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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2004 Commission File No. 000-26363
IPIX Corporation
(Exact name of registrant as specified in its charter)
Delaware 52-2213841
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3160 Crow Canyon Road
San Ramon, California 94583
(Address of principal executive offices, zip code)
Registrant's telephone number, including area code: (925) 242-4002
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
21,529,831 shares of $0.001 par value common stock outstanding as of November 3,
2004.
1
IPIX CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
INDEX
PART I -- FINANCIAL INFORMATION......................................... 3
Item 1. Condensed Consolidated Financial Statements (unaudited)...... 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 21
Item 4. Controls and Procedures...................................... 22
PART II -- OTHER INFORMATION............................................ 23
Item 1. Legal Proceedings............................................ 23
Item 2. Changes In Securities And Use Of Proceeds.................... 23
Item 3. Defaults Upon Senior Securities.............................. 24
Item 4. Submission Of Matters To A Vote Of Security Holders.......... 24
Item 5. Other Information............................................ 24
Item 6. Exhibits And Reports On Form 8-K............................. 24
Signatures.............................................................. 25
Exhibit Index........................................................... 26
2
PART I--FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
IPIX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, September 30,
2003 2004
-------------- --------------
(1) (unaudited)
(In thousands)
ASSETS
Cash and cash equivalents......................................................................... $ 10,241 $ 18,064
Restricted short term investments................................................................. 1,100 800
Short term investments............................................................................ 331 645
Accounts receivable, net.......................................................................... 261 824
Inventory, net.................................................................................... 398 1,311
Prepaid expenses and other current assets......................................................... 1,523 1,527
----------- ------------
Total current assets........................................................................ 13,854 23,171
Computer hardware, software and other, net........................................................ 1,578 974
Restricted cash and other long term assets........................................................ 852 718
----------- ------------
Total assets................................................................................ $ 16,284 $ 24,863
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.................................................................................. $ 612 $ 1,343
Accrued liabilities............................................................................... 3,342 3,778
Deferred revenue.................................................................................. 76 92
Current portion of obligations under capital leases............................................... 608 112
----------- ------------
Total current liabilities................................................................... 4,638 5,325
Other long term liabilities....................................................................... 181 --
----------- ------------
Total liabilities........................................................................ 4,819 5,325
----------- ------------
STOCKHOLDERS' EQUITY:
Preferred stock (Aggregate liquidation value: $23,716 in 2003 and $7,208 in 2004)................. 1 --
Common stock...................................................................................... 9 21
Class B common stock.............................................................................. -- --
Additional paid-in capital........................................................................ 515,186 533,281
Accumulated deficit............................................................................... (503,731) (513,764)
------------ -------------
Total stockholders' equity.................................................................. 11,465 19,538
----------- ------------
Total liabilities and stockholders' equity.................................................. $ 16,284 $ 24,863
=========== ============
- ----------------------
(1) The December 31, 2003 balances were derived from the audited financial
statements.
See accompanying notes to the unaudited condensed consolidated financial
statements.
3
IPIX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended Nine months ended
September 30, September 30,
---------------------------- ------------------------
2003 2004 2003 2004
-------------- -------------- -------------- ---------
(In thousands, except per share data) (unaudited) (unaudited)
Revenue:
Security......................................................... $ 146 $ 724 $ 237 $ 1,130
AdMission........................................................ 5,811 276 17,471 810
InfoMedia........................................................ 666 741 1,858 1,824
--------- --------- -------- -----------
Total revenue................................................. 6,623 1,741 19,566 3,764
--------- --------- -------- -----------
Cost of revenue:
Security......................................................... 75 525 161 814
AdMission........................................................ 1,876 570 5,426 1,808
InfoMedia........................................................ 400 302 1,025 896
--------- ----------- ---------- -----------
Total cost of revenue......................................... 2,351 1,397 6,612 3,518
--------- --------- -------- --------
Gross profit.................................................. 4,272 344 12,954 246
--------- --------- -------- --------
Operating expenses:
Sales and marketing.............................................. 1,899 1,625 5,704 4,620
Research and development......................................... 1,198 952 3,626 2,874
General and administrative....................................... 1,001 1,220 2,664 2,837
--------- --------- -------- --------
Total operating expenses...................................... 4,098 3,797 11,994 10,331
--------- --------- -------- --------
Income (loss) from operations.................................... 174 (3,453) 960 (10,085)
Other............................................................ (20) 32 (103) 52
---------- --------- --------- --------
Net income (loss)................................................ 154 (3,421) 857 (10,033)
Preferred stock dividends........................................ (454) (133) (1,345) (757)
---------- --------- -------- --------
Net loss available to common stockholders........................ $ (300) $ (3,554) $ (488) $(10,790)
========== ========= ========= ========
Loss per common share, basic and diluted ........................ $ (0.04) $ (0.18) $ (0.07) $ (0.73)
Weighted average common shares, basic and diluted................ 7,613 19,625 7,147 14,807
See accompanying notes to the unaudited condensed consolidated financial
statements.
