UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ________ to ________.
Commission file number 000-27941
Imergent, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 87-0591719
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
754 E. Technology Avenue
Orem, Utah 84097
---------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(801) 227-0004
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the proceeding 12 months and (2) has been subject to such filing requirements
for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer as defined
in rule 12b-2 of the Exchange Act. Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock as of
February 10, 2004 was 11,475,519
When we refer in this Form 10-Q to "Imergent," the "Company," "we,"
"our," and "us," we mean Imergent, Inc., a Delaware corporation, together with
our subsidiaries and their respective predecessors.
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets at December 31, 2003
(unaudited) and at June 30, 2003.........................................3
Unaudited Condensed Consolidated Statements of Operations for the
three months and the six months ended December 31, 2003 and 2002.........4
Unaudited Condensed Consolidated Statement of Stockholders'
Equity for the six months ended December 31, 2003........................5
Unaudited Condensed Consolidated Statements of Cash Flows for the
six months ended December 31, 2003 and 2002..............................6
Notes to Unaudited Condensed Consolidated Financial Statements..............7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
General....................................................................16
Critical Accounting Policies and Estimates.................................16
Related Party Transactions.................................................19
Results of Operations......................................................20
Liquidity and Capital Resources............................................26
Item 3. Quantitative and Qualitative Disclosures about Market Risk........28
Item 4. Controls and Procedures...........................................29
Part II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................29
Item 2. Changes in Securities and Use of Proceeds.........................30
Item 3. Defaults Upon Senior Securities...................................31
Item 4. Submission of Matters to a Vote of Security Holders...............31
Item 5. Other Information.................................................32
Item 6. Exhibits and Reports on Form 8-K..................................32
Signatures.................................................................33
2
IMERGENT, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
December 31, 2003 June 30, 2003
----------------- -------------
(Unaudited)
Assets
Current assets
- --------------
Cash $ 2,700,583 $ 2,319,618
Trade receivables, net of allowance for doubtful accounts of $6,146,249 at
December 31, 2003 and $4,471,667 at June 30, 2003 7,247,042 4,965,769
Other receivables - 50,000
Inventories 59,066 34,194
Prepaid expenses 526,142 687,984
Credit card reserves, net of allowance for doubtful accounts of $62,266 at
December 31, 2003 and $319,812 at June 30, 2003 465,391 450,200
------------ ------------
Total current assets 10,998,224 8,507,765
Property and equipment, net 162,727 200,174
Goodwill, net 455,177 455,177
Trade receivables, net of allowance for doubtful accounts of $2,989,021 at
December 31, 2003 and $2,131,593 at June 30, 2003 3,395,301 2,254,969
Other assets, net of allowance for doubtful accounts of $168,691 at
December 31, 2003 and $100,783 at June 30, 2003 206,690 103,460
------------ ------------
Total Assets $ 15,218,119 $ 11,521,545
============ ============
Liabilities and Stockholders' Equity
Current liabilities
- -------------------
Accounts payable $ 1,628,590 $ 1,413,112
Accounts payable - related party - 114,925
Accrued wages and benefits 404,312 411,620
Accrued liabilities 362,812 204,137
Current portion of capital lease obligations 11,171 26,536
Current portion of notes payable - 121,206
Other current liabilities 53,392 35,840
Deferred revenue 173,986 653,463
------------ ------------
Total current liabilities 2,634,263 2,980,839
Capital lease obligations, net of current portion 1,802 1,802
Notes payable, net of current portion 400,000 435,857
------------ ------------
Total liabilities 3,036,065 3,418,498
------------ ------------
Commitments and contingencies
Stockholders' equity
Capital stock, par value $.001 per share
Preferred stock - authorized 5,000,000 shares; none issued
Common stock - authorized 100,000,000 shares; issued and outstanding
11,321,915 and 11,062,290 shares, at December 31, 2003 and
June 30, 2003, respectively 11,322 11,063
Additional paid-in capital 73,060,423 72,605,749
Deferred compensation (16,219) (22,474)
Accumulated other comprehensive loss (4,902) (4,902)
Accumulated deficit (60,868,570) (64,486,389)
------------ ------------
Total stockholders' equity 12,182,054 8,103,047
------------ ------------
Total liabilities and stockholders' equity $ 15,218,119 $ 11,521,545
============ ============
The accompanying notes are an integral part of these financial statements.
3
IMERGENT, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Operations for the
Three Months and the Six Months Ended December 31, 2003 and 2002
Three Months Ended Six Months Ended
----------------------------------- ----------------------------------
December 31, December 31, December 31, December 31,
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
Revenue $ 19,827,058 $ 10,588,680 $ 40,372,194 $ 21,872,529
Cost of revenue 4,545,780 2,138,021 8,907,482 4,175,874
Cost of revenue - related party - 164,936 - 585,517
------------ ------------ ------------ ------------
Total cost of revenue 4,545,780 2,302,957 8,907,482 4,761,391
------------ ------------ ------------ ------------
Gross profit 15,281,278 8,285,723 31,464,712 17,111,138
Operating expenses
Research and development 86,036 - 162,729 -
Selling and marketing 6,704,292 3,601,993 12,850,729 7,983,605
Selling and marketing - related party - 55,608 - 195,343
General and administrative 2,256,990 1,033,681 4,091,958 1,968,099
Depreciation and amortization 24,448 103,886 51,872 252,303
Bad debt expense 5,142,851 2,916,827 11,363,085 5,204,560
------------ ------------ ------------ ------------
Total operating expenses 14,214,617 7,711,995 28,520,373 15,603,910
Earnings from operations 1,066,661 573,728 2,944,339 1,507,228
Other income (expense)
Other income (expense), net 42,318 (1,006) 43,288 699
Interest income 366,513 174,284 641,756 331,216
Interest expense (9,755) (6,664) (11,565) (15,652)
------------ ------------ ------------ ------------
Total other income (expense) 399,076 166,614 673,479 316,263
------------ ------------ ------------ ------------
Earnings before income taxes 1,465,737 740,342 3,617,818 1,823,491
Provision for income taxes - - - -
------------ ------------ ------------ ------------
Net earnings $ 1,465,737 $ 740,342 $ 3,617,818 $ 1,823,491
============ ============ ============ ============
Basic earnings per share:
Basic $ 0.13 $ 0.07 $ 0.32 $ 0.17
Diluted $ 0.12 $ 0.07 $ 0.30 $ 0.16
Weighted average shares outstanding:
Basic 11,306,384 11,007,221 1,228,705 11,001,417
Diluted 12,275,356 11,208,171 12,189,052 11,119,593
The accompanying notes are an integral part of these financial statements.
4
IMERGENT, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statement of Stockholders' Equity
For The Six Months ended December 31, 2003
Accumulated
Other
Common Stock Additional Deferred Compre- Total
--------------------- Paid-in Compen- Accumulated hensive Stockholders'
Shares Amount Capital sation Deficit loss Equity
---------- -------- ------------ --------- ------------- -------- -----------
Balance July 1, 2003 11,062,290 $ 11,063 $ 72,605,749 $ (22,474) $ (64,486,389) $ (4,902) $ 8,103,047
---------- -------- ------------ --------- ------------- -------- -----------
Amortization of deferred compensation 6,255 6,255
Expense for options granted to consultants 193,335 193,335
Common stock issued for payment of interest 9,853 10 61,272 61,282
Common stock issued upon exercise of options
and warrants 249,772 250 200,066 200,316
Net earnings 3,617,818 3,617,818
---------- -------- ------------ --------- ------------- -------- -----------
Balance December 31, 2003 11,321,915 $ 11,322 $ 73,060,423 $ (16,219) $ (60,868,570) $ (4,902) $ 12,182,054
========== ======== ============ ========= ============= ======== ===========
The accompanying notes are an integral part of these financial statements.
5
IMERGENT, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
For the Six Months Ended December 31, 2003 and 2002
2003 2002
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Earnings $ 3,617,818 $ 1,823,491
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities
Depreciation and amortization 51,871 252,303
Amortization of deferred compensation 6,255 6,255
Common stock issued for services - 25,342
Expense for stock options granted to consultants 193,335 -
Provision for bad debts 11,363,085 5,204,560
Changes in assets and liabilities
Trade receivables (14,451,624) (6,137,577)
Inventories (24,872) (20,396)
Prepaid expenses 161,842 (98,986)
Credit card reserves (298,258) 9,248
Other assets (103,230) 208,887
Deferred revenue (479,477) (305,491)
Accounts payable - related party - (54,338)
Accounts payable, accrued expenses and other liabilities 330,756 (462,167)
------------- -------------
Net cash provided by (used in) operating activities 367,501 451,131
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of property and equipment (14,424) (50,891)
------------- -------------
Net cash used in investing activities (14,424) (50,891)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of options and warrants 200,316 -
Bank overdraft borrowings - (133,179)
Repayment of capital lease obligations (15,365) (57,913)
Repayment of notes payable (157,063) (124,143)
------------- -------------
Net cash provided by (used in) financing activities 27,888 (315,235)
------------- -------------
NET INCREASE (DECREASE) IN CASH 380,965 85,005
CASH AT THE BEGINNING OF THE QUARTER 2,319,618 519,748
------------- -------------
CASH AT THE END OF THE QUARTER $ 2,700,583 $ 604,753
============= =============
Supplemental disclosures of non-cash transactions:
Common stock issued for outstanding liabilities $ 61,282 $ 15,000
Accrued interest added to note payable balance - 17,541
Supplemental disclosure of cash flow information
Cash paid for interest - -
The accompanying notes are an integral part of these financial statements.
6
IMERGENT, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
December 31, 2003 and 2002
(1) Description of Business and Basis of Presentation
Imergent, Inc. (the "Company"), was incorporated as a Nevada corporation on
April 13, 1995. In November 1999, it was reincorporated under the laws of
Delaware. Effective July 3, 2002, a Certificate of Amendment was filed to its
Certificate of Incorporation to change its name to Imergent, Inc. from
Netgateway, Inc. Imergent is an e-Services company that provides eCommerce
technology, training and a variety of web-based technology and resources to
nearly 150,000 small businesses and entrepreneurs annually. The Company's
affordably priced e-Services offerings leverage industry and client practices,
and help increase the predictability of success for Internet merchants. The
Company's services also help decrease the risks associated with e-commerce
implementation by providing low-cost, scalable solutions with minimal lead-time,
ongoing industry updates and support. The Company's strategic vision is to
remain an eCommerce provider tightly focused on its target market.
The unaudited consolidated condensed financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America (US GAAP) and pursuant to the rules and regulations of the Securities
and Exchange Commission (SEC) for interim financial statements and do not
include all annual disclosures required by GAAP. These financial statements
should be read in conjunction with the audited Consolidated Financial Statements
and notes thereto included in Form 10-K for the fiscal year ended June 30, 2003.
These unaudited consolidated condensed financial statements, in the opinion of
management, include all adjustments necessary to present fairly the financial
position of the Company as of December 31, 2003 and the consolidated results of
operations, stockholders equity, and cash flows of the Company for the periods
presented. The results for the three and six months ended December 31, 2003 are
not necessarily indicative of results to be expected for the full fiscal year
2004 or any other future periods.
