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 March 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. ------------- (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 -------------- (Registrant's telephone number, including area code) (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 May 14, 2003: 11,035,667 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.
PART I - FINANCIAL INFORMATION Item 1. Financial Statements. Condensed Consolidated Balance Sheets at March 31, 2003 (unaudited) and at June 30, 2002..................................................3 Unaudited Condensed Consolidated Statements of Earnings for the three months and the nine months ended March 31, 2003 and 2002.....................4 Unaudited Condensed Consolidated Statement of Stockholders' Equity for the nine months ended March 31, 2003......................................5 Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended March 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.......................................................................17 Critical Accounting Policies and Estimates....................................17 Related Party Transactions....................................................19 Results of Operation..........................................................20 Liquidity and Capital Resources...............................................26 Item 3. Quantitative and Qualitative Disclosures about Market Risk.......29 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..................................30 Item 4. Submission of Matters to a Vote of Security Holders..............30 Item 5. Other Information................................................31 .. Item 6. Exhibits and Reports on Form 8-K.................................31
PART I - FINANCIAL INFORMATION Item 1. Financial Statements <TABLE> <CAPTION> IMERGENT, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets March 31, 2003 (Unaudited) June 30, 2002 ------------------ ----------------- <S> <C> <C> Assets Current assets Cash $ 926,121 $ 519,748 Trade receivables, net of allowance for doubtful accounts of $3,885,018 at March 31, 2003 and $1,918,673 at June 30, 2002 4,842,742 2,247,129 Inventories 37,405 23,416 Prepaid expenses 514,896 607,857 Credit card reserves, net of allowance for doubtful accounts of $376,700 at March 31, 2003 and $137,370 at June 30, 2002 550,092 1,022,701 ------------------ ----------------- Total current assets 6,871,256 4,420,851 Property and equipment, net 197,807 409,460 Goodwill, net 455,177 455,177 Trade receivables, net of allowance for doubtful accounts of $1,740,912 at March 31, 2003 and $1,357,938 at June 30, 2002 2,243,574 1,673,740 Deferred tax asset 539,973 - Other assets, net of allowance for doubtful accounts of $144,810 at March 31, 2003 and $0 at June 30, 2002 47,766 417,384 ------------------ ----------------- Total Assets $ 10,355,553 $ 7,376,612 ================== ================= Liabilities and Stockholders' Equity Current liabilities Accounts payable $ 1,006,154 $ 1,215,400 Accounts payable - related party 88,219 111,702 Bank overdraft - 150,336 Accrued wages and benefits 323,362 681,472 Past due payroll taxes - 26,797 Income taxes payable 990,248 - Accrued liabilities 161,046 548,016 Current portion of capital lease obligations 22,720 80,938 Current portion of notes payable 26,429 160,671 Other current liabilities 449,630 450,523 Other current liabilities - related party 50,000 - Deferred revenue 459,451 705,558 ------------------ ----------------- Total current liabilities 3,577,259 4,131,413 Capital lease obligations, net of current portion 11,171 27,906 Notes payable, net of current portion 430,088 393,560 Other long term liabilities 5,850 - ------------------ ----------------- Total liabilities 4,024,368 4,552,879 ------------------ ----------------- Commitments and contingencies - - Minority interest - 355,159 ------------------ ----------------- 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 11,035,667 and 10,995,774 shares, at March 31, 2003 and June 30, 2002, respectively 11,036 10,996 Additional paid-in capital 72,450,685 72,017,928 Deferred compensation (25,604) (34,987) Accumulated other comprehensive loss (4,902) (4,902) Accumulated deficit (66,100,030) (69,520,461) ------------------ ----------------- Total stockholders' equity 6,331,185 2,468,574 ------------------ ----------------- Total Liabilities and Stockholders' Equity $ 10,355,553 $ 7,376,612 ================== ================= </TABLE> See Notes to Condensed Consolidated Financial Statements
<TABLE> <CAPTION> IMERGENT, INC. AND SUBSIDIARIES Unaudited Condensed Consolidated Statements of Earnings for the Three Months and the Nine Months Ended March 31, 2003 and 2002 Three Months Ended Nine Months Ended --------------------------------------- ---------------------------------------- March 31, March 31, March 31, March 31, 2003 2002 2003 2002 ------------------ ------------------ ------------------- ------------------- <S> <C> <C> <C> <C> Revenue $ 15,786,458 $ 7,296,696 $ 37,658,988 $ 26,386,485 Cost of revenue 2,713,422 1,334,877 6,904,423 3,657,519 Cost of revenue - related party 348,807 157,437 840,263 720,930 ------------------ ------------------ ------------------- ------------------- Total cost of revenue 3,062,229 1,492,314 7,744,686 4,378,449 ------------------ ------------------ ------------------- ------------------- Gross profit 12,724,229 5,804,382 29,914,302 22,008,036 Operating expenses Product development - 19,654 - 87,604 Selling and marketing 4,856,941 3,019,211 12,855,835 9,127,660 Selling and marketing - related party 160,277 85,866 349,680 353,392 General and administrative 1,197,797 968,712 3,244,830 4,600,962 Depreciation and amortization 57,018 145,131 299,974 446,542 Bad debt expense 4,611,640 1,251,021 9,816,200 3,256,152 ----------------- ------------------ ------------------- ------------------- Total operating expenses 10,883,673 5,489,595 26,566,519 17,872,312 - Earnings from operations 1,840,556 314,787 3,347,783 4,135,725 Other income (expense) Other income 120 1,632 2,992 50,914 Interest income 218,197 96,577 549,414 265,962 Interest expense (11,657) (35,659) (29,483) (1,925,643) ------------------ ------------------ ------------------- ------------------- Total other income (expense) 206,660 62,550 522,923 (1,608,767) ------------------ ------------------ ------------------- ------------------- Earnings before income taxes 2,047,216 377,337 3,870,706 2,526,957 Provision for income taxes 450,275 - 450,275 - ------------------ ------------------ ------------------- ------------------- Net earnings $ 1,596,941 $ 377,337 $ 3,420,431 $ 2,526,957 ================== ================== =================== =================== Eanrnigs per share Basic $ 0.14 $ 0.08 $ 0.31 $ 0.61 Diluted $ 0.14 $ 0.08 $ 0.30 $ 0.61 Weighted average shares outstanding Basic 11,030,931 4,833,462 11,011,070 4,117,136 Diluted 11,290,240 4,833,462 11,219,115 4,135,779 </TABLE> See Notes to Condensed Consolidated Financial Statements
<TABLE> <CAPTION> IMERGENT, INC. AND SUBSIDIARIES Unaudited Condensed Consolidated Statement of Stockholders' Equity For the Nine Months Ended March 31, 2003 Common Stock Additional ------------------------------ Paid-in Deferred Shares Amount Capital Compensation --------------- ----------- -------------- ------------------ - --------------------------------------------------------------- --------------- ----------- -------------- ------------------ <S> <C> <C> <C> <C> Balance July 1, 2002 10,995,774 $ 10,996 $ 72,017,928 $ (34,987) Amortization of deferred compensation - - - 9,383 Private placement of common stock 5,000 5 14,995 - Reconciliaton of common stock following reverse stock split (1,254) (1) 1 - Common stock issued pursuant to finder's agreement 26,675 27 25,315 - Conversion of exchangeable shares 9,472 9 355,150 - Expense for options granted to consultants - - 37,296 - Net earnings - - - - - ---------------------------------------------------------------- -------------- ----------- -------------- ------------------ Balance March 31, 2003 (unaudited) 11,035,667 $ 11,036 $ 72,450,685 $ (25,604) =============== =========== ============== ================== </TABLE> See Notes to Condensed Consolidated Financial Statements (Continued Below) <TABLE> <CAPTION> IMERGENT, INC. AND SUBSIDIARIES Unaudited Condensed Consolidated Statement of Stockholders' Equity For the Nine Months Ended March 31, 2003 (Continued From Above) Accumulated Other Total Accumulated Comprehensive Stockholders' Deficit loss Equity ------------- -------------------- ----------------- - --------------------------------------------------------------- ------------- -------------------- ----------------- <S> <C> <C> <C> Balance July 1, 2002 $ (69,520,461) $ (4,902) $ 2,468,574 Amortization of deferred compensation - - 9,383 Private placement of common stock - - 15,000 Reconciliaton of common stock following reverse stock split - - - Common stock issued pursuant to finder's agreement - - 25,342 Conversion of exchangeable shares - - 355,159 Expense for options granted to consultants - - 37,296 Net earnings 3,420,431 - 3,420,431 - ---------------------------------------------------------------- ------------- -------------------- ----------------- Balance March 31, 2003 (unaudited) $ (66,100,030) $ (4,902) $ 6,331,185 ============= ==================== ================= </TABLE> See Notes to Condensed Consolidated Financial Statements
<TABLE> <CAPTION> IMERGENT, INC AND SUBSIDIARIES Unaudited Condensed Consolidated Statements of Cash Flows For the Nine Months Ended March 31, 2003 and 2002 2003 2002 -------------------------------------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net earnings $ 3,420,431 $ 2,526,957 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities Depreciation and amortization 299,974 446,542 Amortization of deferred compensation 9,383 13,017 Provision for bad debts 9,816,200 3,256,152 Common stock issued for services 25,342 199,657 Expense for options granted to independent consultants 37,296 - Expense for loan restructuring and consultant options - 19,400 Amortization of debt issue costs - 707,385 Amortization of beneficial conversion feature and debt discount - 1,752,056 Changes in assets and liabilities: Trade receivables (12,181,097) (5,625,391) Inventories (13,989) 12,465 Prepaid expenses and other current assets 92,961 (39,849) Credit card reserves (327,939) 406,925 Deferred tax asset (539,973) - Other assets 369,618 (374,924) Deferred revenue (246,107) (5,184,996) Accounts payable, accrued expenses and other liabilities - related party (23,483) - Accounts payable, accrued expenses and other liabilities (874,931) (166,221) Income taxes payable 990,248 -------------------------------------- Net cash provided by (used in) operating activities 853,934 (2,050,825) CASH FLOWS FROM INVESTING ACTIVITIES Acquisition of property and equipment (98,128) (7,698) -------------------------------------- Net cash used in investing activities (98,128) (7,698) -------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from common stock clearing liability - 1,212,753 Proceeds from issuance of common stock - 2,529,823 Proceeds from exercise of options and warrants - 1,727 Change in bank overdraft (150,336) (477,793) Proceeds from short term note - 45,000 Repayment of convertible debenture - (100,000) Repayment of note payable - bank - (97,779) Repayment of capital lease obligations (74,953) (37,803) Repayment of notes payable (124,144) (103,470) -------------------------------------- Net cash provided by (used in) financing activities (349,433) 2,972,458 -------------------------------------- NET INCREASE IN CASH 406,373 913,935 CASH AT THE BEGINNING OF THE PERIOD 519,748 20,123 -------------------------------------- CASH AT THE END OF THE PERIOD $ 926,121 $ 934,059 ====================================== Supplemental disclosures of non-cash transactions: Conversion of debenture to common stock $ - $ 2,115,885 Notes payable settled on private placement of common stock - 490,000 Common stock issued for settlement agreements - 86,000 Conversion of convertible notes to common stock - 2,147,295 Common stock issued for outstanding liabilities 15,000 449,232 Conversion of loan payable to common stock 100,000 Accrued interest added to note payable 26,429 - Conversion of exchangeable shares for minority interest 355,159 Supplemental disclosure of cash flow information: Cash paid for interest - 1,732 </TABLE> See Notes to Condensed Consolidated Financial Statements