4
IPIX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended
September 30,
-----------------
2003 2004
------ -------
(In thousands) (unaudited)
Cash flows from operating activities:
Net income (loss)....................................................................................... $ 857 $ (10,033)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation............................................................................................ 2,725 749
Provision for doubtful accounts receivable.............................................................. 8 3
Changes in operating assets and liabilities:
Accounts receivable.................................................................................. 1,264 (566)
Inventory............................................................................................ (26) (913)
Prepaid expenses and other current assets............................................................ (1,099) (4)
Other long term assets............................................................................... 59 134
Accounts payable..................................................................................... 547 731
Accrued liabilities and other........................................................................ (144) 43
Deferred revenue..................................................................................... 2,981 16
---------- ----------
Net cash provided by (used in) operating activities............................................... 7,172 (9,840)
---------- -----------
Cash flows from investing activities:
Purchases of computer hardware, software and other...................................................... (883) (145)
Maturity of short term investments...................................................................... -- 1,431
Purchase of short term investments...................................................................... -- (1,445)
----------------------
Net cash used in investing activities............................................................. (883) (159)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock.................................................................. 1,432 5,512
Proceeds from issuance of common stock (PIPE), net...................................................... -- 4,898
Exercise of additional investment rights (AIR).......................................................... -- 5,394
Exercise of Series B Preferred Warrants................................................................. -- 2,988
Dividends paid in connection with Series B Preferred Stock conversions.................................. (14) (452)
Repayments of capital lease obligations................................................................. (1,894) (518)
----------------------
Net cash provided by (used in) financing activities............................................... (476) 17,822
---------------------
Effect of exchange rate changes on cash................................................................. 3 --
---------- ----------
Net increase in cash and cash equivalents............................................................... 5,816 7,823
Cash and cash equivalents, beginning of period.......................................................... 3,020 10,241
---------- ----------
Cash and cash equivalents, end of period................................................................ $ 8,836 $ 18,064
========== ==========
See accompanying notes to the unaudited condensed consolidated financial
statements
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
IPIX Corporation, formerly Internet Pictures Corporation, offers mission
critical imaging where visual content is required for the protection of life and
property and eCommerce. IPIX conducts its business through three business units
that share IPIX's patented technology: IPIX Security, IPIX AdMission and IPIX
InfoMedia. Our solutions create, process and manage a rich variety of media
including still images, Full-360 degree immersive images and video. IPIX
Security is a supplier of Full-360 video surveillance technology for critical
government and commercial security applications that provide complete and
continuous situational awareness. IPIX AdMission offers services that visually
enhance online auctions and real estate listings. IPIX InfoMedia supports the
creation of Full-360 degree panoramic photography and movies content.
Our extensive intellectual property covers patents for Full-360 imaging, video
and surveillance applications and image management.
The accompanying unaudited condensed consolidated financial statements include
the accounts of IPIX Corporation and its wholly-owned subsidiaries, Interactive
Pictures Corporation, Interactive Pictures UK Limited, Internet Pictures
(Canada), Inc. and PW Technology, Inc. The consolidation of these entities will
collectively be referred to as the Company or IPIX. All significant intercompany
balances and transactions have been eliminated. We ceased operations in our
Canadian and United Kingdom subsidiaries and we are in the process of
liquidation of those subsidiaries.
We have prepared these financial statements, without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United State of America have been omitted. The unaudited condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in our audited financial
statements as of and for the year ended December 31, 2003.
The information furnished reflects all adjustments which management believes are
necessary for a fair presentation of our financial position as of September 30,
2004 and the results of our operations for the three and nine month periods
ended September 30, 2003 and 2004 and our cash flows for the nine month periods
ended September 30, 2003 and 2004. All such adjustments are of a normal
recurring nature. The results of operations for the three and nine month periods
ended September 30, 2003 and 2004 are not necessarily indicative of the results
to be expected for the respective full years.
