required to provide a specified number of maps for a fixed fee. Revenue from
such arrangements is recognized using the percentage-of-completion method of
accounting (see below).
Service Bureau revenue is comprised of EDI services including data
translation services, EDI-to-print and print-to-EDI purchase order and invoice
processing, UPC services including UPC number generation, UPC catalog
maintenance and UPC label printing. The Service Bureau also derives revenue from
licensing software and providing software maintenance and support. Revenue from
EDI services and UPC services is recognized when the
services are provided. The Company accounts for its EDI software license sales
in accordance with the American Institute of Certified Public Accountants'
Statement of Position 97-2, "Software Revenue Recognition," as amended ("SOP
97-2"). Revenue from software licenses is recognized when all of the following
conditions are met: (1) a non-cancelable non-contingent license agreement has
been signed; (2) the software product has been delivered; (3) there are no
material uncertainties regarding customer acceptance; and (4) collection of the
resulting receivable is probable. Revenue from software maintenance and support
contracts is recognized ratably over the life of the contract. The Service
Bureau's software license revenue was not significant in any of the periods
presented.
In addition, SOP 97-2 generally requires that revenue from software
arrangements involving multiple elements be allocated among each element of the
arrangement based on the relative fair values of the elements, such as software
licenses, post contract customer support, installation or training. Furthermore,
SOP 97-2 requires that revenue be recognized as each element is delivered with
no significant performance obligation remaining on the part of the Company. The
Company's multiple element arrangements generally consist of a software license
and post contract support. The Company allocates the aggregate revenue from
multiple element arrangements to each element based on vendor specific objective
evidence. The Company has established vendor specific objective evidence for
each of the elements as it sells both the software and post contract customer
support independent of multiple element agreements. Customers are charged
standard prices for the software and post contract customer support and these
prices do not vary from customer to customer.
If the Company enters into a multiple element agreement for which vendor
specific objective evidence of fair value for each element of the arrangement
does not exist, all revenue from the arrangement is deferred until all elements
of the arrangement are delivered.
Service revenue from maintenance contracts is recognized ratably over the
term of the maintenance contract, on a straight-line basis. Other service
revenue is recognized at the time the service is performed.
The Company also provides a broad range of professional services
consisting primarily of EDI, electronic commerce consulting, EDI education and
training at seminars throughout the United States. Revenue from EDI and
electronic commerce consulting and education and training are recognized when
the services are provided.
Revenue from fixed fee data mapping and professional service contracts is
recognized using the percentage-of-completion method of accounting, as
prescribed by SOP 81-1 "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts."
The percentage of completion for each contract is determined based on the
ratio of direct labor hours incurred to total estimated direct labor hours
required to complete the contract. The Company may periodically encounter
changes in estimated costs and other factors that may lead to a change in the
estimated profitability of a fixed-price contract. In such circumstances,
adjustments to cost and profitability estimates are made in the period in which
the underlying factors requiring such revisions become known. If such revisions
indicate a loss on a contract, the entire loss is recorded at such time. Amounts
billed in advance of services being performed are recorded as deferred revenue.
Certain fixed-fee contracts may have substantive customer acceptance provisions.
The acceptance terms generally include a single review and revision cycle for
each deliverable to incorporate the customer's suggested or required
modifications. Deliverables are considered accepted upon completion of the
review and revision and revenue cycle is recognized upon acceptance.
Goodwill: Goodwill consists of the excess purchase price over the fair
value of identifiable net assets of acquired businesses. The carrying value of
goodwill is evaluated for impairment on an annual basis. Management also reviews
goodwill for impairment whenever events or changes in circumstances indicate
that the carrying amount of goodwill may be impaired. If it is determined that
an impairment in value has occurred, goodwill is written down to its implied
fair value. The Company's reporting units utilized for evaluating the
recoverability of goodwill are the same as its operating segments.
Other Intangible Assets: Other intangible assets are carried at cost less
accumulated amortization. Other intangible assets are amortized on a
straight-line basis over their expected lives, which are estimated to be five
years. The Company did not have any indefinite lived intangible assets other
than goodwill that were not subject to amortization.
Impairment of long-lived assets: Long-lived assets of the Company,
including amortizable intangibles, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset may
not be recoverable. Management also reevaluates the periods of amortization of
long-lived assets to determine whether events and circumstances warrant revised
estimates of useful lives. When such events or changes in circumstances occur,
the Company tests for impairment by comparing the carrying value of the
long-lived asset to the estimated undiscounted future cash flows expected to
result from use of the asset and its eventual disposition. If the sum of the
expected undiscounted future cash flows is less than the carrying amount of the
asset, the Company would recognize an impairment loss. The amount of the
impairment loss will be determined by comparing the carrying value of the
long-lived asset to the present value of the net future operating cash flows to
be generated by the asset.