(2) Summary of Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, which include Netgateway, Galaxy Enterprises,
Inc., Galaxy Mall, Inc., StoresOnline Inc., StoresOnline, LTD., and
StoresOnline.com, Inc. All significant inter-company balances and transactions
have been eliminated in consolidation.
(b) Cash and Cash Equivalents
Highly liquid investments with original maturities of three months or less when
purchased are considered cash equivalents. The carrying amounts reported in the
consolidated balance sheets for these instruments approximate their fair value.
(c) Accounts Receivable and Allowances
The Company offers to its customers the option to finance, through Extended
Payment Term Arrangements (EPTAs), purchases made at the Internet training
workshops. A significant portion of these EPTAs, are then sold, on a discounted
basis, to third party financial institutions for cash. The remainder of the
EPTAs (those not sold to third parties) is retained as short term and long term
Accounts Receivable on the Company's consolidated balance sheet.
For all EPTA contracts the Company records an allowance for doubtful accounts,
at the time the EPTA contract is perfected. The allowances represent estimated
losses resulting from the customers' failure to make required payments. The
allowances for EPTAs retained by the Company are netted against the current and
long term accounts receivable balances on the consolidated balance sheets, and
the associated expense is recorded as bad debt expense in operating expenses.
7
EPTAs retained by the Company are charged off against the allowance when the
customers involved are no longer making required payments and the EPTAs are
determined to be uncollectible. Interest accrued is discontinued and written off
when an EPTA becomes delinquent.
EPTAs sold to third party financial institutions are generally subject to
recourse by the purchasing finance company after an EPTA is determined to be
uncollectible. The Company also provides an allowance for EPTAs estimated to be
recoursed back to the Company.
All allowance estimates are based on historical bad debt write-offs, specific
identification of probable bad debts based on collection efforts, aging of
accounts receivable and other known factors. If allowances become inadequate
additional allowances may be required.
(d) Transfers of Financial Assets
Transfers of financial assets are accounted for as having been transferred, when
control over the assets has been surrendered. Control over transferred assets is
deemed to be surrendered when (1) the assets have been isolated from the
Company, (2) the transferee obtains the right (free of conditions that constrain
it from taking advantage of the right) to pledge or exchange the transferred
assets, and (3) the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their
maturity.
(e) Goodwill and Intangible Assets
As required by Statement of Financial Accounting Standards ("SFAS") 142,
beginning on July 1, 2002 goodwill is no longer amortized but is tested on an
annual basis for impairment by comparing its fair value to its carrying value.
If the carrying amount of goodwill exceeds its fair value, an impairment loss
will be recognized in an amount equal to that excess.
(f) Financial Instruments
The carrying values of cash, trade-receivables, accounts payable, accrued
liabilities, capital lease obligations, and notes payable approximated fair
value due to either the short maturity of the instruments or the recent date of
the initial transaction.
(g) Income Taxes
The Company utilizes the liability method of accounting for income taxes. Under
the liability method, deferred income tax assets and liabilities are provided
based on the difference between the financial statement and tax bases of assets
and liabilities as measured by the currently enacted tax rates in effect for the
years in which these differences are expected to reverse. Deferred tax expense
or benefit is the result of changes in deferred tax assets and liabilities. An
allowance against deferred tax assets is recorded in whole or in part when it is
more likely than not that such tax benefits will not be realized.
Deferred tax assets are recognized for temporary differences that will result in
tax-deductible amounts in future years and for tax carryforwards if, in the
opinion of management, it is more likely than not that the deferred tax assets
will be realized. Deferred tax assets consist primarily of net operating losses
carried forward. The Company has provided a valuation allowance against all of
its net deferred tax assets at December 31, 2003 and at June 30, 2003. Fiscal
year 2002 was the first profitable year for the Company since its inception.
However, differences between accounting principles generally accepted in the
United States of America ("US GAAP") and accounting for tax purposes caused the
Company to have a tax loss for the fiscal year ended June 30, 2002. For the year
ended June 30, 2003 the Company had taxable income of approximately $8.2
million. Taxable income for the six-months ended December 31, 2003 is estimated
to be approximately $5.0 million.
The Company's net operating loss carry forward ("NOL"), which is approximately
$43 million, represents the losses reported for income tax purposes from the
inception of the Company through June 30, 2002. Fiscal year 2003 was the first
year in the Company's history that generated taxable income. Section 382 of the
Internal Revenue Code ("Section 382") imposes limitations on a corporation's
ability to utilize its NOLs if it experiences an "ownership change". In general
8
terms, an ownership change results from transactions increasing the ownership of
certain stockholders in the stock of a corporation by more than 50 percentage
points over a three-year period. Since our formation, we have issued a
significant number of shares, and purchasers of those shares have sold some of
them, with the result that two changes of control as defined by Section 382 have
occurred. As a result of the most recent ownership change, utilization of the
Company's NOLs is subject to an annual limitation under Section 382 determined
by multiplying the value of its stock at the time of the ownership change by the
applicable long-term tax-exempt rate resulting in an annual limitation amount of
approximately $127,000. Any unused annual limitation may be carried over to
later years, and the amount of the limitation may under certain circumstances be
increased by the "recognized built-in gains" that occur during the five-year
period after the ownership change (the "recognition period"). The Company
believes that it will have significant recognized built-in gains and that during
the recognition period the limitation will be increased by approximately $15
million based on an independent valuation of the Company as of April 3, 2002.
The Company also believes that based on a valuation of the Company as of June
25, 2000, which is currently underway, the earlier ownership change will also
have significant recognized built-in gains and that during the recognition
period the limitation will be further increased by approximately $28 million
thus allowing the Company to utilize its entire NOL. Therefore, no provision for
income taxes has been established in the Statement of Operations for the
three-month and the six-month periods ended December 31, 2003 and 2002.
Significant management judgment was required in estimating the amount of the
recognized built in gain. If it is determined that the actual amount of
recognized built in gain is less than our estimate, the Company may be required
to make a cash payment for taxes due on its income for fiscal year 2004, plus
related interest, which could materially adversely impact the Company's
financial position.
(h) Accounting for Stock Options and Warrants
The Company applies the intrinsic value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations, in accounting for its fixed plan
employee stock options. As such, compensation expense would be recorded on the
date of grant only if the current market price of the underlying stock exceeded
the exercise price. Compensation expense related to stock options granted to
non-employees is accounted for under Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation," whereby compensation
expense is recognized over the vesting period based on the fair value of the
options on the date of grant. The Company had options outstanding of 1,274,397
as of December 31, 2003 and 1,193,528 as of June 30, 2003, with varying prices
between $1.50 and $113.10 per share.
The Company had 400,479 warrants outstanding as of December 31, 2003 and 631,460
warrants outstanding as of June 30, 2003 with varying strike prices between $.40
and $115.50 per share and expiration dates between February 22, 2004 and April
9, 2008.
(i) Stock-Based Compensation
The Company has applied the disclosure provisions of Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure -- An Amendment of FASB Statement No. 123," for the
three months and the six months ended December 31, 2003 and 2002. Issued in
December 2002, SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation" to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based
compensation. In addition, this Statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. As permitted
by SFAS No. 148, the Company continues to account for stock options under APB
Opinion No. 25, under which no compensation has been recognized. The following
table illustrates the effect on net earnings and earnings per share for the
three and six months ended December 31, 2003 and 2002, respectively, if the
Company had applied the fair value recognition provisions of SFAS No. 123, as
amended by SFAS No. 148 to stock-based compensation:
9
Three Months Ended Six Months Ended
------------------------------ ------------------------------
December 31, December 31, December 31, December 31,
2003 2002 2003 2002
------------------------------ ------------------------------
Net earnings as reported $ 1,465,737 $ 740,342 $ 3,617,818 $ 1,823,491
Net earnings proforma $ 1,320,055 $ 728,853 $ 3,376,950 $ 1,800,513
Net earnings per share as reported:
Basic $ 0.13 $ 0.07 $ 0.32 $ 0.17
Diluted $ 0.12 $ 0.07 $ 0.30 $ 0.16
Net earnings per share pro forma:
Basic $ 0.12 $ 0.07 $ 0.30 $ 0.16
Diluted $ 0.11 $ 0.07 $ 0.28 $ 0.16
The Company estimates the fair value of each option grant on the date of each
option grant using the Black-Scholes option-pricing model. Option pricing models
require the input of highly subjective assumptions including the expected stock
price volatility. Also, the Company's employee stock options have
characteristics significantly different from those of traded options including
long-vesting schedules and changes in the subjective input assumptions that can
materially affect the fair value estimate. The Company used the historical
volatility of common stock, as well as other relevant factors in accordance with
SFAS 123, to estimate the expected volatility assumptions. Management believes
the best assumptions available were used to value the options and the resulting
option values were reasonable as of the date of the grant. Pro Forma information
should be read in conjunction with the related historical information and is not
necessarily indicative of the results that would have been attained had the
transaction actually taken place.
(j) Revenue Recognition
On October 1, 2000, the Company started selling a license to use a new product
called the StoresOnline Software ("SOS"). The SOS is a web based software
product that enables the customer to develop their Internet website without
additional assistance from the Company. When a customer purchases a SOS license
at one of the Company's Internet workshops, he or she receives a CD-ROM
containing programs to be used with their computer and a password and
instructions that allow access to the Company's website where all the necessary
tools are located to complete the construction of the customer's website. When
completed, the website can be hosted with the Company or any other provider of
such services. If they choose to host with the Company there is an additional
setup and hosting fee (currently $150) for publishing and 12 months of hosting.
This fee is deferred at the time it is paid and recognized during the subsequent
12 months. A separate file is available and can be used if the customer decides
to create their website on their own completely without access to the Company
website and host their site with another hosting service.
The revenue from the sale of the SOS license is recognized when the product is
delivered to the customer and the three-day rescission period expires. The
Company accepts cash and credit cards as methods of payment and the Company
offers 24-month installment contracts to customers who prefer an Extended
Payment Term Arrangement (EPTA). The Company offers these contracts to all
workshop attendees not wishing to use a check or credit card provided they
complete a credit application, give permission for the Company to independently
check their credit and are willing to make an appropriate down payment. EPTAs
are either sold to third party financial institutions, generally with recourse,
for cash on a discounted basis, or carried on the Company's books as a
receivable.
The EPTAs generally have a twenty-four month term. For more than five years the
Company has offered its customers the payment option of a long-term installment
contract and has a history of successfully collecting under the original payment
terms without making concessions. During fiscal years ended June 30, 1999
through 2003, the Company has collected or is collecting approximately 70% of
all EPTAs issued to customers. Not all customers live up to their obligations
under the contracts. The Company makes every effort to collect on the EPTAs,
including the engagement of professional collection services. Despite reasonable
efforts, approximately 47% of all EPTAs not sold to third party financial
institutions become uncollectible during the life of the contract. All
uncollectible EPTAs are written off against an allowance for doubtful accounts.