2. GOING CONCERN CONSIDERATIONS
The accompanying financial statements have been presented in accordance with
accounting principles generally accepted in the United States of America, which
assume the continuity of the Company as a going concern. During the quarter
ended September 30, 2004 and in the prior fiscal periods, we experienced and
continue to experience, certain going concern issues related to cash flow and
profitability.
During 2003, we changed our relationship with our largest customer, eBay, which
represented 87% of revenue for the year ended December 31, 2003. eBay licensed
technology from us that we had previously used to provide eBay with recurring
services. After 2003, we no longer provide any services to eBay. As a result, we
have a limited operating history as we are operating in 2004 and upon which an
evaluation of our business and prospects may be made. In addition, we are
subject to generally prevailing economic conditions and, as such, our operating
results in 2004 and beyond will be dependent upon our ability to provide quality
products and services, the success of our customers and the appropriations
processes of various commercial and governmental entities.
Management believes, however, that we have sufficient cash resources to meet our
funding needs through at least the next twelve months. We finished the third
quarter of 2004 with approximately $20.1 million in cash reserves (cash and cash
equivalents of $18.1 million, short term restricted investments of $0.8 million,
long term restricted cash of $0.6 million and short term investments of $0.6
million). We have three business units all at different stages in their
development. Management expects to continue to make significant investments in
the development, sale and marketing of new products for the security market and
in the image management business, which may consume some of our cash reserves.
6
3. CASH, CASH EQUIVALENTS AND RESTRICTED SHORT TERM INVESTMENTS
We consider all highly liquid debt instruments with a remaining maturity at date
of purchase of three months or less to be cash equivalents.
At September 30, 2004, we had a $1.4 million short term investment which matures
on June 19, 2005, $0.8 million of which has been provided as collateral for
certain capital lease obligations and, accordingly, classified as restricted
short term investments. We will renew the investment for successive short term
periods until the capital lease obligation restrictions are removed. At
September 30, 2004, we also had $0.6 million of cash deposits restricted as
collateral on a letter of credit for certain co-location facility leases
expiring in 2006 and, accordingly, classified as long term restricted cash.
4. EQUITY
On April 5, 2004, we completed the sale of 909,090 shares of our common stock,
resulting in net proceeds received of approximately $4.9 million, and additional
investment rights ("AIR") to purchase another 888,179 shares of our unregistered
common stock in a private offering to accredited institutional investors
("PIPE"). The shares of common stock were sold at $5.50 per share and the shares
of common stock underlying the AIR are purchasable at $6.05 per share. The AIR
was exercisable until September 28, 2004. As of September 30, 2004, all of the
AIR's had been exercised: 799,361 shares of common stock in the third quarter
and 88,818 shares in the second quarter. Our proceeds from the AIR exercises
were $5.4 million. The common stock sold in the PIPE and from the AIR's has been
registered under the Securities Act of 1933, as amended, and may be offered or
sold in the United States. Our Form S-3 filed on May 5, 2004 provides a
description of this transaction and copies of the executed documents.
During the three months ended March 31, 2004, we issued 442,144 shares of common
stock upon exercise of stock options. Our total proceeds from the first quarter
option exercises were $0.6 million, $0.3 million of which was collected on April
1, 2004. During the quarter ended June 30, 2004, we issued 1,511,680 shares of
common stock upon exercise of stock options. Our proceeds from the second
quarter option exercises were $4.2 million. During the quarter ended September
30, 2004, we issued 185,127 shares of common stock upon exercise of stock
options. Our proceeds from the third quarter option exercises were $0.4 million.
During the quarter ended June 30, 2004, we sold 91,140 shares of common stock to
employees under the IPIX Employee Stock Purchase Plan ("ESPP"). Our proceeds
from these ESPP purchases were $0.1 million. As of September 30, 2004, we have
collected $0.2 million for our employees' fourth quarter 2004 ESPP purchases.
On May 14, 2001, we entered into a definitive agreement with Image Investor
Portfolio, a separate series of Memphis Angels, LLC ("Image") for an investment
by Image in the Company. Pursuant to the terms of a securities purchase
agreement between the Company and Image dated as of May 14, 2001, Image
purchased from us a $10 million convertible senior secured note and received
Tranche A and Tranche B warrants with the right to purchase up to $20 million of
our Series B Preferred Stock. Each share of the Series B Preferred Stock is
convertible into approximately 9.2 shares of common stock and is entitled to
vote on matters submitted to holders of common stock on an as-converted basis.