IMERGENT, INC. AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (1) Description of Business Imergent, Inc. (formerly known as "Netgateway, Inc.", referred to hereinafter as Imergent or 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. Imergent is an e-Services company that provides eCommerce technology, training and a variety of web-based technology and resources to over 100,000 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 eCommerce 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. (2) Summary of Significant Accounting Policies (a) Principles of Consolidation The unaudited condensed consolidated financial statements include the accounts and operations 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 intercompany balances and transactions have been eliminated in consolidation. (b) Reverse Stock Split On June 28, 2002 the stockholders of the Company approved a one-for-ten reverse split of the Company's outstanding common stock, which became effective July 2, 2002. All data for common stock , options and warrants have been adjusted to reflect the one-for-ten reverse split for all periods presented. In addition, all common stock prices and per share data for all periods presented have been adjusted to reflect the one-for-ten reverse stock split. (c) Inventories Inventories are stated at the lower of cost (first-in, first-out) or market. Inventory consists mainly of products provided in conjunction with the Internet training workshops. (d) Property and Equipment Property and equipment are stated at cost. Depreciation expense is computed principally on the straight-line method in amounts sufficient to allocate the cost of depreciable assets, including assets held under capital leases, over their estimated useful lives ranging from 3 to 5 years. The cost of leasehold improvements is being amortized using the straight-line method over the shorter of the estimated useful life of the asset or the terms of the related leases. Depreciable lives by asset group are as follows: Computer and office equipment ......................3 to 5 years Furniture and fixtures..............................4 years Computer software...................................3 years Leasehold improvements..............................term of lease Normal maintenance and repair items are charged to costs and expenses as incurred. The cost and accumulated depreciation of property and equipment sold or otherwise disposed are removed from the accounts and any related gain or loss on disposition is reflected in net earnings (loss) for the period. (e) Goodwill 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 December 31, 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 December 31, 2002. As of March 31, 2003 management continues to believe that the fair market value of the Company's assets exceeded the carrying value and therefore have determined that there is no goodwill impairment as of that date. (f) Product and Development Expenditures Product and development costs are expensed as incurred. Costs related to internally developed software are expensed until technological feasibility has been achieved, after which the costs are capitalized. (g) Impairment of Long-Lived Assets The Company reviews long-lived assets and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted operating cash flows projected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. (h) Financial Instruments The carrying values of cash, accounts receivable, notes receivable, accounts payable, accrued liabilities, capital lease obligations and the current portion of notes payable approximated fair value due to either the short maturity of the instruments or the recent date of the initial transaction. (i) 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 to be 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. Our deferred tax assets consist primarily of net operating losses carried forward. The Company has provided a valuation allowance against some of its net deferred tax assets at March 31, 2003 and against all of its deferred tax assets at June 30, 2002. Fiscal year 2002 was the first profitable year for the Company since its inception. However, differences between accounting principals 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 nine-month period ended March 31, 2003 we have taxable income of approximately $2.5 million,. Our net operating loss carry forward ("NOL"), representing the losses reported for tax purposes from the inception of the Company through June 30, 2002 is subject to a limitation as defined in Section 382 of the Internal Revenue Code. Operating losses from prior years are normally available to offset taxable income in subsequent years. However, Section 382 places a limitation on the amount that can be used in any one year if a "change in control" as defined in the Internal Revenue Code has occurred. Since its formation, the Company has issued a significant number of shares and purchasers of those shares have sold some of them, with the result that a change of control as defined by Section 382 has occurred. We currently estimate that the available NOL for the fiscal year ended June 30, 2003 will be approximately $2.7 million. (j) Accounting for Stock Options 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 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. (k) Revenue Recognition During the fiscal year ended June 30, 2001 the Company changed its product offering at its Internet training workshops. The date of the change was October 1, 2000, the beginning of our second fiscal quarter of fiscal year 2001. Prior to that time, customers were sold a service consisting of the construction of Internet websites for their business, which service was to be provided at any time during the 12 months following the sale. Included in the price paid for this service was one year's hosting beginning when the website was published. Revenue from these transactions was deferred at the time of sale and recognized as the services were rendered or when the right to receive the services terminated. Beginning October 1, 2000, the Company discontinued selling the service and in its place sold 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 us. When a customer purchases a SOS license at one of our 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 our website where all the necessary tools are present to complete the construction of the customer's website. When completed, the website can be hosted with us or any other provider of such services. If they choose to host with us 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 our 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. The Company accepts cash and credit cards as methods of payment and we offer 24-month installment contracts to customers who prefer an extended payment term arrangement. 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 us permission to independently check their credit and are willing to make an appropriate down payment. Installment contracts are carried on our books as a receivable and the revenue generated by these installment contracts is recognized when the product is delivered to the customer and the contract is signed. At that same time an allowance for doubtful accounts is established. This procedure was in effect for the last three quarters of fiscal year 2001, all of fiscal year 2002 and is still in effect for the nine-month period ended March 31, 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. The customer signs one of our order forms and a receipt acknowledging receipt and acceptance of the product. As is noted on the order and acceptance forms, all sales are final. All fees are fixed and final. Some states require a three-day right to rescind the transaction. Sales in these states are not recognized until the rescission period has expired. The Company offers customers the option to pay for the SOS license with Extended Payment Term Arrangements ("EPTAs"). The EPTAs generally have a twenty-four month term. The Company has offered its customers the payment option of a long-term installment contract for more than four years and has a history of successfully collecting under the original payment terms without making concessions. Over the past four years, 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 our efforts, approximately 30 percent of all EPTAs are determined to be uncollectible. 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. As a result, revenue from the sale of the SOS is recognized upon the delivery of the product. (l) Business Segments and Related Information The Company currently operates in one business segment. (m) Foreign Currency Translation The financial statements of the Company's Canadian subsidiary, StoresOnline.com, Ltd. have been translated into U.S. dollars from its functional currency in the accompanying condensed consolidated financial statements in accordance with Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation." Balance sheet accounts of StoresOnline.com, Ltd. are translated at period-end exchange rates while income and expenses are translated at the average of the exchange rates in effect during the period. Translation gains or losses that related to the net assets of StoresOnline.com Ltd. are shown as a separate component of stockholders' equity and comprehensive income (loss). There were no gains or losses resulting from realized foreign currency transactions (transactions denominated in a currency other than the entities' functional currency) during the nine months ended March 31, 2003 or 2002. (n) 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. (o) Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the balance sheet date, and the reporting of revenues and expenses during the reporting periods to prepare these financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates. The Company has estimated that allowances for bad debt for Trade Receivables should be $5,625,930 and $3,276,611 as of March 31, 2003 and June 30, 2002, respectively. In addition, the Company has recorded an allowance for doubtful accounts of $380,892 at March 31, 2003 and $137,370 at June 30, 2002 for estimated credit card chargebacks relating to the most recent 180 days of credit card sales. (p) Commission Expense Commission expense relating to third-party telemarketing activity is recognized as incurred. (q) Recently Issued Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 141, "Business Combinations" and No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which establishes new standards for the treatment of goodwill and other intangible assets. SFAS 142 is effective for fiscal years beginning after December 31, 2001 and permits early adoption for companies with a fiscal year beginning after March 15, 2001. SFAS 142 prescribes that amortization of goodwill will cease as of the adoption date. Additionally, we were required to perform an impairment test within six months as of the adoption date, annually thereafter, and whenever events and circumstances occur that might affect the carrying value of these assets. SFAS 142 was applicable to the Company beginning July 1, 2002. As a result we discontinued the amortization of goodwill and arranged for an independent evaluation to determine if an impairment to our goodwill existed. We hired an independent consulting firm to perform an appraisal. Based on their report, management found that no impairment existed. We are now obligated to make this review annually if events and circumstances occur that might affect the carrying value of our goodwill. