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IMERGENT
INC Files SEC form 10-K, Annual Report Friday September 10 Annual Report
Item 7. 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 report 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 may cause such differences include, but are not limited to, those discussed under the heading "Risk Factors" and elsewhere in this report. This management's discussion and analysis of financial condition and results of operations should be read in conjunction with the financial statements and the related notes included elsewhere in this report. General Our fiscal year ended June 30, 2004 ("FY 2004") was only the third year since the inception of the Company that we were profitable and the second year that we enjoyed positive cash flow from operating activities. As explained in previous annual reports we closed our Internet Commerce Center and the Cable Commerce division in order to concentrate on our StoresOnline business that services the small business and individual entrepreneur markets. We raised approximately $7.2 million in equity capital through the sale of our convertible notes and common stock in three private placements during the fiscal years ended June 30, 2001 and 2002. Using this cash to retire debt and promote our StoresOnline business has enabled us to increase revenues significantly, remain profitable and have positive cash flow from operations. The following discussion further expands on the effects of these changes.
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 effected July 2, 2002. As a result of the reverse stock split, every ten shares of our 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.
On March 6, 2002, the Securities and Exchange Commission ("SEC") notified us that they had reviewed our annual report filed on Form 10-K for the fiscal year ended June 30, 2001 and our quarterly report on Form 10-Q for the quarter ended September 30, 2001. They sent a letter of comments pointing out areas of concern and requested we answer their questions and provide additional information. We exchanged correspondence with members of the SEC staff and provided them with additional information. On September 24, 2002 in a telephone conference call with the SEC staff, we resolved certain of the more material issues. On October 31, 2002 we responded to other comments from the staff in their letter dated August 5, 2002. On November 6, 2002 in a telephone conversation with the SEC staff we resolved the remaining issues without amending our previously filed financial statements. However, certain reclassifications of financial information and additional financial statement disclosures have been reflected in the accompanying financial statements.
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. Our fiscal year ends each June 30 and we experience seasonality in our business. 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. The financial statements for the years ended June 30, 2003 and 2002 have been reclassified to conform to fiscal year 2004 presentation. 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. 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.
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. Beginning in May 2004 the Company no longer sells EPTA's with any recourse provisions. 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 2004, 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 years 2004 and 2003. 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 determinable. 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. The Company receives a commission and recognizes this revenue net of the selling and marketing costs.
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 $9.0 million and $6.6 million as of June 30, 2004 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.
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.
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 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 the future benefit 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, estimated 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, if any, would be reversed. At June 30, 2003 we had recognized a tax valuation allowance of $19.3 million against our deferred tax assets. As of March 31, 2004, we determined that it was more likely than not that $16.7 million, or all but approximately $2.6 million of the deferred tax assets would be realized. This determination was based on current projections of future taxable income when taking into consideration limitations on the utilization of net operating loss carry forwards ("NOL") imposed by Section 382 of the Internal Revenue Code ("Section 382"). 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"). Based on an independent valuation of our company as of April 3, 2002, we have approximately $15 million of recognized built-in gains. Additionally, based on a valuation of our company as of June 25, 2000, which evaluation was completed during the quarter ended March 31, 2004, we also determined the earlier ownership change resulted in built-in gains that allow us to utilize our entire NOL. 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 fiscal year ended June 30, 2004 since Mr. Poelman was not an affiliate of the Company after July 1, 2003. John J. Poelman was the sole owner of ECI during the fiscal year ended June 30, 2002 and during the three months ended September 30, 2002. During this period, the Company purchased a merchant account solutions product from ECI that provided on-line, real-time processing of credit card transactions and resold this product to its customers. The Company also formerly utilized the services of ECI to provide a leasing opportunity to customers who purchased its products at its Internet training workshops. 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's merchant account solutions product, while ECI's business was owned by Mr. Poelman, was $1,453,612 and $5,106,494 for the years ended June 30, 2003 and 2002, respectively. The cost to the Company for these products and services totaled $223,716 and $994,043 for the years ended June 30, 2003 and 2002, respectively. During the years ended June 30, 2003 and 2002 the Company processed leasing transactions for its customers through ECI in the amounts of $0 and $1,090,520, respectively. As of June 30, 2004 and 2003 the Company had no receivable balance due from ECI for leases in process. In addition, the Company had no payable balance due to ECI as of June 30, 2003 for the purchase of the merchant account software while owned by Mr. Poelman. The Company offers its customers at its Internet training workshops, and through telemarketing sales following the workshop certain products intended to assist its customers to become successful with their business. These products include a live chat capability for the customer's own website and web traffic building services. The Company purchases some of these services from EMS. In addition, EMS provides us telemarketing services, selling some of the Company's products and services to contacts provided to EMS by us. Ryan Poelman, owner of EMS, is the son of John J. Poelman our former Chief Executive Officer and a