Stock-based compensation: The Company accounts for stock-based
compensation with its employees using the intrinsic value method in accordance
with the provisions of Account Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees" and complies with the disclosure provisions of SFAS
No. 123, "Accounting for Stock Based Compensation" ("SFAS No. 123"). SFAS No.
123 establishes a fair-value method of accounting for stock-based compensation
plans. Stock-based awards to non-employees are accounted for at fair value in
accordance with SFAS No. 123.Income Taxes: Deferred income taxes are determined
by applying enacted statutory rates in effect at the balance sheet date to the
differences between the tax bases of assets and liabilities and their reported
amounts in the consolidated financial statements. A valuation allowance is
provided based on the weight of available evidence, if it is considered more
likely than not that some portion, or all, of the deferred tax assets will not
be realized.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and reported amounts of revenue and expense
during the reporting period. Actual results could differ from those estimates.
Significant accounting estimates used in the preparation of the Company's
consolidated financial statements include the fair value of equity securities
underlying stock based compensation, the realizability of deferred tax assets,
the carrying value of goodwill, intangible assets and long-lived assets, and
depreciation and amortization. The following discussion reviews items
incorporated into our financial statements for the years ended July 31 2003,
2002 and 2001 that required the use of significant management estimates.
The Company has entered into several transactions involving the issuance
of warrants and options to purchase shares of the Company's class A common stock
to consultants, lenders, warrant holders, placement agents and other business
associates and vendors. The issuance of these securities required management to
estimate their value using the Black-Scholes option-pricing model. The
Black-Scholes option-pricing model requires management to make certain estimates
for values of variables used by the model. Management estimated the values for
stock price volatility, the expected life of the equity instruments and the risk
free rate based on information that was available to management at the time the
Black-Scholes option-pricing calculations were performed. Changes in such
estimates could have a significant impact on the estimated fair value of those
equity instruments.
On May 30, 2003, the Company executed an Accounts Receivable Financing
Agreement ("Financing Agreement") with Silicon Valley Bank ("Bank") with a term
of 1 year. On October 22, 2003, the Company and Silicon Valley Bank amended the
Financing Agreement to extend the term of the agreement to August 31, 2004. In
connection with the Financing Agreement, the Company issued the Bank warrants to
purchase 40,000 shares of the Company's class A common stock. The warrants are
immediately exercisable at an exercise price of $1.39 per share, equal to the
fair market value of the Company's class A common stock on the date of closing
of the Financing Agreement. The warrants are exercisable for a seven-year
period. The value of the warrants in the amount of $34,000 is being amortized
over the life of the Financing Agreement.
On March 10, 2003, the Company issued options to purchase 100,000 shares
of class A common stock to a non-employee member of the board of directors as
compensation for consulting services. The estimated fair value of the options
was determined by management to be $42,000.
The allocation of the proceeds from the sale of the series D preferred
stock and warrants issued in the Company's April 30, 2003 private placement
between the fair value of the series D preferred stock and the fair value
of the detachable warrants required management to estimate the fair value of the
warrants. Management's estimate resulted in a beneficial conversion feature in
the amount of $106,730. The discount was immediately accreted and treated as a
deemed dividend to the holder of the series D preferred as all of the series D
preferred stock was eligible for conversion upon issuance.
In connection with the private placement that closed during April and May
of 2003, the Company incurred fees which were paid by issuing warrants to
purchase 110,680 shares of class A common stock at an exercise price of $1.47
per share. The fair value of the warrants was determined by management to be
$87,800.
In connection with a warrant exchange offer in April 2002, the Company
valued the repriced and newly issued warrants at $461,084 using the
Black-Scholes option-pricing model. This amount has been added to the Company's
net loss to increase the net loss attributable to common stockholders during
fiscal 2002.
In connection with the acquisition of RTCI on November 6, 2000, issued
and outstanding options and warrants to purchase RTCI common stock were
exchanged for options and warrants of ICC, providing the holders the right to
receive, upon exercise, an aggregate of 394,905 shares of ICC class A common
stock and $343,456 of cash. The options and warrants were valued using the
Black-Scholes option-pricing model. The fair value of the vested portion of
the options was included in the purchase price for RTCI.
Goodwill is evaluated for impairment at least annually and whenever events
or circumstances indicate impairment may have occurred. The assessment requires
the comparison of the fair value of each of the Company's reporting units to the
carrying value of its respective net assets, including allocated goodwill. If
the carrying value of the reporting unit exceeds its fair value, the Company
must perform a second test to measure the amount of impairment. The second step
of the goodwill impairment test compares the implied fair value of reporting
unit goodwill with the carrying amount of that goodwill. The Company allocates
the fair value of a reporting unit to all of the assets and liabilities of that
unit as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the price paid to acquire the reporting
unit. The excess of the fair value of a reporting unit over the amounts assigned
to its assets and liabilities is the implied fair value of goodwill. If the
carrying amount of reporting unit goodwill exceeds the implied fair value of
that goodwill, an impairment loss is recognized by the Company in an amount
equal to that excess.