On September 26, 2001, the Company, Image and strategic investors completed the
Tranche B stage of the investment. At that time, we issued 1,115,080 shares of
Series B Preferred Stock for total consideration of $22.3 million, represented
by the conversion of the $10 million note, the conversion of $0.3 million of
interest on the Note and $12 million in cash through the exercise of Tranche B
warrants. The remainder of the Tranche B warrants expired.
At December 31, 2003, there were two Tranche A warrants ("Warrant 1" and
"Warrant 2") outstanding. As of September 30, 2004, Warrant 1, which entitled
the holders to purchase 150,000 shares of Series B Preferred Stock at $20 per
share, has been exercised in full. We issued 1,375,600 shares of common stock in
the third quarter of 2004 and received $3.0 million in cash from the exercise of
part of Warrant 1 and the conversion of the underlying Series B Preferred Stock.
During the second quarter of 2004, 600 shares of the rest of Warrant 1 were
converted into 4,372 shares of common stock. We did not receive any proceeds
from the second quarter Warrant 1 exercise. Warrant 2 entitles the holders to
purchase 100,000 shares of Series B Preferred Stock at $40 per share and is
exercisable at any time before the expiration date of May 14, 2006. During the
second quarter of 2004, 400 shares of Warrant 2 were converted into 2,914 shares
of common stock. We did not receive any proceeds from the second quarter Warrant
2 exercise.
7
5. INCOME (LOSS) PER COMMON SHARE
Basic income (loss) per common share is computed by dividing net income (loss)
available to common stockholders for the period by the weighted average number
of shares of common stock outstanding. Net income (loss) available to common
stockholders is calculated as the net income (loss) less cumulative preferred
stock dividends for the period. If dilutive, the participation right of the
preferred stock is reflected in the calculation of basic income (loss) per share
using the "if converted" method or the "two class method," if more dilutive.
Diluted income (loss) per common share is computed by dividing net income (loss)
for the period by the weighted average number of shares of common stock
outstanding plus, if dilutive, potential common stock outstanding during the
period.
The following table sets forth the computation of basic and dilutive loss per
common share for the periods indicated:
Three months ended Nine months ended
September 30, September 30,
-------------------------- ---------------------
(In thousands, except per share) 2003 2004 2003 2004
------------ ------------ --------- ----------
(unaudited) (unaudited)
NUMERATOR:
Net income (loss).................................................... $ 154 $ (3,421) $ 857 $(10,033)
Preferred stock dividends............................................ (454) (133) (1,345) (757)
--------- --------- -------- --------
Net loss available to common stockholders............................ $ (300) $ (3,554) $ (488) $(10,790)
========= ========= ======== ========
DENOMINATOR:
Weighted average shares outstanding -- Basic and diluted........... 7,613 19,625 7,147 14,807
========= ========= ======== ========
LOSS PER COMMON SHARE, BASIC AND DILUTED............................. $ (0.04) $ (0.18) $ (0.07) $ (0.73)
========= ========= ======== ========
The following table sets forth potential common shares that are not included in
the diluted net loss per common share calculation because to do so would be
antidilutive for the three months ended September 30, 2003 and 2004 as a result
of the net loss available to common stockholders:
(Shares in thousands) Three months ended
September 30,
--------------------------
2003 2004
------------- ---------
Stock options.................................. 1,573 1,685
Convertible preferred stock.................... 11,002 2,835
Series B Warrants.............................. 492 448
Not included in the table above, were the following rights to purchase common
stock where the average exercise price was greater than the average common share
price during the period and, accordingly, they were excluded from diluted net
loss per common share for the three month periods ended September 30, 2003 and
2004:
(Shares in thousands) Three months ended
September 30,
------------------------
2003 2004
------------- ---------
Average share price of IPIX common stock................................... $ 3.39 $ 8.50
Stock options:
Average exercise price of options....................................... $ 55.68 $ 114.32
Shares excluded......................................................... 316 112
Series B Warrants (exercise price $4.34)................................... 921 --
Common Warrants (average exercise price $165.33)........................... 137 137
8
6. RESTRUCTURING AND OTHER
During the nine months ended September 30, 2004, $0.2 million of payments were
made against our restructuring accrual. No additions were made to the accrual
during the nine months ended September 30, 2004. At September 30, 2004 the
remaining balance in the restructuring accrual was $0.2 million.