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). Under this standard, asset retirement obligations will be recognized when incurred at their estimated fair value. In addition, the cost of the asset retirement obligations will be capitalized as a part of the asset's carrying value and depreciated over the asset's remaining useful life. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact on our financial condition or results of operations. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). This standard requires that all long-lived assets (including discontinued operations) that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for fiscal years beginning after December 15, 2001. We do not expect the implementation of SFAS 144 to have a material effect on our financial condition or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002" (SFAS 145). This standard rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements and excludes extraordinary item treatment for gains and losses associated with the extinguishment of debt that do not meet the APB Opinion No. 30, Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB 30) criteria. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. SFAS 145 also amends SFAS 13, Accounting for Leases as well as other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Certain provisions of SFAS 145 are effective for transactions occurring after May 15, 2002 while other are effective for fiscal years beginning after May 15, 2002. We have not assessed the potential impact of SFAS 145 on our financial condition or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146). This standard addresses financial accounting and reporting for costs associated with exit or disposal activities and replaces Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (EITF 94-3). SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for exit costs, as defined in EITF No. 94-3 were recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated by the Company after December 31, 2002. Since we have had no Exit or Disposal activity since December 31, 2002, we do not expect the implementation of SFAS 144 to have a material effect on our financial condition or results of operations. In October, 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions (SFAS 147). This standard relates to acquisitions of financial institutions and is not expected to affect the Company's financial condition or results of operations. In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure" (SFAS 148). This standard amends the disclosure and certain transition provisions of SFAS 123, Accounting for Stock-Based Compensation. Its disclosure provisions are effective for interim periods beginning after December 15, 2002. The Company does not expect that adoption of SFAS 148 will have a material impact on its financial condition or results of operations. (3) Going Concern The accompanying financial statements have been prepared on the basis that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has incurred losses from its inception through the fiscal year ended June 30, 2001. The Company was profitable during the fiscal year ended June 30, 2002 and has been profitable for the nine-month period ended March 31, 2003. The Company, however, has a cumulative net loss of $66,100,030 through March 31, 2003. At March 31, 2003 the Company had $926,121 cash on hand, working capital of $3,293,997 and equity of $6,331,185. Management believes that through future profitable operations and the raising of additional equity or debt capital, if necessary, the Company will be able to continue operating as a going concern. However, there can be no assurance that if additional capital is required that it will be available. The unaudited condensed consolidated financial statements do not include any adjustments that might result from the inability of the Company to continue as a going concern . (4) Selling of Trade Receivables With Recourse The Company offers 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 nine-month periods ended March 31, 2003 and 2002, the Company sold contracts having a principal balance of $3,850,372 and $4,442,364, respectively. The Company maintains approximately a two 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. (5) Notes Payable Notes payable at March 31, 2003 consist of $456,517 of principal and capitalized interest payable to King William (see Note 6). Maturities of notes payable are as follows: Year ending June 30, 2003 $ 26,429 2004 - 2005 - 2006 - 2007 430,088 Thereafter - ------------- $ 456,517 ============= (6) Convertible Debenture In July 2000, the Company entered into a securities purchase agreement with King William, LLC ("King William"). Under the terms of the agreement, the Company issued to King William an 8% convertible debenture due July 31, 2003 in the principal amount of $4.5 million. The debenture was convertible at King William's option into the number of shares of our common stock at the lower of $17.90 or a conversion rate of 80% of the average market price of the common stock during any three non-consecutive trading days during the 20 trading days prior to conversion. The purchase price for the debenture was payable in two tranches. The first tranche of $2.5 million was paid at the closing in July 2000. The value of the beneficial conversion feature on the $2.5 million that has been drawn down was recorded as additional paid in capital and interest expense of $884,000 for the year ended June 30, 2001, as the convertible debentures were immediately exercisable. In connection with the securities purchase agreement, the Company issued to King William a warrant to purchase 23,100 shares of the Company's common stock. In connection with the issuance of the debenture, the Company also issued to Roth Capital Partners, Inc., a warrant to purchase 9,000 shares of common stock and to Carbon Mesa Partners, LLC, a warrant to purchase 1,000 shares of common stock. Each of the warrants is exercisable for five years from the date of issue, at an exercise price of $16.25 per share and with cashless exercise and piggyback registration rights. The fair value of the warrants has been determined to equal $371,000 using the Black-Scholes pricing model with the following assumptions: dividend yield of zero, expected volatility of 80%, risk-free interest rate of 6.5% and expected life of 5 years. The $371,000 was accounted for as additional paid in capital and debt discount and was amortized over the life of the debt. The unamortized balance at December 31, 2002 and June 30, 2002 was $0 and $0, respectively. Effective January 25, 2001, the Company reached an agreement with King William to restructure the debenture (the "Restructuring Agreement"). As of the date of the Restructuring Agreement the Company was in breach and/or violation of the Purchase Agreement, the Debenture, the King William Warrant Agreement, the Registration Rights Agreements and the Equity Agreement. However, pursuant to the terms of the Restructuring Agreement the holder of the convertible debenture has waived all of these defaults as of the date of the Restructuring Agreement. Under the terms of the Restructuring Agreement the agreements were terminated effective as of the date of the Restructuring Agreement and no termination payment or additional warrants were issued in connection therewith. Under the terms of the Restructuring and Amendment Agreement the second tranche of the debenture was not be available to the Company. The Company agreed to repay the full amount of the Debenture plus a 15% premium ($375,000) with respect to the original principal amount in ten payments. As of the date of the Restructuring and Amendment Agreement the principal amount including accrued and unpaid interest was $2,972,781. Additionally, the Company has allowed King William to retain the right to convert any or all portions of the outstanding debt to equity, but only after the stock has traded at or above $30.00 for twenty consecutive trading days, or if the Company does not make a required payment of principal. Warrants already earned by King William were re-priced at $2.50 per share and King William was issued a warrant for an additional 26,900 shares of common stock at $2.50 per share. The incremental fair value of the re-pricing of the warrants and the issuance of the new warrants, valued using the Black-Scholes pricing model with the following assumptions: dividend yield of zero, expected volatility of 170%, risk-free interest rate of 5% and expected life of 5 years, was $9,008 and $129,927, respectively. These costs were classified on the balance sheet as debt financing costs and were being amortized over the life of the debt. The initial payment of $250,000, as called for by the Restructuring and Amendment Agreement, was made during the first week of February 2001. A second payment to be paid on February 28, 2001 was not made. In May 2001 King William elected to convert $200,000 of the principal and accrued and unpaid interest of the debenture (Conversion Amount) into 80,000 shares of Common Stock of the Company, at a conversion price of $2.50 per share. The Conversion Amount was credited toward the payment of $250,000 due on February 28, 2001, with the balance plus interest accrued to be paid on March 10, 2002. In addition, in May 2001, the Company entered into a Waiver Agreement with King William, LLC to amend certain of the terms of the Restructuring Agreement and to waive certain existing defaults under the Restructuring Agreement. The Waiver Agreement amended the Restructuring Agreement payment schedule to postpone the remaining April 2001 payment of $247,278 to February 2002 and the May 2001 payment of $247,278 to March 2002. As of the date of the Waiver Agreement King William had withdrawn and waived all defaults and violations. Effective July 11, 2001 the Company and King William entered into a Second Restructuring Agreement. The Company agreed to pay, and King William agreed to accept, in full and final satisfaction of the