The Company estimates the fair value of its reporting units based on the
net present value of expected future cash flows. The use of this method requires
management to make estimates of the expected future cash flows of the reporting
unit and the Company's weighted average cost of capital. Estimating the
Company's weighted average cost of capital requires management to make estimates
for long-term interest rates, risk premiums, and beta coefficients. Management
estimated these items based on information that was available to management at
the time the Company prepared its estimate of the fair value of the reporting
unit. Changes in either the expected cash flows or the weighted average cost of
capital could have a significant impact on the estimated fair value of the
Company's reporting units.
Impairments of goodwill and acquired intangibles in the amount of
$982,000, $1,711,000 and $16,708,000 were as recorded during the years ended
July 31 2003, 2002 and 2001, respectively. During fiscal 2001, due to a
significant reduction of the workforce of the professional reporting unit, a
steep decline in the value of companies similar to it, continued operating
losses and a significant reduction in the forecasted future operating profits,
management determined that triggering events had occurred related to the certain
acquired intangible assets of the Professional Services reporting unit, namely
its assembled workforce, its customer list and goodwill. The projected cash flow
analysis related to those assets determined that the assets had been impaired.
These intangible assets were written down to fair value based on the discounted
expected future cash flows from the intangible assets over their remaining
estimated useful lives. An impairment loss of $16,708,000 was recognized as a
result of this evaluation. During fiscal 2002, due to a continued decline in its
revenues throughout the course of 2002, continued operating losses and a
significant reduction in forecasted future operating profits, the Professional
Services reporting unit was tested for impairment during the fourth quarter of
fiscal 2002. An impairment loss of $1,711,000 was recognized as a result of this
evaluation. The fair value of the Professional Services reporting unit was
estimated using the net present value of expected future cash flows. During the
fourth quarter of fiscal 2003 the goodwill of the Service Bureau was tested for
impairment due to a significant decline in revenues and operating income
resulting primarily from the bankruptcy of its largest customer. An impairment
loss of $982,142 was recognized as a result of this evaluation. The fair value
of the Service Bureau reporting unit was estimated using the net present value
of expected future cash flows.
Results of Operations and Financial Condition
Fiscal Year Ended July 31, 2003 Compared with Fiscal Year Ended July 31, 2002.
Results of Operations - Consolidated
The following table reflects consolidated operating data by reported
segment. All significant intersegment activity has been eliminated. Accordingly,
the segment results below exclude the effect of transactions with our
subsidiary.
Year Ended
July 31,
--------------------------------
Income (loss) before income taxes: 2003 2002
-------------- ------------
ICC.NET $ (4,872,216) $ (6,552,502)
Service Bureau (1,132,102) 4,949
------------- ------------
Consolidated loss before income taxes $ (6,004,318) $ (6,547,553)
============= ============
Results of Operations - ICC.NET
ICC.NET includes the Company's global Internet-based value added network,
or VAN, which uses the Internet and our proprietary technology to deliver our
customers' documents and data files to members of their trading communities,
many of which may have incompatible systems, by translating the documents and
data files into any format required by the receiver. In addition, ICC.NET
facilitates the development and operation of comprehensive business-to-business
e-commerce solutions. These professional services assist our clients to conduct
business electronically through a continuum of services including eConsulting,
data transformation mapping (EDI, EAI, XML) and internetworking. The following
table summarizes operating results for ICC.NET:
Year Ended
July 31,
------------------------------
2003 2002
------------ ------------
Revenues:
VAN services $ 8,237,525 $ 6,266,277
Mapping services 571,063 1,064,387
Services to Triaton 58,333 105,626
Professional services 1,728,447 2,152,323
Technology license -- 3,000,000
============ ============
10,595,368 12,588,613
Expenses:
Cost of services 6,886,672 7,936,337
Impairment of software inventory 248,092 --
------------ ------------
Total cost of services 7,134,764 7,936,337
Product development and enhancement 975,583 822,314
Selling and marketing 2,899,315 3,376,400
General and administrative 3,955,108 5.337,983
Non-cash charges for stock-based
compensation 139,415 250,008
Impairment of acquired intangibles -- 1,710,617
============ ============
15,104,185 19,433,659
============ ============
Operating loss $ (4,508,817) $ (6,845,046)
Other (expense) income, net (363,399) 292,544
============ ============
Loss before income taxes $ (4,872,216) $ (6,552,502)
============ ============
Revenues - ICC.NET - Revenues from ICC.NET were 88% of our total
consolidated revenues for the fiscal year ended July 31, 2003 ("2003") compared
to 89% for the fiscal year ended July 31, 2002 ("2002"). Total ICC.NET revenue