The allowance is established at the time of sale based on our five-year history
10
of extending EPTAs and revised periodically based on current experience and
information. The revenue generated by sales to EPTA customers is recognized when
the product is delivered to the customer, the contract is signed and the
rescission period expires. At that same time an allowance for doubtful accounts
is established. This procedure has been in effect for all of fiscal year 2003
and for the first six months of fiscal year 2004.
The American Institute of Certified Public Accountants Statement of Position
97-2 ("SOP 97-2") states that revenue from the sale of software should be
recognized when the following four specific criteria are met: 1) persuasive
evidence of an arrangement exists, 2) delivery has occurred, 3) the fee is fixed
and determinable and 4) collectibility is probable. All of these criteria are
met when a customer purchases the SOS product and the three-day rescission
period expires. The customer signs one of the Company's order forms and a
receipt acknowledging receipt and acceptance of the product. As is noted on the
order and acceptance forms the customer has three days to rescind the order.
Once the rescission period expires, all sales are final and all fees are fixed
and final.
The Company also offers its customers, through telemarketing sales following the
workshop, certain products intended to assist the customer in being successful
with their business. These products include a live chat capability for the
customer's own website and web traffic building services. Revenues from these
products are recognized when delivery of the product has occurred. These
products are purchased from independent third party vendors and resold by the
Company to its customers with no continuing obligation on the part of the
Company.
(k) Foreign Currency Translation
Certain extended payment term arrangements are denominated in foreign currencies
with maturity dates between 2004 and 2005. These extended payment term
arrangements are translated into U.S. dollars at the exchange rates as of each
balance sheet date and the resulting gains or losses are recorded in other
income (expense).
(l) Comprehensive Income (Loss)
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income" establishes standards for reporting and displaying
comprehensive income (loss) and its components in a full set of general-purpose
financial statements. This statement requires that an enterprise classify items
of other comprehensive income (loss) by their nature in a financial statement
and display the accumulated balance of other comprehensive income (loss)
separately from retained earnings and additional paid-in capital in the equity
section of a statement of financial position. The Company's only other
comprehensive income (loss) was foreign currency translation adjustments related
to its Canadian subsidiary, StoresOnline, Ltd.
(m) Per Share Data
Basic earnings per share is computed by dividing net earnings available to
common shareholders by the weighted average number of common shares outstanding
during the period. Diluted net earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity.
Unexercised stock options to purchase 1,274,397 shares of the Company's common
stock and unexercised warrants to purchase 400,479 shares of the Company's
common stock were outstanding as of December 31, 2003, of which 710,035 stock
options and 266,368 warrants were included in the diluted per share
computations. Unexercised stock options to purchase 657,190 shares of the
Company's common stock and unexercised warrants to purchase 502,212 shares of
the Company's common stock were outstanding as of December 31, 2002 of which 0
stock options and 200,944 warrants were included in the diluted per share
computations.
(n) Use of Estimates
In the preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America, estimates and
assumptions must be made that affect the reported amounts of assets and
liabilities and disclosure of contingent liabilities, at the date of the balance
sheet, and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. The Company has
11
estimated that allowances for doubtful accounts for trade receivables should be
$9,135,270 as of December 31, 2003 and $6,603,260 as of June 30, 2003. In
addition, the Company has recorded an allowance for doubtful accounts of $62,266
as of December 31, 2003 and $319,812 as of June 30, 2003, for estimated credit
card charge-backs.
(o) Advertising Costs
The Company expenses costs of advertising and promotions as incurred, with the
exception of direct-response advertising costs. SOP 97-3 provides that
direct-response advertising costs that meet specified criteria should be
reported as assets and amortized over the estimated benefit period. The
conditions for reporting the direct-response advertising costs as assets include
evidence that customers have responded specifically to the advertising, and that
the advertising results in probable future benefits. The Company uses
direct-response marketing to register customers for its workshops. The Company
is able to document the responses of each customer to the advertising that
elicited the response. Advertising expenses included in selling and marketing
expenses for the six-month period ended December 31, 2003 and 2002 were
approximately$4.2 and $3.3 respectively, and for the three months ended December
31, 2003 and 2002 were approximately $2.1 million and $1.4 million,
respectively. As of December 31, 2003 the Company recorded $577,190 of direct
response advertising related to future workshops as an asset as compared to
$434,886 as of June 30, 2003.
(p) Recently Issued Accounting Pronouncements
In November 2002, the FASB issued FASB Interpretation No. 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued and
requires that they be recorded at fair value. The initial recognition and
measurement provisions of this interpretation are to be applied only on a
prospective basis to guarantees issued or modified after December 31, 2002,
which, for us, is the fiscal year beginning July 1, 2003. The disclosure
requirements of this interpretation are effective for financial statements of
interim or annual periods ending after December 15, 2002. We do not have any
indirect guarantees of indebtedness of others as of December 31, 2003.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." This interpretation addresses the consolidation of
business enterprises (variable interest entities) to which the usual condition
of consolidation does not apply. This interpretation focuses on financial
interests that indicate control. It concludes that in the absence of clear
control through voting interests, a company's exposure (variable interest) to
the economic risks and potential rewards from the variable interest entity's
assets and activities are the best evidence of control. Variable interests are
rights and obligations that convey economic gains or losses from changes in the
values of the variable interest entity's assets and liabilities. Variable
interests may arise from financial instruments, service contracts, nonvoting
ownership interests and other arrangements. If an enterprise holds a majority of
the variable interests of an entity, it would be considered the primary
beneficiary. The primary beneficiary would be required to include assets,
liabilities and the results of operations of the variable interest entity in its
consolidated financial statements. This interpretation applies immediately to
variable interest entities which are created after or for which control is
obtained after January 31, 2003. For variable interest entities created prior to
February 1, 2003, the provisions would be applied effective July 1, 2003. We do
not have an interest in any variable interest entities as of December 31, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" for
contracts entered into or modified after June 30, 2003; for hedging
relationships designated after June 30, 2003. We do not have any derivative
instruments or hedging activities as of December 31, 2003.
(3) Selling of Accounts Receivable With Recourse
The Company offers to customers the option to finance, through Extended Payment
Term Arrangements (EPTAs), purchases made at the Internet training workshops. A
significant portion of these EPTAs, are then sold, on a discounted basis, to
third party financial institutions for cash. EPTAs sold to third party financial
institutions are generally subject to recourse by the purchasing finance company
after an EPTA is determined to be uncollectible. For the six months ended
12
December 31, 2003 and 2002 the Company sold contracts totaling $2,979,097 and
$1,583,240 respectively, and for the three months ended December 31, 2003 and
December 31, 2002, the Company sold contracts totaling $1,275,338 and $828,489
respectively. The Company maintains approximately a nine percent bad debt
allowance for doubtful accounts on all EPTAs that are purchased by finance
companies. The Company sells contracts to three separate finance companies and
continues to seek relationships with other potential purchasers of these EPTAs.
(4) Goodwill and Intangible Assets
As required by Statement of Financial Accounting Standards ("SFAS") 142,
beginning on July 1, 2002 goodwill is no longer amortized but is tested on an
annual basis for impairment by comparing its fair value to its carrying value.
If the carrying amount of goodwill exceeds its fair value, an impairment loss
will be recognized in an amount equal to that excess. Prior to July 1, 2002
goodwill was being amortized over a ten-year period. During the quarter ended
December 31, 2002 the Company engaged an independent consulting firm to test the
Company's goodwill for impairment. Based on the appraisal made by the
independent consulting firm management has concluded that the fair market value
of the Company's assets exceeded the carrying value at July 1, 2002 and
determined that there is no goodwill impairment as of that date. As a result, no
change to the carrying value of the goodwill is necessary as of July 1, 2002. As
of December 31, 2003 management continues to believe that the fair market value
of the Company's assets exceeded the carrying value and therefore has determined
that there is no goodwill impairment as of that date.
Acquired technology.....................................5 to 7 years
Goodwill.................................................. 10 years
Goodwill as of December 31, 2003 and 2002 is summarized as follows:
2003 2002
------------ ------------
Goodwill $ 867,003 $ 867,003
Less accumulated amortization (411,826) (411,826)
------------ ------------
$ 455,177 $ 455,177
============ ============
(5) Notes Payable
Notes payable at December 31, 2003 consist of $400,000 of principal to King
William LLC. Interest on the note payable to King William is recorded at an
annual interest rate of 8.0% and as of December 31, 2003 totaled $5,348, and is
recorded as accrued interest under current liabilities. Maturities of notes
payable are as follows:
Year ending June 30,
2004 $ -
2005 -
2006 -
2007 -
2008 400,000
Thereafter -
-------------
$ 400,000
=============
(6) Stockholders' Equity
Six months ended December 31, 2003
During the six months ended December 31, 2003 the Company issued 249,772 shares
of common stock, upon the exercise of options and warrants for $200,316. The
Company also issued 9,853 shares as payment of $61,282 of interest due King
William LLC, a note holder.
13
During the six months ended December 31, 2003 the Company recorded an expense
totaling $193,335 related to options granted to consultants that became
exercisable during the six month period ended December 31, 2003.
Six months ended December 31, 2002
On December 6, 2002, the Company issued 26,675 shares of common stock at a price
of $1.75 per share, in settlement of a finder's fee earned in connection with
our private placement of common stock that closed in May 2002.
(7) Related Party Transactions
On July 1, 2003 John J. (Jay) Poelman, retired and in connection therewith
resigned as the Company's Chief Executive Officer and as a Director of the
Company. Transactions with Electronic Commerce International, Inc. ("ECI"),
Electronic Marketing Services, LLC. ("EMS") and Simply Splendid, LLC ("Simply
Splendid") which prior to July 1, 2003 were considered related party
transactions, but are not considered related party transactions for the three
months and six months ended December 31, 2003 since Mr. Poelman was not an
affiliate of the company after July 1, 2003.
John J. Poelman was the sole owner of Electronic Commerce International, Inc.
("ECI") during the three months ended September 30, 2002. During this period,
the Company purchased a merchant account solution product from ECI that provided
on-line, real-time processing of credit card transactions and resold this
product to its customers. Effective October 1, 2002, Mr. Poelman sold certain
assets and liabilities of ECI, including ECI's corporate name and its
relationship with the Company, to an unrelated third party.
Total revenue generated by the Company from the sale of ECI merchant account
solutions while ECI was a related party was $0 and $1,453,672 for the three
months and the six months ended December 31, 2002, respectively. The cost to the
Company for these products and services totaled $0 and $223,716 for the three
months and the six months ended December 31, 2002 respectively.
The Company offers its customers at its Internet training workshops, and through
backend telemarketing sales, certain products intended to assist the customer in
being successful with their business. These products include live chat and web
traffic building services. The Company utilizes Electronic Marketing Services,
LLC. ("EMS") to fulfill these services for the Company's customers. In addition,
EMS provides telemarketing services, selling some of the Company's products and
services. Ryan Poelman, who owns EMS, is the son of John J. Poelman, our former
Chief Executive Officer and formerly a director of the Company. The Company's
revenues generated from the above products and services were $1,429,824 and
$1,943,832 for the three months and the six months ended December 31, 2002
respectively. The Company paid EMS $278,060 and $432,367 to fulfill these
services during the three months and the six months ended December 31, 2002
respectively. In addition, the Company had $92,094 as of June 30, 2003 recorded
in accounts payable relating to the amounts owed to EMS for product and
services.