7. STOCK-BASED COMPENSATION -- FAIR VALUE DISCLOSURES
We comply with the disclosure provisions of Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based
Compensation" ("FAS 123"). We have elected, however, to continue accounting for
stock-based compensation issued to employees using Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25").
Under APB 25, compensation expense is based on the difference, if any, on the
date of grant, between the fair value of our stock and the exercise price of the
option. Stock and other equity instruments issued to non-employees have been
accounted for in accordance with FAS 123 and Emerging Issues Task Force Issue
No. 96-18, "Accounting for Equity Instruments Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods, or Services."
Pro forma information regarding our net income (loss) is required by FAS 123 and
FAS 148 "Accounting for Stock-Based Compensation, Transition and Disclosure,"
and has been determined as if we had accounted for the stock options under the
fair value method of FAS 123.
The computations for pro forma basic and diluted loss per share follow:
Three months ended Nine months ended
September 30, September 30,
-------------------------- -------------------------
(In thousands, except per share data) 2003 2004 2003 2004
------------- ------------ ------------- ----------
(unaudited) (unaudited)
-------------------------- -------------------------
Net loss available to common stockholders............................ $ (300) $ (3,554) $ (488) $ (10,790)
Less total stock-based employee compensation expense
determined under fair value based methods for all awards......... (347) (505) (1,213) (1,786)
---------- ----- ------- -------
Adjusted net loss available to common stockholders................... $ (647) $ (4,059) $ (1,701) $ (12,576)
========== ========== ========= =========
Basic and diluted loss per common share:
Net loss available to common stockholders before pro forma charges.. $ (0.04) $ (0.18) $ (0.07) $ (0.73)
Net effect of pro forma charges..................................... (0.04) (0.03) (0.17) (0.12)
----------- ----------- ----------- -----------
Adjusted net loss per common share available to common stockholders.... $ (0.08) $ (0.21) $ (0.24) $ (0.85)
========== ======== ========== ========
Grants under the ESPP have a look-back feature and a 15% discount and
accordingly under FAS 123 would have had compensation expense calculated as a
result. The fair value disclosure associated with the ESPP grants is included in
the fair value pro-forma information above.
We calculated the fair value of each award on the date of grant using the
Black-Scholes pricing model. The following assumptions were used for each
respective period:
Three Months Ended
September 30,
-------------
2003 2004
---- ----
Risk-free interest rates......................... 4.2% 3.8%
Expected lives (in years)........................ 4.0 3.5
Dividend yield................................... 0% 0%
Expected volatility.............................. 92% 179%
9
8. INVENTORY
Our inventory consists primarily of finished camera products and camera
components. Our inventory is valued at the lower of cost, using the FIFO method,
or market. The table below shows our inventory mix as of December 31, 2003 and
September 30, 2004:
(In thousands) December 31, September 30,
2003 2004
---- ----
Components........................................$ -- $ 620
Finished goods.................................... 546 839
Inventory reserve................................. (148) (148)
------------- ------------
Inventory, net....................................$ 398 $ 1,311
============= ============
9. COMMITMENTS AND CONTINGENCIES
Commitments
The table below shows our contractual obligations as of September 30, 2004:
(In thousands) Payments Due by Period
-----------------------------------------------------
Remainder
Total of 2004 2005 2006 2007
-------- ------------ -------- -------- ---------
Capital leases...................................................... $ 112 $ 112 $ -- $ -- $ --
Operating leases.................................................... 2,520 266 1,419 771 64
-------- ------- ------- ----- ----
Total............................................................... $ 2,632 $ 378 $ 1,419 $ 771 $ 64
======= ======= ======== ===== ====
At September 30, 2004, we had $0.6 million of cash deposits restricted as
collateral on a letter of credit for certain co-location facility leases
expiring in 2006 and, accordingly, classified as long term restricted cash. In
addition, as of September 30, 2004, we have prepaid $0.3 million of our
obligations to the co-location facility. As of September 30, 2004, we have
outstanding purchase orders from our lens and camera vendors valued at $1.6
million for delivery mostly in the fourth quarter of 2004.