Debenture at a closing effective September 10, 2001, (i) a cash payment of $100,000, (ii) a $400,000 promissory note of the Company due August 2004 bearing interest at 8% per annum and (iii) 280,000 shares of the Company's common stock. No accrued interest was payable in connection with these payments. King William has agreed to certain volume limitations relating to the subsequent sale of its shares of the Company's common stock and has also agreed to forgive the promissory note if the Company meets certain specific requirements including a minimal amount ($2,250,000) of proceeds King William receives from its sale of Company common stock. The Final Conversion Shares insure that King William will receive sufficient shares so that on the day of the closing King William will beneficially own common shares equal to 9.99% of the then outstanding shares of the Company. In September 2001 the Company issued the final conversion shares equal to 280,000. No gain or loss on the exchange of shares for debt was recorded in the accompanying financial statements. The Company was in default under the Second Restructuring Agreement for failure to make interest payments on November 10, 2001 and February 10, 2002, as called for by the agreement. King William may have accelerated payment of the unpaid balance of the note plus accrued interest upon written notice to the Company. No written notice of default had been received. Effective February 13, 2002 the Company and King William agreed to amend certain terms of the Second Restructuring Agreement. The New Note is amended to provide for a final maturity on July 10, 2007 and to provide that interest shall accrue at the rate stated in the New Note and be added to the principal balance until August 13, 2002. In addition, interest payable may be paid in either cash or common stock of the Company, which common stock is to be valued at an amount equal to the average closing bid price of the Company's common stock during the five trading days prior to the date the interest payment is made. Upon the signing of this agreement the Company issued 10,000 shares of restricted common stock valued at $13,000. The Company is no longer required to file a registration statement with respect to the common stock of the Company currently held by King William or acquirable by it upon exercise of the warrants held by it. King William has waived any default by the Company under the Second Agreement and the New Note. Finally, the selling limitations in Section 4 of the Second Agreement are no longer in effect and King William is only bound by the limitations under Rule 144 relating to the resale of any securities. (7) Convertible Long Term Notes In January and April 2001, the Company issued long term Convertible Promissory Notes ("Notes") in a private placement offering totaling $2,076,500. The terms of Notes required them to be repaid on July 1, 2004 plus accrual of interest at the rate of eight percent (8%) per annum. The Notes were convertible prior to the Maturity Date at the option of the Holder any time after July 1, 2001, or by the Company at any time after July 1, 2001 upon certain conditions as detailed in the Notes. The Notes were convertible into shares of common stock of the Company by dividing the Note balance on the date of conversion by $2.50, subject to Conversion Price Adjustments as defined in the agreement. The relative fair value of this Beneficial Conversion Feature of the notes was calculated to be $1,347,480 and was recorded as debt discount on the balance sheet, and was amortized over the life of the Notes in accordance with Emerging Issues Task Force issue 00-27 effective November 16, 2000. In connection with the sale of the Notes, the Company issued a warrant to purchase a share of the Company's common stock at an exercise price of $5.00 per share for every two shares of Common Stock into which the Note is originally convertible. The Company issued a total of 366,100 warrants in connection with the sale of the Notes, with a date of expiration not to exceed sixty calendar days following the commencement date of the warrants. The relative fair value of the warrants has been determined to be $512,540 and has been recorded as debt discount on the balance sheet and is amortized over the life of the Notes in accordance with Emerging Issues Task Force issue 00-27 effective November 16, 2000. None of the warrants were exercised. The beneficial conversion feature and debt discounts of $1,347,480 and $512,540, respectively, were netted against the $2,076,500 balance of the Notes on the Balance Sheet were being amortized over the life of the Notes in accordance with Emerging Issues Task Force issue 00-27 effective November 16, 2000. The unamortized balance of the beneficial conversion feature and debt discount at March 31, 2003 and June 30, 2002 was $0 and $269,634, respectively. On July 15, 2001 the Company sent a letter to all holders of the Notes explaining their right to convert their investment into common stock. The letter included a calculation of the interest the note holder had earned and offered to convert both the principal balance of the Note and the accrued interest into common stock at a conversion price of $2.50 per share. As of December 31, 2001, all Note holders, holding $2,147,295 of aggregate principal and accrued interest, had exercised their right to convert both principal and accrued interest into 859,279 shares of common stock. (8) Stockholders' Equity Nine months ended March 31, 2003 In July 2002, the Company issued 5,000 shares of common stock at a price of $3.00 a share relating to the private placement of common stock which closed during November 2001 for which all necessary paperwork had not previously been received. The Company had held these funds as a current liability pending the receipt of all proper paperwork. On December 6, 2002, the Company issued 26,675 shares of common stock in settlement of a finder's fee earned in connection with our private placement of common stock that closed in May 2002. On February 14, 2003 we issued 9,472 shares of our common stock in exchange for 9,472 Exchangeable Shares of StoresOnline.com, Ltd. held by a former employee. The shares of our common stock were issued pursuant to the provisions of a Stock Purchase Agreement dated November 1, 1998 which was entered into in connection with our acquisition of StoresOnline.com Ltd. (9) Related Entity Transactions Effective October 1, 2002 John J. Poelman, Chief Executive Officer and a director and stockholder of the Company, sold his interest in Electronic Commerce International, Inc. ("ECI") to an unrelated third party. The Company utilizes the services of ECI, a Utah corporation, to provide a credit card merchant account solution to our customers and, formerly, to provide a leasing opportunity to customers who purchased our products at the Internet training workshops. The Company buys a product from ECI that provides on-line, real-time processing of credit card transactions and resells it to its customers. John J. Poelman, was the sole owner of ECI during the three months ended September 30, 2002 and the nine months ended March 31, 2002. Total revenue generated by the Company from the sale of ECI merchant account solutions, while owned by Mr. Poelman, was $1,453,612 and $3,363,486 for the nine months ended March 31, 2003 and 2002, respectively. The cost to the Company for these products and services totaled $223,716 for the quarter ended September 30, 2002 and $720,930 for the nine months ended March 31, 2002. During the nine months ended March 31, 2003 and 2002 the Company processed leasing transactions for its customers through ECI, while owned by Mr. Poelman, in the amounts of $0 and $1,090,520, respectively. In addition, the Company had $0 and $26,702 as of March 31, 2003 and June 30, 2002, respectively, recorded in accounts payable relating to the amounts owed to ECI 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 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. The Company utilizes Electronic Marketing Services, LLC. ("EMS") to fulfill these services to 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. The Company's revenues generated from the above products and services were $5,609,553 and $3,196,348 for the nine months ended March 31, 2003 and 2002, respectively. The Company paid EMS $692,845 and $353,392 to fulfill these services during the nine months ended March 31, 2003 and 2002, respectively. In addition, the Company had $76,165 and $53,023 as of March 31, 2003 and June 30, 2002, respectively, recorded in accounts payable relating to the amounts owed to EMS for product and services. The Company sends 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 our products at the conclusion of the Workshop. The Company utilizes Simply Splendid, LLC ("Simply Splendid"), which offered the lowest price compared to several alternatives, to provide these gift packages to the Company's customers. Aftyn Morrison, who owns Simply Splendid, is the daughter of John J. Poelman, Chief Executive Officer, a director and a stockholder of the Company. The Company paid Simply Splendid $273,382 and $0 to fulfill these services during the nine months ended March 31, 2003 and 2002, respectively. In addition, the Company had $12,054 and $0 as of March 31, 2003 and June 30, 2002, respectively, recorded in accounts payable relating to the amounts owed to Simply Splendid for services. (10) Earnings Per Share Unexercised stock options to purchase 900,903 shares of the Company's common stock and unexercised warrants to purchase 484,708 shares of the Company's common stock were outstanding as of March 31,2003, of which 595,000 stock options and 269,640 warrants were included in the diluted per share computation. Unexercised stock options to purchase 595,000 shares of the Company's common stock and unexercised warrants to purchase 269,640 shares of the Company's common stock were included in the computation of diluted loss per share for the quarter ending March 31,2003 and for the nine month period ending March 31, 2003. The following data was used in computing earnings per share: <TABLE> <CAPTION> Three Months Ended Nine Months Ended ----------------------------- ----------------------------- March 31, March 31, March 31, March 31, 2003 2002 2003 2002 -------------- -------------- ------------- -------------- <S> <C> <C> <C> <C> Net Earnings available to common shareholders $ 1,596,941 $ 377,337 $ 3,420,431 $ 2,526,957 Basic EPS - ----------------------------------------------------------------------------------------------------------- Common shares outstanding entire period 11,026,195 4,657,073 10,995,774 2,446,019 Weighted average common shares: Issued during period 4,736 176,389 15,296 1,671,117 Canceled during period _ - - - -------------- -------------- ------------- -------------- Weighted average common shares outstanding during period 11,030,931 4,833,462 11,011,070 4,117,136 -------------- -------------- ------------- -------------- Earnings per common share - basic $ 0.14 $ 0.08 $ 0.31 $ 0.61 ============== ============== ============= ============== Diluted EPS - ----------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding during period - basic 11,030,931 4,833,462 11,011,070 4,117,136 Dilutive effect of common stock equivalents 259,309 - 208,045 18,643 -------------- -------------- ------------- -------------- Weighted average common shares outstanding during period - diluted 11,290,240 4,833,462 11,219,115 4,135,779 -------------- -------------- ------------- -------------- Earnings per common share - diluted $ 0.14 $ 0.08 $ 0.30 $ 0.61 ============== ============== ============= ============== </TABLE>