The Company utilizes Simply Splendid to provide complimentary gift packages to
its customers who register to attend the Company's workshop training sessions.
An additional gift is sent to workshop attendees who purchase products at the
conclusion of the workshop. Aftyn Morrison, who owns Simply Splendid, is the
daughter of John J. Poelman, our former Chief Executive Officer, and formerly a
director of the Company. The Company paid Simply Splendid $0 and $124,776 to
fulfill these services during the three month period and the six month period
ended December 31, 2002 respectively. In addition, the Company had $22,831 as of
June 30, 2003 recorded in accounts payable relating to the amounts owed to
Simply Splendid for gift packages.
In each of the above-described transactions and business relationships, we
believe that the terms under which business is transacted with all related
parties are at least as favorable to us as would be available from an
independent third party providing the same goods or services.
14
(8) Earnings Per Share
Three Months Ended Six Months Ended
------------------------------ -----------------------------
December 31, December 31, December 31, December 31,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net earnings available to common shareholders $ 1,465,737 $ 740,342 $ 3,617,818 $ 1,823,491
Basic EPS
- -----------------------------------------------------------------------------------------------------------------------
Common shares outstanding entire period 11,272,441 11,999,520 11,062,290 10,995,774
Weighted average common shares:
Issued during period 33,943 7,706 166,415 5,643
Canceled during period - - - -
------------- ------------- ------------- -------------
Weighted average common shares outstanding
during period 11,306,384 11,007,226 11,228,705 11,001,417
------------- ------------- ------------- -------------
Earnings (loss) per common share - basic $ 0.13 $ 0.07 $ 0.32 $ 0.17
============= ============= ============= =============
Diluted
- -----------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding
during period - basic 11,306,384 11,007,226 11,228,705 11,001,417
Dilutive effect of stock stock equivalents 968,052 200,945 959,427 118,176
------------- ------------- ------------- -------------
Weighted average common shares outstanding
during period - diluted 12,274,436 11,208,171 12,188,132 11,119,593
------------- ------------- ------------- -------------
Earnings (loss) per common share - diluted $ 0.12 $ 0.07 $ 0.30 $ 0.16
============= ============= ============= =============
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This management's discussion and analysis of financial condition and
results of operations and other portions of this Quarterly Report on Form 10-Q
contain forward-looking information that involves risks and uncertainties. Our
actual results could differ materially from those anticipated by this
forward-looking information. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed or referred to in
the Annual Report on Form 10-K for the year ended June 30, 2003, filed on
September 29, 2003, under the heading Information Regarding Forward-Looking
Statements and elsewhere. Investors should review this quarterly report on Form
10-Q in combination with our Annual Report on Form 10-K in order to have a more
complete understanding of the principal risks associated with an investment in
our common stock. This management's discussion and analysis of financial
condition and results of operations should be read in conjunction with our
unaudited condensed consolidated financial statements and related notes included
elsewhere in this document.
GENERAL
Reverse Stock Split
On June 28, 2002, our stockholders approved amendments to our
Certificate of Incorporation to change our corporate name to "Imergent, Inc."
and to effect a one-for-ten reverse split of the issued and outstanding shares
of our common stock and reduce the authorized number of shares of common stock
from 250,000,000 to 100,000,000. These changes were effective July 2, 2002. As a
result of the reverse stock split, every ten shares of our then existing common
stock was converted into one share of our new common stock under our new name,
Imergent, Inc. Fractional shares resulting from the reverse stock split were
settled by cash payment. Throughout this discussion references to numbers of
shares and prices of shares have been adjusted to reflect the reverse stock
split.
Fluctuations in Quarterly Results and Seasonality
In view of the rapidly evolving nature of our business and the market
we serve, we believe that period to period comparisons of our operating results,
including our gross profit and operating expenses as a percentage of revenues
and cash flow, are not necessarily meaningful and should not be relied upon as
an indication of future performance. We experience seasonality in our business.
Our fiscal year ends each June 30. Revenues from our core business during the
first and second fiscal quarters tend to be lower than revenues in our third and
fourth quarters. We believe this to be attributable to summer vacations and the
Thanksgiving and December holiday seasons that occur during our first and second
quarters.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
("US GAAP") and form the basis for the following discussion and analysis on
critical accounting policies and estimates. The preparation of these financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On a regular basis we evaluate
our estimates and assumptions. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. Senior management has discussed the development,
selection and disclosure of these estimates with the Board of Directors and its
Audit Committee. There are currently five members of the Board of Directors,
three of whom make up the Audit Committee. The Board of Directors has determined
that each member of the Audit Committee qualifies as an independent director and
that the chairman of the Audit Committee qualifies as an "audit committee
financial expert" as defined under the rules adopted by the SEC.
A summary of our significant accounting policies is set out in Note 2
to our Financial Statements as found in our Form 10-K for the year ended June
30, 2003. We believe the critical accounting policies described below reflect
our more significant estimates and assumptions used in the preparation of our
consolidated financial statements. The impact and any associated risks on our
business that are related to these policies are also discussed throughout this
Management's Discussion and Analysis of Financial Condition and Results of
Operations where such policies affect reported and expected financial results.
16
Revenue Recognition
On October 1, 2000, the Company started selling a license to use a new
product called the StoresOnline Software ("SOS"). The SOS is a web based
software product that enables the customer to develop their Internet website
without additional assistance from the Company. When a customer purchases a SOS
license at one of the Company's Internet workshops, he or she receives a CD-ROM
containing programs to be used with their computer and a password and
instructions that allow access to the Company's website where all the necessary
tools are located to complete the construction of the customer's website. When
completed, the website can be hosted with the Company or any other provider of
such services. If they choose to host with the Company there is an additional
setup and hosting fee (currently $150) for publishing and 12 months of hosting.
This fee is deferred at the time it is paid and recognized during the subsequent
12 months. A separate file is available and can be used if the customer decides
to create their website on their own completely without access to the Company
website and host their site with another hosting service.
The revenue from the sale of the SOS license is recognized when the
product is delivered to the customer and the three-day rescission period
expires. The Company accepts cash and credit cards as methods of payment and the
Company offers 24-month installment contracts to customers who prefer an
Extended Payment Term Arrangement (EPTA). The Company offers these contracts to
all workshop attendees not wishing to use a check or credit card provided they
complete a credit application, give permission for the Company to independently
check their credit and are willing to make an appropriate down payment. EPTAs
are either sold to third party financial institutions with recourse for cash on
a discounted basis, or carried on the Company's books as a receivable.
The EPTAs generally have a twenty-four month term. For more than five
years the Company has offered its customers the payment option of a long-term
installment contract and has a history of successfully collecting under the
original payment terms without making concessions. During fiscal years ended
June 30, 1999 through 2003, the Company has collected or is collecting
approximately 70% of all EPTAs issued to customers. Not all customers live up to
their obligations under the contracts. The Company makes every effort to collect
on the EPTAs, including the engagement of professional collection services.
Despite reasonable efforts, approximately 47% of all EPTAs not sold to third
party financial institutions become uncollectible during the life of the
contract. All uncollectible EPTAs are written off against an allowance for
doubtful accounts. The allowance is established at the time of sale based on our
five-year history of extending EPTAs and revised periodically based on current
experience and information. The revenue generated by sales to EPTA customers is
recognized when the product is delivered to the customer, the contract is signed
and any rescission period lapses. At that same time an allowance for doubtful
accounts is established. This procedure has been in effect for all of fiscal
year 2003 and for the first six months of fiscal year 2004.
The American Institute of Certified Public Accountants Statement of
Position 97-2 ("SOP 97-2") states that revenue from the sale of software should
be recognized when the following four specific criteria are met: 1) persuasive
evidence of an arrangement exists, 2) delivery has occurred, 3) the fee is fixed
and determinable and 4) collectibility is probable. All of these criteria are
met when a customer purchases the SOS product and the three-day rescission
period expires. The customer signs one of the Company's order forms, and a
receipt acknowledging receipt and acceptance of the product. As is noted on the
order and acceptance forms the customer has three days to rescind the order.
Once the rescission period expires, all sales are final and all fees are fixed
and final.
The Company also offers its customers, through telemarketing sales
following the workshop, certain products intended to assist the customer in
being successful with their business. These products include a live chat
capability for the customer's own website and web traffic building services.
Revenues from these products are recognized when delivery of the product has
occurred. These products are purchased from independent third party vendors and
resold by the Company to its customers with no continuing obligation on the part
of the Company.
17
Valuation of Long-Lived Assets Including Goodwill and Purchased Assets
We review property, equipment, goodwill and purchased intangible assets
for impairment whenever events or changes in circumstances indicate the carrying
value of an asset may not be recoverable. This review is conducted as of
December 31st of each year or more frequently if necessary. Our asset impairment
review assesses the fair value of the assets based on the future cash flows the
assets are expected to generate. An impairment loss is recognized when estimated
undiscounted future cash flows expected to result from the use of the asset plus
net proceeds expected from the disposition of the asset (if any) are less than
the carrying value of the asset. This approach uses our estimates of future
market growth, forecasted revenue and costs, expected period the assets will be
utilized and appropriate discount rates. When an impairment is identified, the
carrying amount of the asset is reduced to its estimated fair value.
Allowance for Doubtful Accounts
We record an allowance for doubtful accounts and disclose the
associated expense as a separate line item in operating expenses. The allowance,
which is netted against our current and long term accounts receivable balances
on our consolidated balance sheets, totaled approximately $ 9.1million and $6.6
million as of December 31, 2003 and June 30, 2003, respectively. The amounts
represent estimated losses resulting from the inability of our customers to make
required payments. The estimates are based on historical bad debt write-offs,
specific identification of probable bad debts based on collection efforts, aging
of accounts receivable and other known factors. If the financial condition of
our customers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances may be required.
Income Taxes
In preparing our consolidated financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate. This
process involves estimating actual current tax liabilities together with
assessing temporary differences resulting from differing treatment of items for
tax and financial reporting purposes. These differences result in deferred tax
assets and liabilities. Our deferred tax assets consist primarily of net
operating losses carried forward. We record a valuation allowance to reduce our
deferred tax assets to the amount that is more likely than not to be realized.
We have considered historical operations and current earnings trends, future
market growth, forecasted earnings, future taxable income, the mix of earnings
in the jurisdictions in which we operate and prudent and feasible tax planning
strategies in determining the need for a valuation allowance. In the event we
were to determine that we would not be able to realize all or part of our net
deferred tax assets in the future, an adjustment to the deferred tax assets
would be charged to earnings in the period such determination is made. Likewise,
if we later determine that it is more likely than not that the net deferred tax
assets would be realized, the previously provided valuation allowance would be
reversed. For the three and six month periods ended December 31, 2003 and 2002
we have established a 100% reserve. We intend to reevaluate this reserve
requirement upon completion of the Section 382 study and valuation currently in
progress .