decreased $1,993,000 in 2003 from 2002, or approximately 16%. VAN and services
to Triaton revenues increased $1,924,000, or approximately 30%, in 2003 from the
prior year. The increase in VAN services revenue is attributable to an increase
in the number of customers to approximately 1,100 in July 2003 from
approximately 600 in July 2002. Approximately 300 of these new customers signed
up for our service during the month of April 2003. Mapping services decreased
$493,000 or approximately 46% in 2003 compared to 2002 primarily due to the
continued slowdown in the economy. Revenue generated from professional services
consists of consulting and educational services. As a result of the continued
slowdown in the economy, which has resulted in a decrease in capital
expenditures for information technology and related services, revenue from our
professional services decreased $424,000 in 2003 from 2002. During 2002, we
recognized technology license revenue of $3,000,000 from Triaton GmbH, a
subsidiary of Thyssen Krupp Information Services, GmbH, for the license of our
ICC.NET service. Under the terms of the July 2002 license agreement, we granted
Triaton a non-exclusive license to use ICC's electronic data interchange system
in its most recent version anywhere in the continent of Europe, Great Britain
and Ireland for a five-year term. Triaton has the right to use and provide the
ICC.NET service to its customers. Triaton paid us $1,500,000 in July 2002 and an
additional $1,500,000 in October 2002 under this license agreement. ICC will not
report any additional revenues under the July 2002 agreement with Triaton,
except that, at Triaton's request, ICC will provide sales support, customer
support and software support on ICC's standard terms and conditions. 2002
included $105,000 of fees from Triaton under a July 2001 agreement.
Cost of services - ICC.NET - Cost of services relating to our ICC.NET was
67% of revenue derived from the ICC.NET service in 2003, compared to 63% of
revenue in 2002. Excluding the impairment of software inventory, the total cost
of services was 65% of revenue in 2003 compared to 63% of revenue in 2002. Cost
of services related to our ICC.NET consists primarily of salaries and employee
benefits, contract labor, connectivity fees, amortization and rent. Cost of
services excluding impairment of software inventory decreased $1,050,000 in 2003
from 2002. Salaries and employee benefits decreased $470,000 primarily due to a
reduction of personnel to 36 at the end of 2003 from 62 at the beginning of
2002. Product development personnel who were temporarily assigned to cost of
services during 2002 represented $278,000 of this decrease. These employees were
used to implement alternative connectivity solutions for the ICC.NET service
when GXS and Sterling disconnected our service from their networks during 2002.
Amortization decreased $246,000 in 2003 compared to 2002 primarily due to
certain capitalized software costs becoming fully amortized during 2002. In
addition, consulting costs decreased $159,000 in 2003 from 2002 due primarily to
decrease in costs associated with technology license revenue from Triaton.
Travel, meals and entertainment decreased $104,000 in 2003 from 2002 due to
lower travel requirements associated with projects. In addition, costs for
rental of space for educational seminars decreased $62,000 in 2003 from 2002 due
to the use of lower cost facilities. However, these savings were partially
offset by increased connectivity costs of $306,000 in 2003 compared to 2002. The
increase in connectivity fees was primarily due to additional fees incurred to
offer our customers and their trading partners alternative connectivity when GXS
and Sterling disconnected our service from their networks during 2002. Cost of
services relating to VAN services decreased to $3,744,000 in 2003 from
$4,009,000 in 2002. Cost of services relating to mapping services decreased to
$1,424,000 in 2003 from $1,683,000 in 2002. Cost of services relating to
services provided to Triaton was $53,000 in 2002 compared to no costs in 2003.
Impairment of software inventory of $248,000 in 2003 represents an impairment
for software inventory held by Professional Services reporting unit resulting
from insufficient historical and projected revenue from these products to
support the recoverability of that carrying value. We anticipate that our
ICC.NET cost of services will decline as a percentage of revenue in future
periods due to increased utilization of our existing communications
infrastructure as we expect the use of our VAN service to increase.
Product development and enhancement - ICC.NET - Product development and
enhancement costs relating to our ICC.NET consist primarily of salaries and
employee benefits. The increase of $153,000 in 2003 over 2002 was primarily
attributable to an increase of $267,000 of costs relating to product development
personnel who had been temporarily assigned to cost of services during 2002. The
personnel were utilized to implement alternative connectivity solutions for our
ICC.NET when GXS and Sterling disconnected our service from their networks
during 2002. The prior year allocation was partially offset by a decrease of
$78,000 in salaries and employee benefits as a result of reduction in staff to 8
at the end of 2003 from 14 at the beginning of 2002. Also, consulting costs
decreased $17,000 in 2003 compared to 2002 due to increased reliance on staff.