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, 2002, filed on October 15, 2002, 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 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. Review by the Securities and Exchange Commission On March 6, 2002, the Securities and Exchange Commission ("SEC") notified us that they 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 requesting 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 any change in our accounting policies or previously reported financial statements. 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 in 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 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. Senior management has discussed the development, selection and disclosure of these estimates with the Board of Directors. There are currently four members on the Board of Directors and they together function as the Audit Committee of Imergent, Inc. Actual results may differ from these estimates under different assumptions or conditions. A summary of our significant accounting policies is set out in Note 2 to our Consolidated Financial Statements in our Form 10-K for the fiscal year ended June 30, 2002. We believe the critical accounting policies described below reflect our more significant estimates and assumptions used in the preparation of these unaudited condensed 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. 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. Revenue Recognition During the fiscal year ended June 30, 2001 the Company changed its product offering at its Internet training workshops. The date of the change was October 1, 2000, the beginning of our second fiscal quarter of fiscal year 2001. Prior to that time, customers were sold a service consisting of the custom construction of Internet websites for their business, which service was to be provided at any time during the 12 months following the sale. Included in the price paid for this service was one year's hosting beginning when the website was published. Revenue from these transactions was deferred at the time of sale and recognized as the services were rendered or when the right to receive the services terminated. Beginning October 1, 2000, we discontinued selling the service and in its place sold 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 us. When a customer purchases a SOS license at one of our 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 our website where all the necessary tools are present to complete the construction of the customer's website. If they choose to host with us 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 computer file is provided to the purchaser at the time of purchase and can be used if the customer decides to create their website on their own completely without access to our 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. We accept cash and credit cards as methods of payment and we offer 24-month installment contracts to customers who prefer an extended payment term arrangement. 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. Installment contracts are carried on our books as a receivable and the revenue generated by these installment contracts is recognized when the product is delivered to the customer and the contract is signed. At that same time an allowance for doubtful accounts is established. This procedure was in effect for all of fiscal year 2002 and is still in effect for the nine-month period ended March 31, 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. The customer signs one of our order forms and a receipt acknowledging receipt and acceptance of the product. As is noted on the order and acceptance forms, all sales are final. All fees are fixed and final. Some states require a three-day right to rescind the transaction. Sales in these states are not recognized until the rescission period has expired. We offer customers the option to pay for the SOS license with Extended Payment Term Arrangements ("EPTAs"). The EPTAs generally have a twenty-four month term. We have offered our customers the payment option of a long-term installment contract for more than five years and have a history of successfully collecting under the original payment terms without making concessions. Over the past five years, we have collected or are collecting approximately 70% of all EPTAs issued to customers. Not all customers live up to their obligations under the contracts. We make every effort to collect on the EPTAs, including the engagement of professional collection services. Despite our efforts, approximately 30 percent of all EPTAs are determined to be uncollectible. All uncollectible EPTAs are written off against an allowance for doubtful accounts. The allowance is established at the time of sale based on our four-year history of extending EPTAs. As a result, revenue from the sale of the SOS is recognized upon the delivery of the product. 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 trade accounts receivable balances on our condensed consolidated balance sheets, totaled approximately $5.6 million as of March 31, 2003 compared to approximately $3.3 million as of June 30, 2002. 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 deteriorates, 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 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. Our net operating loss carry forward ("NOL"), representing the losses reported for tax purposes from the inception of the Company through June 30, 2002 is subject to a limitation as defined in Section 382 of the Internal Revenue Code. Operating losses from prior years are normally available to offset taxable income in subsequent years. However, Section 382 places a limitation on the amount that can be used in any one year if a "change in control" as defined in the Internal Revenue Code has occurred. Since its formation, the Company has issued a significant number of shares and purchasers of those shares have sold some of them, with the result that a change of control as defined by Section 382 has occurred. We currently estimate that the available NOL for the fiscal year ended June 30, 2003 will be approximately $2.7 million, but we have not concluded our analysis. RELATED PARTY TRANSACTIONS Effective October 1, 2002 John J. Poelman, Chief Executive Officer and a director and stockholder of the Company, sold his interest in Electronic Commerce International, Inc. ("ECI") to an unrelated third party. The Company utilizes the services of ECI, a Utah corporation, to provide a credit card merchant account solution to our customers and, formerly, to provide a leasing opportunity to customers who purchased our products at the Internet training workshops. The Company buys a product from ECI that provides on-line, real-time processing of credit card transactions and resells it to its customers. John J. Poelman, was the sole owner of ECI during the three months ended September 30, 2002 and the nine months ended March 31, 2002. Total revenue generated by the Company from the sale of ECI merchant account solutions, while owned by Mr. Poelman, was $1,453,612 and $3,363,486 for the nine months ended March 31, 2003 and 2002, respectively. The cost to the Company for these products and services totaled $223,716 for the quarter ended September 30, 2002 and $720,930 for the nine months ended March 31, 2002. During the nine months ended March 31, 2003 and 2002 the Company processed leasing transactions for its customers through ECI, while owned by Mr. Poelman, in the amounts of $0 and $1,090,520, respectively. In addition, the Company had $0 and $26,702 as of March 31, 2003 and June 30, 2002, respectively, recorded in accounts payable relating to the amounts owed to ECI 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 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. The Company utilizes Electronic Marketing Services, LLC. ("EMS") to fulfill these services to 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. The Company's revenues generated from the above products and services were $5,609,553 and $3,196,348 for the nine months ended March 31, 2003 and 2002, respectively. The Company paid EMS $692,845 and $353,392 to fulfill these services during the nine months ended March 31, 2003 and 2002, respectively. In addition, the Company had $76,165 and $53,023 as of March 31, 2003 and June 30, 2002, respectively, recorded in accounts payable relating to the amounts owed to EMS for product 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 these gift packages to the Company's customers. Aftyn Morrison, who owns Simply Splendid, is the daughter of John J. Poelman, Chief Executive Officer, a director and a stockholder of the Company. The Company paid Simply Splendid $273,382 and $0 to fulfill these services during the nine months ended March 31, 2003 and 2002, respectively. In addition, the Company had $12,054 and $0 as of March 31, 2003 and June 30, 2002, respectively, recorded in accounts payable relating to the amounts owed to Simply Splendid for services. 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 Nine-month period ended March 31, 2003 compared to the nine-month period ended March 31, 2002 Revenue Our fiscal year ends on June 30 of each year. Revenues for the nine-month period ended March 31, 2003 increased to $37,658,988 from $26,386,485 in the nine-month period ended March 31, 2002, an increase of 43%. 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, 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 2002. 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 the nine-month period ended March 31, 2003 compared to the nine-month period ended March 31, 2002 can be attributed to various factors. First, there was an increase in the number of Internet training workshops conducted during the current fiscal year to date. The number increased to 233, including 11 that were held outside the United States of America, for the current fiscal year from 187 in the nine-month period ended March 31, 2002, nine 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 91, compared to 76 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 an individual and his/her guest constitute one buying unit. If the person attends alone that single person also counts as one buying unit. Approximately 31% of the buying units made a purchase at the workshop in the current fiscal period compared to 29% in the comparable period of fiscal year 2002. The average revenue per workshop purchase also increased in the nine-month period of the fiscal year ended March 31, 2003 to approximately $4,500 compared to approximately $4,200 in the nine-month period ended March 31, 2002. We will seek to continue to hold workshops with a larger number of attendees in future quarters. We will seek to increase the number of these larger workshops during the balance of fiscal year 2003. Revenue during the nine-month period ended March 31, 2003 compared to the same nine-month period in fiscal year 2002 was higher in spite of the loss of a benefit relating to the recognition of revenue deferred from historical workshop sales at rates greater than the level at which revenue is required to be deferred from the current period. During the nine-month period ended March 31, 2003, we recognized only $246,107 in net revenue from sales made in prior periods compared to $5,184,996 recognized from sales made in prior periods during the nine-month period ended March 31, 2002.This benefit experienced during the nine-month period ended March 31, 2002 resulted from a change in the business model and product offering at the workshops. This benefit has now been fully realized and we do not expect it to reoccur. We anticipate that in future quarters the amount of revenue recognized from earlier periods will be approximately equal to that deferred into future periods. Effective January 1, 2002, we began making our product offerings through our StoresOnline subsidiary rather than our Galaxy Mall subsidiary. This culminated an eighteen month long plan to fully incorporate the SOS throughout the engineering and programming departments, servers and infrastructure and to move away from a mall-based hosting environment. Our services have been used for several years by non-mall based merchants, and we believe that principles taught by us work equally well for stand-alone websites, as they do with sites hosted on the mall. Although Galaxy Mall remains an active website, all new customers are sold the SOS through our StoresOnline previews and workshops. 