Our net operating loss carry forward ("NOL"), which was approximately
$43 million prior to the application of our estimated FY 2003 taxable income of
approximately $8.2 million, represents the losses reported for income tax
purposes from the inception of the Company through June 30, 2002. Fiscal year
2003 was the first year in our history that generated taxable income. Section
382 of the Internal Revenue Code ("Section 382") imposes limitations on a
corporation's ability to utilize its NOLs if it experiences an "ownership
change". In general terms, an ownership change results from transactions
increasing the ownership of certain stockholders in the stock of a corporation
by more than 50 percentage points over a three-year period. Since our formation,
we have issued a significant number of shares, and purchasers of those shares
have sold some of them, with the result that two changes of control as defined
by Section 382 have occurred. As a result of the most recent ownership change,
utilization of our NOLs is subject to an annual limitation under Section 382
determined by multiplying the value of our stock at the time of the ownership
change by the applicable long-term tax-exempt rate resulting in an annual
limitation amount of approximately $127,000. Any unused annual limitation may be
carried over to later years, and the amount of the limitation may under certain
circumstances be increased by the "recognized built-in gains" that occur during
the five-year period after the ownership change (the "recognition period"). We
believe that we will have significant recognized built-in gains and that during
the recognition period the limitation will be increased by approximately $15
million based on an independent valuation of the Company as of April 2, 2002. We
18
also believe that based on a valuation of the Company as of June 25, 2000, which
is currently underway, the earlier ownership change will also have significant
recognized built-in gains and that during the recognition period the limitation
will be further increased by approximately $28 million thus allowing the Company
to utilize its entire NOL. Significant management judgment was required in
estimating the amount of the recognized built in gain. If it is determined that
the actual amount of recognized built in gain is less than our estimate, we may
be required to make a cash payment for taxes due on our income for fiscal years
2003 and 2004, plus related interest, which could materially adversely impact
our financial position.
RELATED PARTY TRANSACTIONS
On July 1, 2003 John J. (Jay) Poelman, retired and in connection
therewith resigned as the Company's Chief Executive Officer and as a Director of
the Company. Transactions with Electronic Commerce International, Inc. ("ECI"),
Electronic Marketing Services, LLC. ("EMS") and Simply Splendid, LLC ("Simply
Splendid") which prior to July 1, 2003 were considered related party
transactions, but are not considered related party transactions for the three
months and six months ended December 31, 2003 since Mr. Poelman was not an
affiliate of the company after July 1, 2003.
John J. Poelman was the sole owner of Electronic Commerce
International, Inc. ("ECI") during the three months ended September 30, 2002.
During this period, the Company purchased a merchant account solution product
from ECI that provided on-line, real-time processing of credit card transactions
and resold this product to its customers. Effective October 1, 2002, Mr. Poelman
sold certain assets and liabilities of ECI, including ECI's corporate name and
its relationship with the Company, to an unrelated third party.
Total revenue generated by the Company from the sale of ECI merchant
account solutions while ECI was a related party was $0 and $1,453,672 for the
three months and the six months ended December 31, 2002, respectively. The cost
to the Company for these products and services totaled $0 and $223,716 for the
three months and the six months ended December 31, 2002 respectively.
The Company offers its customers at its Internet training workshops,
and through backend telemarketing sales, certain products intended to assist the
customer in being successful with their business. These products include live
chat and web traffic building services. The Company utilizes Electronic
Marketing Services, LLC. ("EMS") to fulfill these services for the Company's
customers. In addition, EMS provides telemarketing services, selling some of the
Company's products and services. Ryan Poelman, who owns EMS, is the son of John
J. Poelman, our former Chief Executive Officer and formerly a director of the
Company. The Company's revenues generated from the above products and services
were $1,429,824 and $1,943,832 for the three months and the six months ended
December 31, 2002 respectively. The Company paid EMS $278,060 and $432,367 to
fulfill these services during the three months and the six months ended December
31, 2002 respectively. In addition, the Company had $92,094 as of June 30, 2003
recorded in accounts payable relating to the amounts owed to EMS for product and
services.
The Company utilizes Simply Splendid to provide complimentary gift
packages to its customers who register to attend the Company's workshop training
sessions. An additional gift is sent to workshop attendees who purchase products
at the conclusion of the workshop. Aftyn Morrison, who owns Simply Splendid, is
the daughter of John J. Poelman, our former Chief Executive Officer, and
formerly a director of the Company. The Company paid Simply Splendid $0 and
$124,776 to fulfill these services during the three month period and the six
month period ended December 31, 2002 respectively. In addition, the Company had
$22,831 as of June 30, 2003 recorded in accounts payable relating to the amounts
owed to Simply Splendid for gift packages.
In each of the above-described transactions and business
relationships, we believe that the terms under which business is transacted with
all related parties are at least as favorable to us as would be available from
an independent third party providing the same goods or services.
19
RESULTS OF OPERATIONS
Six-month period ended December 31, 2003 compared to the six-month
period ended December 31, 2002
Revenue
Our fiscal year ends on June 30 of each year. Revenues for the
six-month period ended December 31, 2003 increased to $40,372,194 from
$21,872,529 in the six-month period ended December 31, 2002, an increase of 85%.
Revenues generated at our Internet training workshops for the periods in both
fiscal years were from the sale of the SOS product as described in Critical
Accounting Policies and Estimates above. Revenues also include fees charged to
attend the workshop, web traffic building products, mentoring, consulting
services and access to credit card transaction processing interfaces. We expect
future, operating revenue to be generated principally following a business model
similar to the one used in our fiscal year that ended June 30, 2003. The
Internet environment continues to evolve, and we intend to offer future
customers new products as they are developed. We anticipate that our offering of
products and services will evolve as some products are dropped and are replaced
by new and sometimes innovative products intended to assist our customers
achieve success with their Internet-related businesses.
The increase in revenues for the six-month period ended December 31,
2003 compared to the six-month period ended December 31, 2002 can be attributed
to various factors. There was an increase in the number of Internet training
workshops conducted during the current six-month period. The number increased to
234 (including 13 that were held outside the United States of America) during
the first two quarters of the current fiscal year ("FY 2004") from 135 (11of
which were held outside the United States of America) in the first two quarters
of FY 2003. The average number of "buying units" in attendance at our workshops
during the current six-month period decreased to 94 from 95 in the comparable
period of the prior fiscal year. Persons who pay an enrollment fee to attend our
workshops are allowed to bring a guest at no additional charge, and that
individual and his/her guest constitute one buying unit. If the person attends
alone that single person also counts as one buying unit. Approximately 35% of
the buying units made a purchase at the workshops during the first six-month
period of FY 2004 compared to 29% in the first six-month period of FY 2003. The
average revenue per workshop purchase declined to approximately $4,200 during
the current six-month period from approximately $4,300 during the six-month
period ended December 31, 2002. We will seek to increase the number of workshops
held in the future including some in English speaking countries outside of the
United States of America.
Other revenues, including fees to attend the workshop, sales to
customers following the workshops, and hosting services were approximately
$8,400,000 in the six-month period ended December 31, 2003 compared to
$5,200,000 in the six-month period ended December 31, 2002, a 62% increase.
Gross Profit
Gross profit is calculated as revenue less the cost of revenue, which
consists of the cost to conduct Internet training workshops, to program customer
storefronts, to provide customer technical support and the cost of tangible
products sold. Gross profit for the six-month period ended December 31, 2003
increased to $31,464,712 from $17,111,138 for the same six-month period in the
prior year. The increase in gross profit primarily reflects the increased
revenue during the period.
Gross profit as a percent of revenue for six-month period ended
December 31, 2003 was 78%, the same as for the six-month period ended December
31, 2002.
Cost of revenues includes related party transactions of $0 in the
six-month period ended December 31, 2003 and $585,517 in the comparable period
of the prior fiscal year. These related party transactions are more fully
described in the notes to the condensed consolidated financial statements as
Note 7. We have determined, based on competitive bidding and experience with
independent vendors offering similar products and services, that the terms under
which business is transacted with this related party is at least as favorable to
us as would be available from an independent third party.
20
Research and Development
Research and development expenses consist primarily of payroll and
related expenses. Research and development expenses in the six-month period
ended December 31, 2003 were $162,729 compared to $0 in the six-month period
ended December 31, 2002. These expenses consisted of work on the StoresOnline,
version 4, product that is used in the StoresOnline Software sold at our
Internet training workshops and the improvement of our internal database used by
management to control operations.
We intend to make enhancements to our technology as new methods and
business opportunities present themselves. We will undertake additional
development projects as the needs are identified and as the funds to undertake
the work are available.
Selling and Marketing
Selling and marketing expenses consist of payroll and related expenses
for sales and marketing, the cost of advertising, promotional and public
relations expenditures and related expenses for personnel engaged in sales and
marketing activities, and commissions paid to telemarketing companies. Selling
and marketing expenses for the six-month period ended December 31, 2003
increased to $12,850,729 from $8,178,948 in the six-month period ended December
31, 2002. The increase in selling and marketing expenses is primarily
attributable to the increase in the number of workshops held during the current
six month period and the associated expenses including advertising and
promotional expenses necessary to attract the attendees. Advertising expenses
for the six-month period ended December 31, 2003 were approximately $4.2 million
compared to approximately $3.4 million in the six-month period ended December
31, 2002. Commissions paid to independent contract telemarketing companies
increased to $3.9 million in the current fiscal six-month period from $2.2
million in the comparable six-month period of the prior fiscal year. Selling and
marketing expenses as a percentage of revenues were 32% for the first six months
of FY2004 compared to 37% in the first six months of FY 2003.
Selling and marketing expenses include related party transactions of $0
and $195,343 in the six-month periods ended December 31, 2003 and 2002,
respectively. These are more fully described in the notes to the condensed
consolidated financial statements as Note 7. We have determined, based on
competitive bidding and experience with independent vendors offering similar
products and services, that the terms under which business is transacted with
this related party is at least as favorable to us as would be available from an
independent third party.
General and Administrative
General and administrative expenses consist of payroll and related
expenses for executive, accounting and administrative personnel, professional
fees, finance company discounts and other general corporate expenses.
General and administrative expenses for the six-month period ended
December 31, 2003 increased to $4,091,958 from $1,968,099 in the comparable
period of the previous fiscal year. This increase is attributable to increases
in finance company discounts and collection costs, salaries and fringe benefits,
and legal, accounting and other professional services. Finance company discounts
arise in connection with our practice of accepting 24-month installment
contracts from our customers as one of several methods of payment. Some of these
contracts are subsequently sold to finance companies at a discount. The
discounts generally range between 15% and 25% depending upon the credit
worthiness of our customer. Contracts that are not sold are carried by the
Company and the servicing and collection activity t is outsourced to independent
collection companies. Fees for servicing are approximately 8% of the funds
collected and for collection 33% of the funds collected. Increases in salaries
and fringe benefits occurred because we hired additional personnel to support
our increased business activity. Increases in legal fees, outside accounting
fees and other professional fees resulted from various activities. In order to
analyze and determine the amount of Net Operating Loss Carryforward for income
tax purposes is available to us we incurred additional consulting and accounting
fees. (See a discussion of this topic in the section of Critical Accounting
Policies relating to income taxes above.) We experienced increased legal fees
and other administrative expenses as a result of settlements the Company made
with various persons and governmental jurisdictions as more fully described in
Legal Proceedings in Part II, Item 1 of this Form 10-Q.