Selling and marketing - ICC.NET - Selling and marketing expenses relating
to our ICC.NET consist primarily of salaries and employee benefits, advertising
and trade show costs and travel-related costs. Selling and marketing expenses
related to our ICC.NET service were reduced $477,000 in 2003 from 2002. The
decrease in selling and marketing expenses was primarily attributable to a
decrease in salaries and benefits of $196,000 in 2003. Advertising and trade
show costs were reduced $175,000 because we attended fewer trade shows and
placed fewer print advertisements. In addition, rent, travel and entertainment
and severance decreased $28,000, $26,000 and $21,000, respectively, in 2003 from
2002.
General and administrative - ICC.NET - General and administrative expenses
supporting our ICC.NET consist primarily of salaries and employee benefits,
facility costs, legal and professional fees, depreciation, amortization and
telephone charges. General and administrative costs supporting our ICC.NET
decreased $1,383,000 in 2003. Legal fees decreased $465,000 in 2003 relating to
our disconnection from other VAN's and resolution of a legal matter in 2002.
Rent expense of $393,000 as a result of the renegotiation of our leases. In
addition, salary and benefits decreased $258,000 primarily due to a reduction in
personnel in our professional service reporting unit to 3 at the end of 2003
from 6 at the end of 2002 and 10 at the beginning of 2002. Bad debt expense
decreased $173,000 in 2003 from 2002 due to a decrease in customer defaults from
the prior year. In addition, depreciation and amortization decreased $93,000 in
2003 from 2002 due to assets reaching the end of their depreciable or
amortizable lives. These decreases were partially offset by an increase in
accounting fees of $130,000 in 2003 over 2002 due to services provided in
connection with SEC filings and other matters. For cost reduction purposes, the
Company's executive management, human resources, accounting and finance
functions for
both segments of the Company were centralized and are now performed by ICC.NET
personnel. Commencing in the second fiscal quarter of 2003, ICC.NET began
allocating the costs of executive management, human resources, accounting and
finance tasks to the Service Bureau segment based on the level of services
provided. In 2003, these allocations totaled $135,000.
Non-cash charges - ICC.NET - Non-cash charges decreased $111,000 in 2003
from 2002. In 2003, $60,000 of expense was recognized for common stock and
options issued to a non-employee member of our board of directors as
compensation for consulting services. In addition, expense recognized for common
stock to be issued to non-employee members of our board of directors as
compensation increased $19,000 in 2003 from 2002. Non-cash charges of $190,000
in 2002 consisted of stock-based compensation expense related to assumed
unvested restricted shares issued to RTCI employees in connection with our
acquisition of RTCI.
Other income, net - ICC.NET - Other expenses increased $656,000 in 2003
compared to 2002. An impairment charge of $318,000 was recorded in 2003 for the
write down of available-for-sale marketable securities due to an other than
temporary decline in value. In 2002 other income includes a legal settlement
from a competitor of $63,000 and the favorable settlement of an
acquisition-related liability of $145,000. In addition, net gains from the
disposition of marketable securities decreased $140,000 in 2003 from 2002.
Results of Operations - Service Bureau
Our service bureau manages and translates the data of small and mid-sized
companies that exchange EDI data with large companies and provides various EDI
and UPC (universal product code) services. Our service bureau also licenses EDI
software. The following table summarizes operating results for our service
bureau:
Year Ended
July 31,
----------------------------
2003 2002
----------- -----------
Revenues:
Services $ 1,487,946 $ 1,633,183
Expenses:
Cost of services 735,136 839,217
Impairment of capitalized software 148,479 --
----------- -----------
Total cost of services 883,615 839,217
Product development and enhancement 135,358 154,589
Selling and marketing 135,411 123,100
General and administrative 483,522 511,328
Impairment of acquired intangible 982,142
----------- -----------
2,620,048 1,628,234
----------- -----------
Operating income (loss) (1,132,102) 4,949
----------- -----------
Other income, net -- --
----------- -----------
Income (loss) before income taxes $(1,132,102) $ 4,949
=========== ===========
Revenues - Service Bureau - Revenue related to our service bureau was 12%
of our consolidated revenue in 2003 compared to 11% of consolidated revenue in
2002. The service bureau's revenue was primarily generated from services
performed, customer support and licensing fees. The decrease in revenue of
$145,000 in 2003 compared to 2002 was primarily the result of a decrease in
service revenue of $122,000 due to a large customer ceasing operations.
Cost of services - Service Bureau - Total cost of services relating to our
Service Bureau was 58% of revenue derived from the service bureau in 2003
compared to 51% in 2002. Excluding the impairment of the
capitalized software, costs of services was 49% of revenue derived from the
Service Bureau in 2003 compared to 51% of revenue derived from the Service
Bureau in 2002. Cost of services related to our service bureau consists
primarily of salaries and employee benefits and rent. Cost of services,
excluding the capitalized software impairment charge, decreased $104,000 in
2003. This decrease in cost of services was primarily the result of an $80,000
decrease in the use of consultants for customer service and support and data
entry services and a decrease in salary and benefits of $22,000. Delivery
charges to customers decreased $11,000 in 2003 compared to 2002 due to customers
paying these cost directly to the delivery agent. Cost of services - impairment
of capitalized software of $148,000 in 2003 represents an impairment of
capitalized software for in-process projects that management decided, due to
unfavorable market conditions continuing into the foreseeable future, not to
complete.