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 nine-month ended March 31, 2003 increased to $29,914,302 from $22,008,036 for the same nine-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 the nine-month period ended March 31, 2003 was 79% compared to 83% for the same nine-month period ended March 31, 2002. The reduction in the gross margin percentage was primarily attributable to the recognition of $5,184,996 in deferred revenue during the nine-month period ended March 31, 2002, as compared to $246,326 in deferred revenue that was recognized during the nine-month period ended March 31, 2003, which deferred revenue amounts had no costs associated with them because those costs were recognized at the time the products were delivered in the relevant prior periods. Cost of revenues includes related party transactions of $840,263 in the nine-month period ended March 31, 2003 and $720,930 in the comparable period of the prior fiscal year. These are more fully described in the notes to the condensed consolidated financial statements as Note 9. 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. Product Development Product development expenses consist primarily of payroll and related expenses. We had no product development expenses for the nine-month period ended March 31, 2003. Product development expenses in the nine-month period ended March 31, 2002 were $87,604. They consisted of work on the StoresOnline, version 4, product which is used in the StoresOnline Software sold at our Internet training workshops. 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 nine-month period ended March 31, 2003 increased to $13,205,515 from $9,481,051 in the nine-month period ended March 31, 2002. The increase in selling and marketing expenses is primarily attributable to the increase in the number of workshops held during the current year including having a greater number of attendees on average at each workshop and the associated expenses including advertising and promotional expenses necessary to attract the attendees. Advertising expenses for the nine-month period ended March 31, 2003 were approximately $5.4 million compared to $3.5 million in the nine-month period ended March 31, 2002. Selling and marketing expenses as a percentage of sales were 35% of revenues for the 2003 fiscal year to date and including the deferred revenue mentioned above, selling and marketing expenses were 36% for the nine-month period ended March 31, 2002. Selling and marketing expenses include related party transactions of $349,680 and $353,392 in the nine-month periods ended March 31, 2003 and 2002, respectively. These are more fully described in the notes to the condensed consolidated financial statements as Note 9. 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. We accept twenty-four 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 20% depending upon the credit worthiness of our customer. These discounts, which amounted to $1,087,118 in the nine-month period ended March 31, 2003, and $1,319,636 in the nine-month period ended March 31, 2002, are included in general and administrative expenses. General and administrative expenses for nine-month period ended March 31, 2003 decreased to $3,244,830 from $4,600,962 in the comparable period of the previous fiscal year. This decrease is partially attributable to the fact that in the period ended March 31, 2002 we incurred $555,201 in debt issuance costs associated with a convertible debenture owned by King William, LLC. Since King William converted the debenture into common stock, the debt issuance costs were written off rather than being amortized over the life of the debenture. Other items contributing to the reduction were a decrease in the 2003 nine-month period in payroll and related expenses that resulted from reducing the size of our workforce, elimination of certain consulting fees associated with financial public relations firms, and a reduction in legal and other professional expenses. Also during March 2003 we resolved a lawsuit brought by Category 5 Technologies, Inc. ("Cat 5"). In April 2002 Cat 5 had demanded that we reimburse them for $260,000 of their expenses associated with merger negotiations between our companies. (See "Legal Proceedings," below, for a more detailed explanation of this matter.) As a result we accrued that amount as a contingent liability during the quarter ended June 30, 2002. A settlement agreement was signed and the lawsuit dismissed eliminating the contingent liability and therefore the accrual was reversed in the period ended March 31, 2003 reducing general and administrative expenses. Further cost reductions in general and administrative expenses at current revenue levels are unlikely. We anticipate that general and administrative expenses will increase in future years as our business grows. 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. These installment contracts are sometimes sold to various 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 theses sales. 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 advertising, meeting room expense, travel, etc. have already been incurred, we believe extending this credit on these terms is prudent even though we incur significant bad debt expense. Bad debt expense was $9,816,200 in the nine-month period ended March 31, 2003 compared to $3,256,152 in the prior fiscal year. The increase is due to an increase in the number of workshops held, an increase in the number of installment contracts carried by us and to our recent collection experience. During the nine-month period ended March 31, 2003 workshop sales financed by installment contracts were approximately $16.0 million compared to $9.4 million in the comparable period of the prior fiscal year. As a percentage of workshop sales, however, installment contracts were 56% in the nine-month period ended March 31, 2003 compared to 59% in the nine-month period ended March 31, 2002. During the first fiscal quarter of fiscal year 2002 there were no finance companies willing to purchase our installment contracts. During the nine-month period ended March 31, 2003 the contracts carried by us, before any adjustment for an allowance for doubtful accounts, increased by approximately $5.5 million to approximately $12.7 million. The balance carried at June 30, 2002 was approximately $7.2 million. This required an increase in our allowance for doubtful accounts of approximately $2.3 million. Based on our increased volume of installment contracts, our collection history and the possible consequences of the full recourse installment contract sales it was necessary to increase the allowance for doubtful accounts to provide for possible future losses. The table below shows the activity in our allowance for doubtful accounts during the nine-month period ended March 31, 2003. Allowance balance at the beginning of the period $3,413,981 Plus provision for doubtful accounts 9,816,200 Less accounts written off (7,490,440) Plus collections on accounts previously written off 262,889 ---------------- Allowance balance at the end of the period $6,002,630 ================ 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 nine-month period ended March 31, 2003 was $549,414 compared to $265,962 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. Interest Expense Interest expense during the nine-month period ended March 31, 2003 decreased to $29,483 from $1,925,643 in the nine-month period ended March 31, 2002. Included in interest expense in the nine-month period ended March 31, 2002 was a one-time charge of $437,474 relating to the conversion of an 8% convertible debenture belonging to King William, LLC into common stock and a charge of $708,542 relating to the conversion into common stock of convertible long term notes held by investors who participated in a private placement of the notes in January and April 2001. Upon conversion of these items the debt discount previously recorded was written off in the nine-month period ended March 31, 2002 instead of being amortized over the life of the notes. We have repaid most the various debt instruments, which created the balance of the interest expense for the nine-month period ended March 31, 2002. Income Taxes Fiscal year 2002 was the first profitable year for the Company since its inception. However, differences in generally accepted accounting principals ("GAAP") and accounting for tax purposes caused us to have a tax loss for the fiscal year ended June 30, 2002. For the nine-month period ended March 31, 2003 we have estimated our taxable income to be approximately $2,500,000. Total income taxes due on this amount are estimated to be approximately $1,000,000, of which $539,973 is deferred into future periods because of temporary differences between GAAP and tax accounting. The remaining $450,275 is the income tax expense reported for the nine-month period ended March 31, 2003. During the quarter ended March 31, 2003 we incurred a tax liability for the first time in this fiscal year after the application of the net operating loss carry forward ("NOL"). Our NOL, representing the losses reported for tax purposes from the inception of the Company through June 30, 2002, is subject to a limitation as defined in Section 382 of the Internal Revenue Code. Operating losses from prior years are normally available to offset taxable income in subsequent years. However, Section 382 places a limitation on the amount that can be used in any one year if a "change in control" as defined in the Internal Revenue Code has occurred. Since its formation, the Company has issued a significant number of shares and purchasers of those shares have sold some of them, with the result that a change of control as defined by Section 382 has occurred. We have estimated that the available NOL for the fiscal year ended June 30, 2003 will be approximately $2.7 million. We have undertaken a study to determine the amount of NOL that will be