21
General and administrative expenses as a percentage of revenues
increased during the six-month period ended December 31, 2003 to 10% from 9% in
the same six-month period of the prior fiscal year. We anticipate that general
and administrative expenses will increase in future years as our business grows,
but will decrease as a percentage of revenues.
Bad Debt Expense
Bad debt expense consists mostly of actual and anticipated losses
resulting from the extension of credit terms to our customers when they purchase
products from us. We encourage customers to pay for their purchases by check or
credit card since these are the least expensive methods of payment for our
customers, but we also offer installment contracts with payment terms up to 24
months. We offer these contracts to all workshop attendees not wishing to use a
check or credit card provided they complete a credit application, give us
permission to independently check their credit and are willing to make an
appropriate down payment of from 5% to 10% of the purchase price. These
installment contracts are sometimes sold to finance companies, with partial or
full recourse, if our customer has a credit history that meets the finance
company's criteria. If not sold, we carry the contract and out-source the
collection activity. Our collection experience with these 24-month contracts is
satisfactory given the low marginal cost associated with these sales and that
the down payment received by us at the time the contract is entered into exceeds
the cost of the delivered products. Since all other expenses relating to the
sale, such as salaries, advertising, meeting room expense, travel, etc., have
already been incurred, we believe there is a good business reason for extending
credit on these terms.
Bad debt expense was $11,363,085 in the first two quarters of FY 2004
compared to $5,204,560 in the comparable period of the prior fiscal year. This
significant increase is due to an increase in the number of installment
contracts entered into, an increase in the number of contracts carried by us,
and our recent collection experience. During the first six months of FY 2004 we
wrote off approximately $7.3 million of installment contracts that originated in
FY 2003, 2002 and 2001. We provided for bad debts as of June 30, 2003 and 2002
based on the best information available at the time, including historical
write-off patterns. We have begun to have access to much more detailed
information from the finance companies that service the installment contracts,
and we have also had more historical data with which to estimate the appropriate
bad debt reserve. We believe that bad debt expense in future years will decline
as a percentage of revenues. We believe the allowance for doubtful accounts of
approximately $9.2 million at December 31, 2003 is adequate to cover all future
losses associated with the contracts in our accounts receivable as of December
31, 2003.
During the first two quarters of FY 2004 workshop sales financed by
installment contracts were approximately $19.4 million compared to approximately
$9.0 million in the first two quarters of the prior fiscal year. As a percentage
of workshop sales, installment contracts were 60% in the first two quarters of
FY 2004 compared to 57% in the first two quarters of FY 2003. During the
six-month period ended December 31, 2003 contracts carried by us, before any
adjustment for an allowance for doubtful accounts, increased by approximately
$6.0 million to approximately $19.8 million. The balance carried at December 31,
2003 net of the allowance for doubtful accounts was approximately $10.6 million.
The allowance for doubtful accounts as of December 31, 2003, related to
installment contracts, was 46% of gross accounts receivable compared to 48% at
June 30, 2003. These factors and other non-installment contract receivables
required us to increase our total allowance for doubtful accounts by
approximately $2.6 million during the six-month period ended December 31, 2003.
The table below shows the activity in our total allowance for doubtful accounts
during the six-month period ended December 31, 2003.
Allowance balance July 1, 2003 $ 7,023,855
Plus provision for doubtful accounts 11,363,085
Less accounts written off (9,165,430)
Plus collections on accounts previously written off 144,717
Allowance balance December 31, 2003 $ 9,366,227
===========
22
Interest Income
Interest income is derived from the installment contracts carried by
the Company. Our contracts have an 18% simple interest rate and interest income
for the six-month period ended December 31, 2003 was $641,756 compared to
$331,216 in the comparable period of the prior fiscal year. In the future as our
cash position strengthens we may be able to carry more installment contracts
rather than selling them at a discount to finance companies. If we were able to
carry more of these contracts it would increase interest income and reduce
administrative expenses. The discounts are included in administrative expenses,
as discussed above.
Income Taxes
We have made no provision for income taxes in our Statement of
Operations for the six-month periods ended December 31, 2003 and 2002, because
we believe our net operating loss carry forward ("NOL") will offset our entire
earnings before income taxes during those periods. Our NOL, which is
approximately $43 million, represents the losses reported for income tax
purposes from our inception through June 30, 2002. FY 2003 was the first year in
our history that generated taxable income. Section 382 of the Internal Revenue
Code ("Section 382") imposes limitations on a corporation's ability to utilize
its NOLs if it experiences an "ownership change". In general terms, an ownership
change results from transactions increasing the ownership of certain
stockholders in the stock of a corporation by more than 50 percentage points
over a three-year period. Since our formation, we have issued a significant
number of shares, and purchasers of those shares have sold some of them, with
the result that two changes of control as defined by Section 382 have occurred.
As a result of the most recent ownership change, utilization of our NOLs is
subject to an annual limitation under Section 382 determined by multiplying the
value of our stock at the time of the ownership change by the applicable
long-term tax-exempt rate resulting in an annual limitation amount of
approximately $127,000. Any unused annual limitation may be carried over to
later years, and the amount of the limitation may under certain circumstances be
increased by the "recognized built-in gains" that occur during the five-year
period after the ownership change (the "recognition period"). We believe that we
will have significant recognized built-in gains and that during the recognition
period the limitation will be increased by approximately $15 million based on an
independent valuation of our company as of April 3, 2002. We also believe that
based on a valuation of our company as of June 25, 2000, which evaluation is
currently underway, the earlier ownership change will also have significant
recognized built-in gains and that during the recognition period the limitation
will be further increased by approximately $28 million thus allowing us to
utilize our entire NOL. Significant management judgment was required in
estimating the amount of the recognized built in gain. If it is determined that
the actual amount of recognized built in gain is less than our estimate, we may
be required to make a cash payment for taxes due on our income for fiscal years
2003 and 2004, plus related interest, which could materially adversely impact
our financial position.
Three-month period ended December 31, 2003 compared to the three-month
period ended December 31, 2002
Revenue
Revenues for the three-month period ended December 31, 2003 increased
to $19,827,058 from $10,588,680 in the three-month period ended December 31,
2002, an increase of 87%. Revenues generated at our Internet training workshops
for the periods in both fiscal years were from the sale of the SOS product as
described in Critical Accounting Policies and Estimates above. Revenues also
include fees charged to attend the workshop, web traffic building products,
mentoring, consulting services and access to credit card transaction processing
interfaces. We expect future, operating revenue to be generated principally
following a business model similar to the one used in our fiscal year that ended
June 30, 2003. The Internet environment continues to evolve, and we intend to
offer future customers new products as they are developed. We anticipate that
our offering of products and services will evolve as some products are dropped
and are replaced by new and sometimes innovative products intended to assist our
customers achieve success with their Internet-related businesses.
The increase in revenues from our second fiscal quarter ended December
31, 2003 compared to the three-month period ended December, 2002 can be
attributed to various factors. There was an increase in the number of Internet
23
training workshops conducted during the current fiscal quarter. The number
increased to 116 (13 of which were held outside of the United States of America)
in the second quarter of the current fiscal year ("FY 2004") from 68 (all of
which were held within the United States) in the second quarter of FY 2003. The
average number of "buying units" in attendance at our workshops during the
period increased to 96 from 90 in the comparable period in the prior fiscal
year. Persons who pay an enrollment fee to attend our workshops are allowed to
bring a guest at no additional charge, and that individual and his/her guest
constitute one buying unit. If the person attends alone that single person also
counts as one buying unit. Approximately 34% of the buying units made a purchase
at the workshops in the second quarter of FY 2004 compared to 30% in the second
quarter of FY 2003. The average revenue per workshop purchase declined to
approximately $4,100 during the current quarter from approximately $4,300 during
the comparable quarter of the prior fiscal year. We will seek to increase the
number of workshops held in the future including some in English speaking
countries outside of the United States of America.
Other revenues including fees to attend the workshop, sales to
customers following the workshops, and hosting services were approximately
$4,500,000 in the three-month period ended December 31, 2003 compared to
approximately $2,000,000 in the three-month period ended December 31, 2002, a
125% increase.
Gross Profit
Gross profit is calculated as revenue less the cost of revenue, which
consists of the cost to conduct Internet training workshops, to program customer
storefronts, to provide customer technical support and the cost of tangible
products sold. Gross profit for the three-month ended December 31, 2003
increased to $15,281,278 from $8,285,723 for the same three-month period in the
prior year. The increase in gross profit primarily reflects the increased
revenue during the period.
Gross profit as a percent of revenue for quarter ended December 31,
2003 was 77% compared to 78% for the quarter ended December 31, 2002.
Cost of revenues includes related party transactions of $0 in the
three-month period ended December 31, 2003 and $164,936 in the comparable period
of the prior fiscal year. These related party transactions are more fully
described in the notes to the condensed consolidated financial statements as
Note 7. We have determined, based on competitive bidding and experience with
independent vendors offering similar products and services, that the terms under
which business is transacted with this related party is at least as favorable to
us as would be available from an independent third party.
Research and Development
Research and development expenses consist primarily of payroll and
related expenses. Research and development expenses in the current fiscal
quarter were $86,036 compared to $0 in the quarter ended December 31, 2002.
These expenses consisted of work on the StoresOnline, version 4, product that is
used in the StoresOnline Software sold at our Internet training workshops and
the improvement of our internal database used by management to control
operations.
We intend to make enhancements to our technology as new methods and
business opportunities present themselves. We will undertake additional
development projects as the needs are identified and as the funds to undertake
the work are available.
Selling and Marketing
Selling and marketing expenses consist of payroll and related expenses
for sales and marketing, the cost of advertising, promotional and public
relations expenditures and related expenses for personnel engaged in sales and
marketing activities, and commissions paid to telemarketing companies. Selling
and marketing expenses for the quarter ended December 31, 2003 increased to
$6,704,292 from $3,657,601 in the quarter ended December 31, 2002. The increase
in selling and marketing expenses is primarily attributable to the increase in
the number of workshops held during the current three month period and the
associated expenses including advertising and promotional expenses necessary to
attract the attendees. Advertising expenses for the three-month period ended
December 31, 2003 were approximately $2.1 million compared to approximately $1.4
million in the three-month period ended December 31, 2002. Commissions paid to
24
independent contract telemarketing companies increased to $2.1 million in the
current fiscal quarter from $0.9 million in the comparable quarter of the prior
fiscal year. Selling and marketing expenses as a percentage of sales were 34% of
revenues for the second quarter of FY2004 compared to 35% in the second quarter
of FY 2003.