former director who retired effective July 1, 2003 and, in connection therewith, resigned as an officer and director of the Company. The Company's revenues generated from the above products and services were $6,330,343 and $4,806,497 for the fiscal years ended June 30, 2003 and 2002, respectively. The Company paid EMS $994,827 and $479,984 to purchase these services during the fiscal years ended June 30, 2003 and 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 products and services. The Company sends complimentary gift packages to its customers who register for the Company's Workshop training sessions. An additional gift is sent to Workshop attendees who purchase our products at the conclusion of the Workshop. The Company utilizes Simply Splendid, LLC ("Simply Splendid") to provide some of these gift packages to the Company's customers. Aftyn Morrison, owner of Simply Splendid, is the daughter of John J. Poelman our former Chief Executive Officer and a former director. We paid Simply Splendid $421,265 and $0 to fulfill these services during the fiscal years ended June 30, 2003 and 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. We engaged vFinance Investments, Inc. ("vFinance") as a financial advisor and placement agent for our private placement of unregistered securities that closed during May 2002. Shelly Singhal, a former member of our Board of Directors, was a principal of vFinance at the time of the private placement. During the year ended June 30, 2002 we paid vFinance $61,500 in fees and commissions for their services. The offering was successful with adjusted gross proceeds to us of $2,185,995. We engaged SBI-E2 Capital USA Ltd. ("SBI") as a financial consultant to provide us with various financial services. Shelly Singhal a former member of our Board of Directors is a managing director of
SBI. During the year ended June 30, 2002 SBI provided us with a Fairness Opinion relating to our proposed merger with Category 5 Technologies, for which we paid $67,437. We also paid SBI $58,679 for expenses and commissions relating to our private placement of unregistered securities that closed during November 2001. The offering was successful with adjusted gross proceeds to us of $2,898,455. Pursuant to an agreement dated February 15, 2002, SBI also rendered certain financial advisory services to us in connection with our private placement that closed in May 2002, including delivery of a fairness opinion with respect to such private placement. Pursuant to this agreement, we paid SBI a total of $40,000 and issued to SBI and various of its designees an aggregate of 112,500 shares of our common stock. 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. Results of Operations Fiscal year ended June 30, 2004 compared to fiscal year ended June 30, 2003
Our fiscal year ends on June 30 of each year. Revenues for the fiscal year ended June 30, 2004 ("FY 2004") increased to $81,027,517 from $46,470,678 for the fiscal year ended June 30, 2003 ("FY 2003"), an increase of 74%. Revenues generated at our Internet training workshops 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, access to credit card transaction processing interfaces and sales of banner advertising. We expect future operating revenues to be generated principally following a business model similar to the one used in fiscal year 2004. 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. We also intend to expand our product offerings to locations outside the United States of America. The increase in revenues from FY 2004 compared to FY 2003 can be attributed to various factors. There was an increase in the number of Internet training workshops conducted during the current fiscal years. The number increased to 544 including 58 that were held outside the United States of America, for the current fiscal year from 336 in FY 2003, 11 of which were held outside the United States. In addition, the average number of persons attending each workshop increased and the average number of "buying units" in attendance at our workshops during the period increased to 89, compared to 84 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 35% of the buying units made a purchase at the workshop in FY 2004 compared to 32% FY 2003. The average revenue per workshop purchase decreased in the current fiscal year ended June 30, 2004 to approximately $4,300 compared to approximately $4,500 in the fiscal year ended June 30, 2003. We contact all persons who attend our workshops beginning approximately two weeks after the event was held in an attempt to sell them a mentoring program and products that will drive traffic to their web site. These contacts are made through telemarketing companies that we engage as subcontractors. The Company receives a commission and recognizes this revenue net of the selling and marketing costs.
Telemarketing sales, included in total revenue described above, increased during FY 2004 to approximately $6.5 million from $3.7 million in FY 2003, an increase of 73%.
Gross profit is calculated as revenue less the cost of revenue, which consists of the cost to conduct Internet training workshops, to provide customer technical support, credit card fees and the cost of tangible products sold. Gross profit for FY 2004 increased to $62,281,247 from $35,568,308 during FY 2003. The increase in gross profit primarily reflects the increased revenue during the period. Gross profit as a percent of revenue for FY 2004 was 76.9% compared to 76.5% for FY 2003. Cost of revenues includes related party transactions of $1,118,002 in FY 2003. These are more fully described in the notes to the consolidated financial statements as Note 13. 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 these related parties is at least as favorable to us as would be available from an independent third party.
Selling and marketing expenses consist of payroll and related expenses for sales and marketing, the cost of advertising, promotional and public relations expenditures, related expenses for personnel engaged in sales and marketing activities, and commissions paid to telemarketing companies. Selling and marketing expenses for FY 2004 increased to $20,964,701 from $11,632,209 in FY 2003. The increase in selling and marketing expenses is primarily attributable to the increase in the number of workshops held during FY 2004. Expenses were higher because of the greater number of attendees at our preview sessions and the associated expenses including advertising and promotional expenses necessary to attract the attendees. Total selling and marketing expenses as a percentage of revenues were 25.9% for FY 2004 and 25.0% FY 2003. Selling and marketing expenses include related party transactions of $349,680 in the fiscal year ended June 30, 2003. These are more fully described in note 13 to the consolidated financial statements. 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 are at least as favorable to us as would be available from an independent third party. Contact: iMergent, Inc.
Rob Lewis, 801-431-4695 (CFO)
investor_relations@imergentinc.com
or
Lippert/Heilshorn & Assoc.
Steve Kuzmic, skuzmic@lhai.com 415-433-3777 (Investor Relations)
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