available to us for the balance of this fiscal year and into the future. We anticipate that this study will be completed before the end of our fiscal year, which is June 30, 2003. Therefore we have estimated that approximately $1,000,000 of income taxes will have to be paid on the net earnings for the nine-month period ended March 31, 2003 no later than June 15, 2003, unless the study indicates that additional NOL is available to reduce this liability. Three-month period ended March 31, 2003 compared to the three-month period ended March 31, 2002 Revenue Revenues for the three-month period ended March 31, 2003, our third fiscal quarter of fiscal year 2003, increased to $15,786,458 from $7,296,696 in the three month period ended March 31, 2002, an increase of 116%. Revenues for the quarter were effected by the same business model change described above in the discussion of the nine-month period ended March 31, 2003. The increase in revenues for the quarter ended March 31, 2003 compared to the three-month period ended March 31, 2002 can be attributed to various factors. There was an increase in the number of Internet training workshops conducted during the current quarter. The number increased to 87 compared to 50 in the quarter ended March 31, 2002. Although the average number of persons (buying units) attending each workshop during both periods remained essentially the same, the percentage of buying units making a purchase in the period ended March 31, 2003 was approximately 36% compared to only approximately 28% in the quarter ended March 31, 2002. The size of the average purchase made at the workshops in the quarter ended March 31, 2003 as approximately $4,700 compared to $4,200 in the comparable quarter of the prior fiscal year. Revenue during the quarter ended March 31, 2003 compared to the same period of the prior fiscal year was higher in spite of the loss of a benefit relating to the recognition of revenue deferred from historical workshop sales at rates greater than the level at which revenue is deferred from the current period. During the quarter ended March 31, 2003 we deferred revenue of $59,384 from current period sales into future periods whereas in the quarter ended March 31, 2002 we recognized revenue of $423,022 of net deferred revenue from sales made in prior periods. Gross Profit Gross profit for the fiscal quarter ended March 31, 2002 increased to $12,724,229 from $5,804,382 in the comparable period of the prior year. The increase in gross profit primarily reflects the increased revenue. Gross profit as a percent of revenue for the quarter ended March 31, 2003 was 81% compared to 80% for the quarter ended March 31, 2002. Cost of revenues includes related party transactions of $348,807 in the quarter ended March 31, 2003 and $157,437 in the comparable period of the prior fiscal year. These are more fully described in the notes to the condensed consolidated financial statements as Note 9. 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. Product Development We had no product development expenses for the quarter ended March 31, 2003. Product development expenses in the quarter ended March 31, 2002 were $19,654. They consisted of work on the StoresOnline, version 4, product that is used in the StoresOnline Software. Selling and Marketing Selling and marketing expenses for the quarter ended March 31, 2003 increased to $5,017,218 from $3,105,077 in the quarter ended March 31, 2002. The increase in selling and marketing expenses is primarily attributable to the increase in the number of workshops held during the current quarter and the associated expenses including advertising and promotional expenses necessary to attract the attendees. Advertising expenses for the quarter ended March 31, 2003 were approximately $2.0 million compared to $1.2 million in the quarter ended March 31, 2002. Selling and marketing expenses as a percentage of sales were 32% of revenues for the 2003 fiscal quarter compared to 43% for the quarter ended March 31, 2002. Selling and marketing expense includes related party transactions of $160,277 and $85,866 in the quarters ended March 31, 2003 and 2002, respectively. These are more fully described in the notes to the condensed consolidated financial statements as Note 9. 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. General and Administrative General and administrative expenses for the quarter ended March 31, 2003 increased to $1,197,797 from $968,712 in the comparable quarter of the previous fiscal year. This increase is attributable to payroll and related expenses, increased accounting fees and an increase in financial discounts associated with the installment contracts we accept as one form of payment from our customers. (See the discussion for the nine-month period above for a complete explanation of financial discounts.) General and administrative expenses during the quarter ended March 31, 2003 increased in spite of the reversal of an accrued liability of $260,000 associated with the Category 5 Technologies, Inc. settlement, which is described in detail in the discussion of general and administrative expenses for the nine-month period ended March 31, 2003 above. We anticipate that general and administrative expenses will increase in future quarters as our business grows. Bad Debt Expense Bad debt expense was $4,611,640 in the quarter ended March 31, 2003 compared to $1,251,021 in the same quarter of the prior fiscal year, an increase of $3,360,619. The increase is due to an increase in the number of workshops held, an increase in the number of installment contracts generated at those workshops as a percentage of total units sold, an increase in the number of contracts carried by us and to our recent collection experience. During the quarter ended March 31, 2003 the contracts carried by us increased by approximately $3.1 million. The table below shows the activity in our allowance for doubtful accounts during the quarter ended March 31, 2003. Allowance balance at the beginning of the quarter $4,593,880 Plus provision for doubtful accounts 4,611,640 Less accounts written off (3,259,756) Plus collections on accounts previously written off 56,866 --------------- Allowance balance at the end of the quarter $6,002,630 =============== Interest Income Interest income for the three-month period ended March 31, 2003 was $218,197 compared to $96,577 in the comparable period of the prior fiscal year. Interest income is derived from the installment contracts carried by the Company. Income Taxes We have net operating loss carry forwards sufficient to reduce our provision for income taxes for the quarter ended March 31, 2003 to $450,275, therefore, we have established a provision for federal income taxes in that amount in our Statement of Earnings. See the discussion above for the nine-month period ended March 31, 2003 for a more detailed explanation of our income tax situation. LIQUIDITY AND CAPITAL RESOURCES The accompanying financial statements have been prepared on the basis that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has incurred losses from its inception through the fiscal year ended June 30, 2001. The Company was profitable during the fiscal year ended June 30, 2002 and has been profitable for the nine-month period ended March 31, 2003. The Company, however, has a cumulative net loss of $66,100,030 through March 31, 2003. At March 31, 2003 the Company had $926,121 cash on hand, working capital of $3,293,997 and equity of $6,331,185. Management believes that through future profitable operations and the raising of additional equity or debt capital, if necessary, the Company will be able to continue operating as a going concern. However, there can be no assurance that if additional capital is required that it will be available. The unaudited condensed consolidated financial statements do not include any adjustments that might result from the inability to continue as a going concern . Cash At March 31, 2003, we had $926,121 of cash on hand, an increase of $406,373 from June 30, 2002. Net cash provided by operating activities was $853,934 for the nine-month period ended March 31, 2003. The significant items contributing to net cash provided by operating activities were net income of $3,420,431, a provision for bad debts of $9,816,200, and depreciation and amortization of $309,321, but partially offset by an increase in accounts receivable of $12,181,097. The increase in accounts receivable occurred because we generated approximately $12 million in installment contracts during the nine-month period ended March 31, 2003 that were not sold to finance companies. Because the contracts are sold on a discounted basis, over the life of the contract we will have a greater cash flow from collecting the monthly payments than from selling them. The decision to sell or retain the contracts is part of our cash management system and is governed by our cash requirements at the time. Trade Receivables Trade receivables, carried as a current asset, net of allowance for doubtful accounts, were $4,842,742 at March 31, 2003 compared to $2,247,129 at June 30, 2002. Trade receivables, carried as a long-term asset, net of allowance for doubtful accounts, were $2,243,574 at March 31, 2003 compared to $1,673,740 at June 30, 2002. 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 March 31, 2003 are carried as long-term trade receivables. A significant portion of our revenue is derived each year from installment contract sales. During the nine-month periods ended March 31, 2003 and 2002 the percentage of total revenue attributable to installment contracts was approximately 42% and 36% respectively. During the nine-months ended March 31, 2003 we generated approximately $16.0 million in installment contracts of which approximately $3.9 million were sold upon origination to finance companies with the balance being carried by us. After the contracts carried by the Company have been successfully collected for a period of between 3 and 6 months they become eligible for purchase by finance companies. During October 2002, we sold some of these aged contracts having a principal balance of approximately $405,000 and they generated approximately $317,000 in cash for us. Additional contracts are currently eligible for sale and may be sold from time to time as our cash requirements dictate. Accounts Payable Accounts payable, including related party transactions, at March 31, 2003, totaled $1,094,373 as compared to $1,327,102 at June 30, 2002. As of March 31, 2003 our accounts payable were generally within our vendor's terms. Deferred Revenue Deferred revenue, to be recognized in future periods, totaled $459,451 at March 31, 2003 as compared to $705,558 at June 30, 2002. We recognize deferred revenue as our services related thereto are rendered or when the time period in which customers have the right to receive the services expires. The decrease from the prior fiscal year end is the result of a change in the products offered starting October 1, 2000 at our Internet training workshops. Under this new model, we now recognize most of the revenue generated at our Internet workshops at the time of the sale and delivery of the SOS product to our customer. Stockholders' Equity Stockholders' equity increased to $6,331,185 at March31, 2003, as compared to $2,468,574 at June 30, 2002. This mainly resulted from net earnings during the current nine-month period. Financing Arrangements We accept payment for the sales made at our Internet training workshops by cash, credit card, installment contract, or until December 31, 2001, by a third party leasing option. 