Selling and marketing expenses include related party transactions of $0
and $55,608 in the three-month periods ended December 31, 2003 and 2002,
respectively. These are more fully described in the notes to the condensed
consolidated financial statements as Note 7. We have determined, based on
competitive bidding and experience with independent vendors offering similar
products and services, that the terms under which business is transacted with
this related party is at least as favorable to us as would be available from an
independent third party.
General and Administrative
General and administrative expenses consist of payroll and related
expenses for executive, accounting and administrative personnel, professional
fees, finance company discounts and other general corporate expenses.
General and administrative expenses for the three-month period ended
December 31, 2003 increased to $2,256,990 from $1,033,681 in the comparable
period of the previous fiscal year. This increase is attributable to increases
in finance company discounts and collection costs, salaries and fringe benefits,
and legal, accounting and other professional services. Finance company discounts
arise in connection with our practice of accepting 24-month installment
contracts from our customers as one of several methods of payment. Some of these
contracts are subsequently sold to finance companies at a discount. The
discounts generally range between 15% and 25% depending upon the credit
worthiness of our customer. Contracts that are not sold are carried by the
Company and the collection effort is outsourced to independent collection
companies. Fees for the collection services are approximately 8% of the funds
collected. Increases in salaries and fringe benefits occurred because we hired
additional personnel to support our increased business activity. Increases in
legal fees, outside accounting fees and other professional fees resulted from
various activities. In order to take advantage of our Net Operating Loss
Carryforward for income tax purposes additional consulting and accounting fees
were necessary. (See a complete discussion of this topic in the section of
Critical Accounting Policies relating to income taxes above.) Increased legal
fees and other administrative expenses resulted from settlements the Company
made with various persons and governmental jurisdictions as more fully described
in Legal Proceedings in Part II, Item 1 of this Form 10-Q.
General and administrative expenses as a percentage of revenues
increased during the three-month period ended December 31, 2003 to 11% from 10%
in the same three-month period of the prior fiscal year. We anticipate that
general and administrative expenses will increase in future years as our
business grows, but will decrease as a percentage of revenues.
Bad Debt Expense
Bad debt expense consists mostly of actual and anticipated losses
resulting from the extension of credit terms to our customers when they purchase
products from us. We encourage customers to pay for their purchases by check or
credit card since these are the least expensive methods of payment for our
customers, but we also offer installment contracts with payment terms up to 24
months. We offer these contracts to all workshop attendees not wishing to use a
check or credit card provided they complete a credit application, give us
permission to independently check their credit and are willing to make an
appropriate down payment of from 5% to 10% of the purchase price. These
installment contracts are sometimes sold to finance companies, with partial or
full recourse, if our customer has a credit history that meets the finance
company's criteria. If not sold, we carry the contract and out-source the
collection activity. Our collection experience with these 24-month contracts is
satisfactory given the low marginal cost associated with these sales and that
the down payment received by us at the time the contract is entered into exceeds
the cost of the delivered products. Since all other expenses relating to the
sale, such as salaries, advertising, meeting room expense, travel, etc., have
already been incurred, we believe there is a good business reason for extending
credit on these terms.
Bad debt expense was $5,142,851 in the second quarter of FY 2004
compared to $2,916,827 in the comparable period of the prior fiscal year. This
significant increase is due to an increase in the number of installment
contracts entered into, an increase in the number of contracts carried by us,
and our recent collection experience. We believe that bad debt expense in future
25
quarters will decline as a percentage of revenues. We believe the allowance for
doubtful accounts of approximately $9.2 million at December 31, 2003 is adequate
to cover all future losses associated with the contracts in our accounts
receivable as of December 31, 2003.
During the second quarter of FY 2004 workshop sales financed by
installment contracts were approximately $9.0 million compared to approximately
$4.6 million in the second quarter of the prior fiscal year. As a percentage of
workshop sales, installment contracts were 58% in the second quarter of FY 2004,
the same as the second quarter of FY 2003.
Interest Income
Interest income is derived from the installment contracts carried by
the Company. Our contracts have an 18% simple interest rate and interest income
for the three-month period ended December 31, 2003 was $366,513 compared to
$174,284 in the comparable period of the prior fiscal year. In the future as our
cash position strengthens we may be able to carry more installment contracts
rather than selling them at a discount to finance companies. If we were able to
carry more of these contracts it would increase interest income and reduce
administrative expenses. The discounts are included in administrative expenses,
as discussed above.
Income Taxes
We have made no provision for income taxes in our Statement of
Operations for the three-month period ended December 31, 2003 and 2002, because
we believe our net operating loss carry forward ("NOL") will offset our entire
earnings before income taxes during those periods. Our NOL, which is
approximately $43 million, represents the losses reported for income tax
purposes from our inception through June 30, 2002. FY 2003 was the first year in
our history that generated taxable income. Section 382 of the Internal Revenue
Code ("Section 382") imposes limitations on a corporation's ability to utilize
its NOLs if it experiences an "ownership change". In general terms, an ownership
change results from transactions increasing the ownership of certain
stockholders in the stock of a corporation by more than 50 percentage points
over a three-year period. Since our formation, we have issued a significant
number of shares, and purchasers of those shares have sold some of them, with
the result that two changes of control as defined by Section 382 have occurred.
As a result of the most recent ownership change, utilization of our NOLs is
subject to an annual limitation under Section 382 determined by multiplying the
value of our stock at the time of the ownership change by the applicable
long-term tax-exempt rate resulting in an annual limitation amount of
approximately $127,000. Any unused annual limitation may be carried over to
later years, and the amount of the limitation may under certain circumstances be
increased by the "recognized built-in gains" that occur during the five-year
period after the ownership change (the "recognition period"). We believe that we
will have significant recognized built-in gains and that during the recognition
period the limitation will be increased by approximately $15 million based on an
independent valuation of our company as of April 3, 2002. We also believe that
based on a valuation of our company as of June 25, 2000, which evaluation is
currently underway, the earlier ownership change will also have significant
recognized built-in gains and that during the recognition period the limitation
will be further increased by approximately $28 million thus allowing us to
utilize our entire NOL. Significant management judgment was required in
estimating the amount of the recognized built in gain. If it is determined that
the actual amount of recognized built in gain is less than our estimate, we may
be required to make a cash payment for taxes due on our income for fiscal years
2003 and 2002, plus related interest, which could materially adversely impact
our financial position.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003 we had working capital of $8,363,961 compared to
$5,562,926 at June 30, 2003. Our shareholders equity was $12,182,054 at December
31, 2003 compared to $8,103,047 at June 30, 2003. We generated revenues of
$40,372,194 for the six-month period ended December 31, 2003 compared to
$21,872,529 for the comparable period of the prior fiscal year. For the
six-month period ended December 31, 2003 we generated net earnings of $3,617,818
compared to $1,823,491 for the six-month ended December 31, 2002. For the
six-month period ended December 31, 2003, we recorded positive cash flows from
operating activities of $367,501 compared to positive cash flows of $451,131 in
the comparable period of the prior fiscal year.
26
Although we had historically incurred losses during our first several
years of operations, we became profitable in FY 2002 and continued our
profitability in FY 2003 and in the first two quarters of FY 2004. Our
historical losses, however, have resulted in a cumulative net loss of
$60,868,570 through December 31, 2003. We have historically relied upon private
placements of our stock and the issuance of debt to generate funds to meet our
operating needs. However in FY 2003 we had positive cash flow from operations of
$2,080,778, and during the six-month period ended December 31, 2003 we had
positive cash flows from operations of $367,501. We may in the future seek to
raise additional debt or equity capital to further increase our growth potential
and take advantage of strategic opportunities. However, there can be no
assurance that additional financing will be available on acceptable terms, if at
all.
Cash
At December 31, 2003, we had $2,700,583 cash on hand compared to
$2,319,618 at June 30, 2003. Cash provided by operating activities was $367,501
for the six-month period ended December 31, 2003. Net cash provided by
operations was mainly net earnings of $3,617,818 and a provision for bad debts
of $11,363,085, but partially offset by an increase in trade receivables of
$14,451,624. The increase in trade receivables occurred because our increase in
revenues generated additional installment contracts. See the discussion of Bad
Debt Expense in the Results of Operations above for a detailed discussion.
Trade Receivables
Trade receivables, carried as a current asset, net of allowance for
doubtful accounts, were $7,247,042 at December 31, 2003 compared to $4,965,769
at June 30, 2003. Trade receivables, carried as a long-term asset, net of
allowance for doubtful accounts, were $3,395,301 at December 31, 2003 compared
to $2,254,969 at June 30, 2003. We offer our customers a 24-month installment
contract as one of several payment options. The payments that become due more
than 12 months after the end of the fiscal period are carried as long-term trade
receivables. During the six-month period ended December 31, 2003 workshop sales
financed by installment contracts were approximately $19.4 million compared to
approximately $9.0 million in the six-month period ended December 31, 2002.
We sell, on a discounted basis with recourse, a portion of these
installment contracts to third party financial institutions for cash. Currently
we sell these installment contracts to three separate financial institutions
with different recourse rights. When contracts are sold the discount varies
between 15% and 25% depending on the credit quality of the customer involved.
During the current six-month period our cash position was strong enough to
retain some of the contracts we otherwise would have sold. Contracts with
customers whose credit rating would have allowed us to sell them and having an
original principal balance of approximately $542,000 were retained by the
Company. The savings in discount by not selling the contracts was approximately
$98,000. During the balance of the fiscal year ending June 30, 2004 we expect to
retain additional contracts.
Accounts Payable
Accounts payable at December 31, 2003, totaled $1,628,590, compared to
$1,528,037 at June 30, 2003. Our accounts payable as of December 31, 2003 were
generally within our vendor's terms of payment.
Stockholders' Equity
Stockholders' equity at December 31, 2003 was $12,182,054 compared to
$8,103,047 at June 30, 2003. The increase was mainly due to profitable
operations for the first two quarters of FY2004. Net earnings during the six
month period were $3,617,818.
Financing Arrangements
We accept payment for the sales made at our Internet training workshops
by cash, credit card, or installment contract. As part of our cash flow
management and in order to generate liquidity, we have sold on a discounted
basis a portion of the installment contracts generated by us to third party
financial institutions for cash. See "Liquidity and Capital Resources - Trade
Receivables," for further information.
27
NASDAQ Application
On June 6, 2003 the Company filed an application for a listing on the
NASDAQ Small Cap Market. Our application is subject to review and approval by
the NASDAQ. Since the filing, we continue to receive and answer questions from
NASDAQ. The Company believes that because we are seeking to be listed other than
in the context of an underwritten public offering and also because we had
previously been delisted in January of 2001, the increase in volume and price of
our stock price and the level and nature of primarily past complaints and
inquiries from customers and regulators about certain of our business practices,
NASDAQ is conducting a more complete and lengthy review of us than is normally
conducted in connection with a listing application. We met members of NASDAQ's
staff on October 28, 2003 and that was a positive and fruitful meeting. We have
continued to follow up since that time, providing information requested by
NASDAQ to enable it to conclude its investigation. NASDAQ has indicated in all
likelihood there will be an additional request for information and a meeting at
NASDAQ's headquarters with management after completion of the review of the
information they currently have. We continue to feel confident that we meet all
of the criteria and the standards of NASDAQ and are hopeful that our application
will be accepted.