Product development and enhancement - Service Bureau - Product development
and enhancement costs consist primarily of salaries and employee benefits and
rent. Product development and enhancement costs incurred by our service bureau
decreased $19,000 in 2003 from 2002. This decrease was primarily attributable to
a decrease in salaries and employee benefits of $16,000 as a result of reduced
staffing to 4 at the end of 2003 from 5 at the beginning of 2002.
Selling and marketing - Service Bureau - Selling and marketing expenses
relating to our service bureau consist primarily of salaries and employee
benefits and rent. Selling and marketing increased $12,000 in 2003 primarily due
to an increase in salaries and employee benefits of $8,000, and a $5,000
severance payment in 2003.
General and administrative - Service Bureau - General and administrative
expenses relating to our service bureau consist primarily of salaries and
employee benefits, depreciation, rent, telephone and office expenses. General
and administrative costs decreased $28,000 in 2003 from 2002. Salaries decreased
$160,000 in 2003 from 2002 as a result of a reduction in staff to 1 at the end
of 2003 from 4 at the end of 2002, and 6 at the beginning of 2002. This was
offset by an increase of $135,000 in general and administrative support staff
salary and benefits allocated by ICC.NET to the Service Bureau in 2003. See
"General and administrative - ICC.NET" above for a discussion of the allocation
of general and administrative expenses among segments.
Impairment of Acquired Intangibles - Service Bureau - During the fourth
quarter of fiscal 2003 the goodwill of the Service Bureau was tested for
impairment due to a significant decline in revenues and operating income
resulting primarily from the bankruptcy of its largest customer. An impairment
loss of $982,142 was recognized as a result of this evaluation. The fair value
of the Service Bureau reporting unit was estimated using the net present value
of expected future cash flows.
Results of Operations and Financial Condition
Fiscal Year Ended July 31, 2002 Compared with Fiscal Year Ended July 31, 2001.
Results of Operations - Consolidated
The following table reflects consolidated operating data by reported
segment. All significant intersegment activity has been eliminated. Accordingly,
the segment results below exclude the effect of transactions with our
subsidiary.
Year Ended
July 31,
-------------------------------
Income (loss) before income taxes: 2002 2001
------------ ------------
ICC.NET $ (6,552,502) $(32,394,191)
Service Bureau 4,949 (391,048)
------------ ------------
Consolidated loss before income taxes $ (6,547,553) $(32,785,239)
============ ============
Results of Operations - ICC.NET
ICC.NET includes the Company's global Internet-based value added network,
or VAN, which uses the Internet and our proprietary technology to deliver our
customers' documents and data files to members of their trading communities,
many of which may have incompatible systems, by translating the documents and
data files into any format required by the receiver. In addition, ICC.NET
facilitates the development and operation of comprehensive business-to-business
e-commerce solutions. These professional services assist our clients to conduct
business electronically through a continuum of services including eConsulting,
data transformation mapping (EDI, EAI, XML) and internetworking. The following
table summarizes operating results for ICC.NET:
Year Ended
July 31,
------------------------------
2002 2001
------------ ------------
Revenues:
VAN services $ 7,330,664 $ 4,690,919
Services to Triaton 105,626 1,068,500
Professional services 2,152,323 2,521,012
Technology license 3,000,000 --
------------ ------------
12,588,613 8,280,431
Expenses:
Cost of services 7,936,337 8,685,819
Product development and enhancement 822,314 625,279
Selling and marketing 3,376,400 5,278,202
General and administrative 5,337,983 8,909,115
Non-cash charges 250,008 991,048
Impairment of acquired intangible 1,710,617 16,708,479
------------ ------------
19,433,659 41,197,942
------------ ------------
Operating loss (6,645,046) $(32,917,511)
------------ ------------
Other income, net 292,544 523,320
------------ ------------
Loss before income taxes $ (6,552,502) $(32,394,191)
============ ============
Revenues - ICC.NET - Revenues from ICC.NET were 89% of our total
consolidated revenues for the fiscal year ended July 31, 2002 ("2002"). ICC.NET
revenues increased $4,308,000 in 2002 from the fiscal year ended July 31, 2001
("2001"). VAN revenues increased $2,640,000 in 2002, or 56% from the prior year.