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. Impact of Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 141, "Business Combinations" and No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which establishes new standards for the treatment of goodwill and other intangible assets. SFAS 142 is effective for fiscal years beginning after December 31, 2001 and permits early adoption for companies with a fiscal year beginning after March 15, 2001. SFAS 142 prescribes that amortization of goodwill will cease as of the adoption date. Additionally, we were required to perform an impairment test within six months as of the adoption date, annually thereafter, and whenever events and circumstances occur that might affect the carrying value of these assets. SFAS 142 was applicable to the Company beginning July 1, 2002. As a result we discontinued the amortization of goodwill and arranged for an independent evaluation to determine if an impairment to our goodwill existed. We hired an independent consulting firm to perform an appraisal as of December 31, 2002. Based on their report, management found that no impairment existed. We are now obligated to make this review annually as of December 31 of each year or sooner if events and circumstances occur that might affect the carrying value of our goodwill. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). Under this standard, asset retirement obligations will be recognized when incurred at their estimated fair value. In addition, the cost of the asset retirement obligations will be capitalized as a part of the asset's carrying value and depreciated over the asset's remaining useful life. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact on our financial condition or results of operations. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). This standard requires that all long-lived assets (including discontinued operations) that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for fiscal years beginning after December 15, 2001. We do not expect the implementation of SFAS 144 to have a material effect on our financial condition or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002" (SFAS 145). This standard rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements and excludes extraordinary item treatment for gains and losses associated with the extinguishment of debt that do not meet the APB Opinion No. 30, Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB 30) criteria. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. SFAS 145 also amends SFAS 13, Accounting for Leases as well as other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Certain provisions of SFAS 145 are effective for transactions occurring after May 15, 2002 while other are effective for fiscal years beginning after May 15, 2002. We have not assessed the potential impact of SFAS 145 on our financial condition or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146). This standard addresses financial accounting and reporting for costs associated with exit or disposal activities and replaces Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (EITF 94-3). SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for exit costs, as defined in EITF No. 94-3 were recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated by the Company after December 31, 2002. Since we have had no Exit or Disposal activity since December 31, 2002, we do not expect the implementation of SFAS 144 to have a material effect on our financial condition or results of operations. In October, 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions (SFAS 147). This standard relates to acquisitions of financial institutions and is not expected to affect the Company's financial condition or results of operations. In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure" (SFAS 148). This standard amends the disclosure and certain transition provisions of SFAS 123, Accounting for Stock-Based Compensation. Its disclosure provisions are effective for interim periods beginning after December 15, 2002. The Company does not expect that adoption of SFAS 148 will have a material impact on its financial condition or results of operations. Item 3. Quantitative and Qualitative Disclosures about Market Risk We do not believe we have material market risk exposure. We do not invest in market risk sensitive instruments for trading purposes. Our excess cash is placed in short-term interest-bearing accounts or instruments that are based on money market rates. Item 4. Controls and Procedures Within the 90-day period prior to the filing of this report, evaluations were carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based upon those evaluations, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluations. PART II - OTHER INFORMATION Item 1. Legal Proceedings. In April 2002 Category 5 Technologies, Inc. ("Cat 5") filed a lawsuit seeking reimbursement of $260,000 of their expenses associated with merger negotiations between our companies. We have resolved this matter and entered into a First Amendment to Termination Agreement with Cat 5 dated as of March 10, 2003 memorializing that resolution. On April 9, 2003 a STIPULATION OF SETTLEMENT AND ORDER OF DISMISSAL, Case No. 020902991 was signed by Judge J. Dennis Frederick dismissing the lawsuit with prejudice. The Company previously reported that it was the subject of a nonpublic investigation by the Federal Trade Commission. The first investigation activity began nearly five years ago when the FTC had announced what they refer to as a "sweep" of the industry. The Company cooperated fully with all requests for information and details, and after over a year's investigation, no action against the Company was taken and the case went dormant. During this same period of time, other unrelated companies and individuals targeted by the FTC were subject to consent agreements and injunctions and paid large financial penalties. Some of those companies are no longer in business. About two years ago, based on various allegations and customer complaints, the FTC re-opened its investigation of the Company, requesting once again complete details about the Company, its marketing, sales, customer service policies and other matters. The FTC also obtained details regarding customer complaints from the Better Business Bureau and various AG offices, and was fully aware of the "wrong doings" alleged by a nationally broadcast television story. In addition, FTC representatives attended one or more of the Company's workshops, visited the Company's offices and were afforded an opportunity to review the Company's customer files. After nearly two years in this most recent investigation, the Company received written notice that the FTC investigation has been officially closed. In its letter the FTC's states that it "... has conducted a nonpublic investigation to determine whether Galaxy Mall and related entities have violated the Federal Trade Commission Act through the use of deceptive practices in connection with the sale of electronic "storefronts" or web sites or storefront-related products or services." and concludes in part by stating, "Upon further review of this matter, it now appears that no further action is warranted by the Commission at this time. Accordingly, the investigation has been closed." The FTC letter also states that "The Commission reserves the right to take such further action as the public interest may require." The Company certainly regrets even one complaint, but can no more accept responsibility for failure of a business that purchases its products and services than the telephone company, a computer manufacturer or a business college, can accept responsibility for the failure of a customer or student to achieve success using, or not using, their telephone or computer or the knowledge learned from a college course. Although the Company is constantly looking for ways to improve its products and services, because its products and services are used by entrepreneurs and small businesses with such a broad range of objectives, backgrounds and skills, the Company anticipates that it will continue to receive complaints from some of its customers who are not able to successfully extend their business on the Internet. Regardless, the Company remains committed to work with and assist each of its customers by providing them information and tools necessary to help them extend their business to the Internet. The Company is pleased that the FTC's investigations over this long period of time have been closed without any formal action by the agency. The Company has long believed that it operates its business with integrity and in compliance with applicable laws and regulations. The Company fully supports the various federal and state agencies that it interacts with and, as in the past, will continue to cooperate with them. From time to time, we receive inquiries from and/or have been made aware of investigations by government officials in many of the states in which we operate, as well as by the Federal Trade Commission. These inquiries and investigations generally concern compliance with various city, county, state and/or federal regulations involving sales and marketing practices. We have and do respond to these inquiries and have generally been successful in addressing the concerns of these persons and entities, although there is often no formal closing of the inquiry or investigation. The Federal Trade Commission investigation has been resolved as indicated above. There can be no assurance that the ultimate resolution of these or other inquiries and investigations will not have a material adverse effect on our business or operations. 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. Item 2. Changes in Securities and Use of Proceeds Recent Sales of Unregistered Securities On February 14, 2003 we issued 9,472 shares of our common stock at a price of $1.95 per share in exchange for 9,472 Exchangeable Shares of StoresOnline.com, Ltd. held by a former employee. The shares of our common stock were issued pursuant to the provisions of a Stock Purchase Agreement dated November 1, 1998 which was entered into in connection with our acquisition of StoresOnline.com Ltd. In our opinion, the issuance of these common shares was exempt by virtue of Section 4(2) of the Securities Act and the rules promulgated there under. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 99.1 Certification pursuant to 18 U.S.C. Section 1350 99.2 Certification pursuant to 18 U.S.C. Section 1350 (b) Reports on Form 8 K None. 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. By: /s/ John J. Poelman May 15, 2003 John J. Poelman Chief Executive Officer May 15, 2003 By: /s/ Frank C. Heyman Frank C. Heyman Chief Financial Officer
CERTIFICATIONS I, John J. Poelman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Imergent, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/ John J. Poelman John J. Poelman Chief Executive Officer
I, Frank C. Heyman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Imergent, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/ Frank C. Heyman Frank C. Heyman Chief Financial Officer