Impact of Recent Accounting Pronouncements
In November 2002, the FASB issued FASB Interpretation No. 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued and requires that they be recorded at fair value. The initial
recognition and measurement provisions of this interpretation are to be applied
only on a prospective basis to guarantees issued or modified after December 31,
2002, which, for us, is the fiscal year beginning July 1, 2003. The disclosure
requirements of this interpretation are effective for financial statements of
interim or annual periods ending after December 15, 2002. We do not have any
indirect guarantees of indebtedness of others as of December 31, 2003.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities." This interpretation addresses the consolidation
of business enterprises (variable interest entities) to which the usual
condition of consolidation does not apply. This interpretation focuses on
financial interests that indicate control. It concludes that in the absence of
clear control through voting interests, a company's exposure (variable interest)
to the economic risks and potential rewards from the variable interest entity's
assets and activities are the best evidence of control. Variable interests are
rights and obligations that convey economic gains or losses from changes in the
values of the variable interest entity's assets and liabilities. Variable
interests may arise from financial instruments, service contracts, nonvoting
ownership interests and other arrangements. If an enterprise holds a majority of
the variable interests of an entity, it would be considered the primary
beneficiary. The primary beneficiary would be required to include assets,
liabilities and the results of operations of the variable interest entity in its
consolidated financial statements. This interpretation applies immediately to
variable interest entities which are created after or for which control is
obtained after January 31, 2003. For variable interest entities created prior to
February 1, 2003, the provisions would be applied effective July 1, 2003. We do
not have an interest in any variable interest entities as of December 31, 2003.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" for
contracts entered into or modified after June 30, 2003; for hedging
relationships designated after June 30, 2003. We do not have any derivative
instruments or hedging activities as of September 30, 2003.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk from changes in interest and foreign
exchange rates. We have minimal fair value exposure related to interest rate
changes associated with our long-term, fixed-rate debt. We do not believe we
have material market risk exposure and have not entered into any market risk
sensitive instruments to mitigate these risks or for trading or speculative
purposes.
28
We currently have outstanding $ 631,929 of extended payment term
arrangements denominated in foreign currencies with maturity dates between 2004
and 2005. These extended payment term arrangements are translated into U.S.
dollars at the exchange rates as of each balance sheet date and the resulting
gains or losses are recorded in other income (expense). The fluctuations of
exchange rates may adversely affect our results of operations, financial
position and cash flows.
Item 4. Controls and Procedures
Our principal executive and financial officers have evaluated our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) as of December 31, 2003. They have
determined that such disclosure controls and procedures are effective to ensure
that information required to be disclosed in our filings under the Securities
Exchange Act of 1934 with respect to the Company and its consolidated
subsidiaries is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms
and is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate, to allow
timely decisions regarding required disclosures.
We regularly evaluate our internal controls over financial reporting
and discuss these matters with our independent accountants and our audit
committee. Based on these evaluations and discussions, we consider what
revisions, improvements or corrections are necessary in order to ensure that our
internal controls are and remain effective. As a result, we continue to improve
and change our internal controls over financial reporting relating to the
evaluation of estimates and have brought these items to the attention of our
audit committee. The principal focus of these improvements and changes is
developing and implementing new policies, procedures and systems designed to
more efficiently and effectively monitor the accuracy of management's estimates
to comply with financial reporting and regulatory requirements. Full
implementation of these changes may continue throughout the fiscal year. Pending
implementation of these changes, we have other procedures and policies to
maintain our ability to accurately record, process, and summarize financial data
and prepare financial statements that fairly present our financial condition,
results of operations, and cash flows. We have made no other significant changes
in internal controls over financial reporting during the last fiscal quarter
that materially affected or are reasonably likely to materially affect our
internal controls over financial reporting. We intend to continue to refine our
internal controls on an ongoing basis as we deem appropriate with a view towards
continuous improvements.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As disclosed in our quarterly report on Form 10-Q on November 13, 2003,
on August 12, 2002, the Office of the District Attorney of San Mateo County,
California, notified us that it was investigating whether we were operating in
violation of the California Seminar Sales Act (California Civil Code ss.
1689.20-1693)), the Seller Assisted Marketing Plans Act (California Civil Code
ss. 1812.200-1812.221), and California's Unfair Competition Act (California
Business & Professions Code ss. 17200 et. seq.). The Seminar Sales Act provides
customers a three day right of rescission in connection with purchases made in a
seminar setting (as defined by that Act). The Seller Assisted Marketing Plan Act
is California's business opportunity sales law and it requires that persons who
sell business opportunities (as defined in the that act) to register with the
state and make certain pre-sale disclosures to purchasers. The Unfair
Competition Act prohibits deceptive acts and practices generally in all
industries. After receiving this notice, we reviewed the customer complaints
that the District Attorney's office provided to us and have been able to resolve
most of those complaints. We have also worked with that office to resolve the
regulatory compliance issues raised by it. The Company has voluntarily
implemented a change in its customer service policies which allows a three-day
right of rescission in an effort to resolve conflicts such as this. With that,
we have voluntarily submitted a proposal for settlement with the office of the
District Attorney in which the following was included: an agreement to continue
to provide a three-day right of rescission in California; register to do
29
business in the State of California; disclose to potential California customers
our full corporate name, and the fact that no guarantees are given as to results
of the product; pay costs and settle certain complaints, which amounts have
either already been paid or reserved for; continue our ongoing efforts
demonstrating good faith.
While we continue to believe that our business is not subject to
regulation under the Seller Assisted Marketing Plan Act or the Seminar Sales Act
and believe that we have meritorious defenses to those claims we made the offer
to resolve the dispute in a cost effective and reasonable manner. The office of
the San Mateo District Attorney is reviewing the proposal, and has entered into
a "tolling agreement" so that no action need be filed while the negotiations are
ongoing. We are optimistic that there will be a resolution with the District
Attorney, and are further optimistic that the resolution will convince the
Attorney General and -the District Attorney that there is no basis for further
action. Although we are continuing to work to resolve this matter through the
negotiated settlement we are prepared to vigorously defend any action brought by
either the office of the San Mateo District Attorney or the Attorney General of
the state of California. If an enforcement action is brought against us and we
are not able to prevail on the merits or if we are prevented from conducting
operations in California during the pendency of the proceedings our business
would likely be materially adversely affected.
On December 16, 2003 the Company and the Utah Department of Commerce,
Division of Consumer Protection, entered in to a settlement agreement of an
Administrative Citation in the Matter Of: Imergent, Inc. and StoresOnline, Inc.,
previously known as Galaxy Mall, Inc., UDCP Case No. CP30320 et al. The Company
agreed in part to: continue to work together to resolve outstanding disputes,
continue to offer a three-day right of rescission in Utah (which as discussed
before is the new policy of the Company); pay costs and settle certain
complaints which amounts have been paid or reserved for; provide a "light"
disclosure in Utah. The Company and the Department will work together to resolve
any complaints that may arise in the future. The Company and the Department will
continue to work together to resolve any complaint if they arise in the future.
On December 16, 2003 the Company and, Maria J. Smith, entered in a
settlement of the outstanding complaint. The complaint stemmed from a dispute,
purportedly on behalf of Ms. Smith herself and the general public as private
attorney general, together with other defendants, including Leasecomm
Corporation and Electronic Commerce International, Inc. ("ECI" which is owned by
John J. Poelman, our former Chief Executive Officer and a former director). The
Company as its part of the settlement agreed to pay a fee, and has agreed to
provide all affected parties with the opportunity to upgrade to the current
StoresOnline Software, and to provide those customers one year free web hosting.
All amounts have been reserved for. The parties are continuing to draft a
comprehensive settlement document. At present there is a hearing scheduled on
March 5, 2004 before the Orange County Superior Court, Central Justice Center,
in the State of California, before the Honorable Steven Perk, Dept. C27 (Case
No. 030005871 to adopt the settlement for March 5, 2004.
From time to time, we receive inquiries from and/or have been made
aware of investigations by government officials in some states in which we
operate. These inquiries and investigations generally concern compliance with
various cities, county, state and/or federal regulations involving sales and
marketing practices. We respond to these inquiries and have generally been
successful in addressing the concerns of these persons and entities. We also
receive complaints and inquiries in the ordinary course of our business from
both customers and governmental and non-governmental bodies on behalf of
customers. To date we have been able to resolve these matters on a mutually
satisfactory basis and we believe that we will be successful in resolving
matters going forward, but there can be no assurance that the ultimate
resolution of matters may not have a material adverse affect on our business or
operations.
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
On December 8, 2003 we issued of 7,158 restricted shares of our common
stock pursuant to the exercise of outstanding warrants. In our opinion, the
issuance of these shares was exempt by virtue of Section 4(2) of the Securities
Act and the rules promulgated there under.
30
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held an annual meeting of stockholders on December 3, 2003.
The security holders were asked to vote (1) for the election of directors (2) to
ratify the amendment to the 1998 Stock Option Plan for Senior Executives (3) to
ratify the amendment to the 1999 Stock Option Plan for Non-executives (4) to
approve the 2003 Equity Incentive Plan and (5) to ratify the appointment of
Grant Thornton LLP as our auditors for the fiscal year ending June 30, 2004.
The results of the voting for directors were:
Class II Directors:
Gary Gladstein - Votes for 9,335,429 Votes withheld 10,787
Peter Fredericks - Votes for 9,335,423 Votes withheld 10,793
Brandon Lewis - Votes for 9,038,516 Votes withheld 307,700
The results of voting to ratify the amendment to the 1998 Stock Option
Plan for Senior Executives:
Votes for 5,362,057 Votes against 478,782 Votes abstaining 41,755
The results of voting to ratify the amendment to the 1999 Stock Option
Plan for Non-executives:
Votes for 5,360,457 Votes against 480,212 Votes abstaining 41,925
The results of voting to approve the 2003 Equity Incentive Plan:
Votes for 5,451,852 Votes against 389,005 Votes abstaining 41,737
The results of the vote for ratification of Grant Thornton LLP as
auditors:
Votes for 9,137,320 Votes Against 207,984 Votes Abstaining 912
In addition, the following directors terms of office continued after
the meeting:
Donald Danks term ending 2005
Thomas Scheiner term ending 2005
31
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31.1 Certification of the Chief Executive Officer
31.2 Certification of the Chief Financial Officer
32.1 Certification of the Chief Executive Officer
32.2 Certification of the Chief Financial Officer
(b) Reports on Form 8 K
1. We filed a Current Report on Form 8-K on November 5,
2003 announcing our earnings for the three-month
period ended September 30, 2003.
2. We filed a Current Report on Form 8-K on February 5,
2004 announcing our earnings for the six-month and
three-month periods ended December 31, 2003.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Imergent, Inc.
February 12, 2004 By: /s/ Donald L. Danks
--------------------------
Donald L. Danks
Chief Executive Officer
February 12, 2004 By: /s/ Frank C. Heyman
--------------------------
Frank C. Heyman
Chief Financial Officer
33