ICC.NET revenue included $1,064,000 attributable to mapping and XML services in
2002 as compared to $913,000 in 2001. This increase is the result of a larger
customer base and increased volume. Services to Triaton decreased from
$1,069,000 under the original agreement in 2001 to $106,000 in 2002. Revenues
from professional services consist of consulting and educational services. As a
result of the continuing economic slowdown, revenues from professional services
decreased $369,000 in 2002 from 2001 for consulting services primarily as a
result of a reduced number of consulting projects. During 2002, we recognized
technology license revenue of $3,000,000 from Triaton for the license of ICC.NET
.. Under the terms of the July 2002 license agreement, we granted Triaton a
non-exclusive license to use ICC's electronic data interchange system in its
most recent version anywhere in the continent of Europe, Great Britain and
Ireland for a five-year term. Triaton has the right to provide and use the
ICC.NET service to its customers. Triaton paid us $1,500,000 in July 2002 and an
additional $1,500,000 in October 2002 under this license agreement. ICC will not
report any additional revenues under the amended agreement with Triaton, except
that, at Triaton's request, ICC will provide sales support, customer support and
software support on ICC's standard terms and conditions.
Cost of services - ICC.NET - Cost of services relating to ICC.NET was 63%
of revenues derived from the service in 2002, compared to 105% of revenues
derived from the service in 2001. These costs consist primarily of salaries and
employee benefits, data lines, consultants, travel related expenses,
amortization and off-site facilities. ICC.NET cost of services included
$1,683,000 attributable to mapping and XML services in 2002 as compared to
$1,905,000 in 2001. Cost of services decreased $750,000 in 2002 from the prior
year. We reduced our cost of services personnel to 41 at the end of 2002 from 62
at the end of 2001 and as a result we were able to reduce salaries and employee
benefits by $679,000. The reduction in the number of employees did not affect
the quality or reliability of our service. Amortization expense decreased
$472,000 from the prior year. As required by FAS 142, we reclassified the
workforce intangible from other intangible assets to goodwill and as a result,
no such amortization charge was incurred in 2002. In addition, facility-related
costs and computer equipment rentals decreased $170,000 in 2002 compared to the
prior year. Connectivity fees are those costs that we incur to transmit data
electronically. These fees include charges from other VANs and charges from
Internet service providers. Total connectivity fees increased $370,000 in 2002.
The increase in connectivity fees was primarily due to additional fees incurred
to offer our customers and their trading partners alternate connectivity as a
result of GXS and Sterling disconnecting our service from their networks. In
addition, amortization expense relating to mapping technology increased $239,000
in 2002. This was primarily due to the acquisition of RTCI. Because the
acquisition took place at the beginning of the second quarter of 2001, only nine
months of mapping technology amortization was recognized in 2001 compared to
twelve months of amortization recognized in 2002. We anticipate that our ICC.NET
cost of services will continue to decline as a percentage of revenues in future
periods due to increased utilization of our existing infrastructure as we expect
the use of our ICC.NET service to increase.
Product development and enhancement - ICC.NET - Product development and
enhancement costs relating to ICC.NET consist primarily of salaries and employee
benefits. The increase of $197,000 in 2002 from 2001 was primarily caused by an
increase in salaries and employee benefits of $317,000 partially offset by
reductions in facility-related costs of $72,000, travel expenses which were
reduced $22,000 and computer equipment rental costs which were reduced $27,000.
These reductions were the result of our cost reduction measures.
Selling and marketing - ICC.NET - Selling and marketing expenses relating
to ICC.NET consist primarily of salaries and employee benefits, advertising,
trade shows, travel-related costs and amortization. Selling and marketing
expenses related to our ICC.NET were reduced $1,902,000 in 2002 from 2001.
Salaries and employee benefits related to ICC.NET decreased $723,000, primarily
due to the elimination of our telesales force. Consulting and professional fees
were reduced $275,000, advertising and trade show expenses were reduced
$233,000, rent and facility-related costs were reduced $157,000 and
travel-related costs were reduced $141,000--all as a result of our cost
reduction measures. In addition, as part of our cost reduction measures, our
professional service reporting unit reduced travel-related expenses, tradeshow
fees, advertising expenses and office expenses by $272,000 in 2002 compared to
the prior year. Amortization expense for the acquired customer list was no
longer recognized during 2002 as an impairment charge for the full carrying
value of this asset was recognized in the fourth quarter of 2001. This resulted
in a decrease of $61,000 in amortization expense in 2002 from 2001.
General and administrative - ICC.NET - General and administrative expenses
supporting ICC.NET consist primarily of salaries and employee benefits, rent,
depreciation, telephone, insurance, amortization and consulting and professional
fees. General and administrative expenses supporting ICC.NET decreased
$3,571,000 in 2002 from the prior year. Salaries and related employee benefits
decreased $1,474,000 in 2002 due to a reduction in workforce. Amortization and
depreciation decreased $1,005,000, primarily as a result of the Company's
implementation of SFAS No. 142, effective August 1, 2001, which requires
goodwill to be tested for impairment on a periodic basis and no longer permits
amortization of goodwill. Consulting and professional fees decreased $643,000 in
2002 primarily as a result of the termination of a consulting contract with a
former officer of the Company that was recognized in 2001. Severance payments of
$448,000, primarily due to the termination of an officer, were included in 2001.
In addition, recruiting fees decreased $137,000. These decreases were offset by
a lease abandonment charge of $193,000 in 2002.
Non-cash charges - ICC.NET - During 2002, the non-employee members of our
Board of Directors received class A common stock with a value of $60,000 as
compensation for their services. No such compensation was paid in 2001. In March
2000, ICC granted an option to purchase 100,000 shares of class A common stock
pursuant to a consulting agreement with a former executive officer and board
member of ICC. Non-cash consulting charges for this stock option amounted to
$450,000 in 2001. No such charges were incurred in 2002. Non-cash charges in
2002 consisted of $190,000 of stock-based compensation expenses related to
172,907 unvested restricted shares issued to RTCI employees in connection with
our acquisition of RTCI. The value of the restricted shares was amortized from
the date of acquisition through January 1, 2002. During 2001, our professional
service reporting unit recognized $541,000 of stock based compensation expense
related to these restricted shares.
Other income, net - ICC.NET - Other income supporting ICC.NET decreased
$231,000 in 2002 from the prior year. Interest and investment income decreased
$364,000 in 2002 compared to 2001 as the result of lower average cash balances
and interest rates compared to the prior year. This was partially offset by
other non-operating income of $208,000 during 2002. This includes a legal
settlement from a competitor of $63,000 and the favorable settlement of an
acquisition liability of $145,000. No such settlements were recorded in 2001.
Impairment of Acquired Intangibles -ICC.NET - During 2001, our
professional services reporting unit recorded an impairment charge of
$16,708,000 related to the intangibles acquired from RTCI. Due to a significant
reduction of the workforce in the professional services reporting unit, a steep
decline in the value of similar companies, continued operating losses and a
significant reduction in forecasted operating profits, management determined
that a triggering event related to certain acquired intangible assets of the
professional services reporting unit had occurred, namely the assembled
workforce, the customer list and goodwill. Projected cash flow analysis related
to these assets determined that their value had been impaired. These intangible
assets were written down in 2001 to fair value based on the related discounted
expected future cash flows from the intangible assets. During 2002 management
once again determined that triggering events had occurred related to goodwill.
The carrying value of goodwill was reevaluated for impairment and an impairment
charge of $1,711,000 was recognized in 2002.
Results of Operations - Service Bureau
Our service bureau manages and translates the data of small and mid-sized
companies that exchange EDI data with large companies and provides various EDI
and UPC (universal product code) services. Our service bureau also licenses EDI
software. The following table summarizes operating results for our service
bureau:
Year Ended
July 31,
---------------------------
2002 2001
----------- -----------
Revenues:
Services $ 1,633,183 $ 1,462,088
Expenses:
Cost of services 839,217 668,535
Product development and enhancement 154,589 305,750
Selling and marketing 123,100 105,382
General and administrative 511,328 773,469
----------- -----------
1,628,234 1,853,136
----------- -----------
Operating income (loss) 4,949 (391,048)
----------- -----------
Other income, net -- --
----------- -----------
Income (loss) before income taxes $ 4,949 $ (391,048)
=========== ===========
Revenues - Service Bureau - Revenues of our service bureau were 11% of our
consolidated revenues for 2002. The service bureau's revenues were primarily
generated from services performed, customer support and licensing fees. The
increase in revenues of $171,000 in 2002 as compared to 2001 was primarily the
result of an increased demand for barcode label printing from existing
customers. Cost of services - Service Bureau - Cost of services relating to our
service bureau was 51% of revenues of the service bureau in 2002, compared to
46% of revenues in 2001. These costs consist primarily of salaries and employee
benefits, data lines, rent and consultants. Salary and benefits increased by
$112,000 in 2002 from 2001, primarily as a result of an increase in staff.
Facilities related costs increased $29,000 and consulting expenses increased
$10,000 from the prior year.
Product development and enhancement - Service Bureau - Product development
and enhancement costs relating to our service bureau consist primarily of
salaries and employee benefits and rent. Product development and enhancement
costs incurred by our service bureau decreased $151,000 in 2002 from 2001. The
decrease was primarily attributable to capitalized labor costs for newly
developed software in the amount of $92,000. Consulting fees were also reduced
by $52,000.
Selling and marketing - Service Bureau - Selling and marketing expenses
relating to our service bureau consist primarily of salaries and employee
benefits and rent, which increased $18,000 in 2002.
General and administrative - Service Bureau - General and administrative
expenses supporting our service bureau consist primarily of salaries and
employee benefits, depreciation, amortization, rent, telephone and office
expenses. Amortization decreased $241,000 in 2002 as compared to 2001, primarily
as a result of the Company's implementation of SFAS No. 142, effective August 1,
2001, which requires goodwill to be tested for impairment on a periodic basis
and no longer permits the amortization of goodwill.