Contingencies
On November 15, 2002, a First Amended Consolidated Complaint for violation of
federal securities laws was filed against Homestore.com, Inc. ("Homestore") by
the California Teachers' Retirement System ("CalSTRS"). The Complaint is a class
action lawsuit filed on behalf of stockholders of Homestore which flows from
alleged misstatements and omissions made by Homestore and the other named
defendants, which include us. The Complaint alleges that during 2001, Homestore
and IPIX entered into fraudulent reciprocal transactions intended to
artificially bolster and maintain Homestore's and our respective stock prices.
The Complaint alleges that Homestore's public statements with respect to these
transactions are attributable to us and violate Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. We joined with other co-defendants and filed a
joint motion to dismiss, alleging that the Complaint fails to state a claim upon
which relief may be granted, among other things. On March 7, 2003, the United
States District Court for the District of Central California granted our motion
to dismiss, with prejudice. On April 7, 2004, the California Teachers'
Retirement System filed a notice of appeal with the United States Court of
Appeals for the Ninth Circuit appealing the dismissal of the First Amended
Consolidated Complaint for violation of federal securities laws filed against
Homestore.com, Inc, us and the other named defendants. On July 22, 2004, CalSTRS
and IPIX filed a Stipulation of Dismissal with the Court of Appeals pursuant to
which the appeal was dismissed, with prejudice, against us.
In June 2003, we filed a lawsuit against Ford Oxaal and Minds-Eye-View, Inc. in
the United States District Court for the Eastern District of Tennessee alleging
patent infringement of certain patents and other causes of action. The
defendants in the lawsuit have filed counterclaims against the Company in their
response to our action. The litigation is in the pre-trial motion stage at the
current time.
We are not currently a party to any other legal proceedings the adverse outcome
of which, individually or in the aggregate, we believe could have a material
adverse effect on our business, financial condition, results of operations or
cash flows.
10
Indemnification Provisions
During the ordinary course of business, in certain limited circumstances, we
include indemnification provisions within certain of our contracts. Pursuant to
these agreements, we will indemnify, hold harmless and agree to reimburse the
indemnified party for losses suffered or incurred by the indemnified party,
generally parties with which we have commercial relations, in connection with
certain intellectual property infringement claims by any third party with
respect to our products and services. To date, we have not incurred any costs in
connection with such indemnification clauses.
10. SEGMENTS
We currently have three reportable segments. The accounting policies of the
segments are the same as those of the Company. Management evaluates the
performance of the segments and allocates resources to them based on evaluations
of the segment's revenues and gross profit. There are no inter-segment revenues.
We do not make allocations of corporate costs to the individual segments and do
not identify separate assets of the segments in making decisions regarding the
performance or the allocation of resources to them.
Information about the reported segments is as follows:
Three months ended Nine months ended
September 30, September 30,
-------------------------- ----------------------
(In thousands) 2003 2004 2003 2004
------------- ------------ --------- ---------
Revenue:
Security.................................................... $ 146 $ 724 $ 237 $ 1,130
AdMission................................................... 5,811 276 17,471 810
InfoMedia................................................... 666 741 1,858 1,824
-------- -------- -------- --------
Total.......................................................... $ 6,623 $ 1,741 $ 19,566 $ 3,764
======== ======== ======== ========
Gross profit (loss):
Security.................................................... $ 71 $ 199 $ 76 $ 316
AdMission................................................... 3,935 (294) 12,045 (998)
InfoMedia................................................... 266 439 833 928
-------- -------- -------- --------
Total.......................................................... $ 4,272 $ 344 $ 12,954 $ 246
======== ======== ======== ========
11. CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject us to a concentration of credit
risk consist of cash, cash equivalents, short term investments and accounts
receivable. Cash, cash equivalents and short term investments are deposited with
high quality financial institutions. Our accounts receivable are derived from
revenue earned from customers located in the U.S. and abroad. We perform ongoing
credit evaluations of our customers' financial condition and we do not require
collateral from our customers.
The following table summarizes the revenue from customers in excess of 10% of
total revenues:
Three months ended Nine months ended
September 30, September 30,
-------------------- -----------------
2003 2004 2003 2004
------- -------- -------- -------
Homestore............................................................... 3% 7% 3% 10%
eBay.................................................................... 84% --% 85% --%
UK Distributor.......................................................... 2% 43% 1% 32%
At September 30, 2004, Homestore represented 6% of accounts receivable and our
UK distributor represented 41% of accounts receivable. There are no amounts due
from eBay as of September 30, 2004. At December 31, 2003, Homestore represented
22% and our UK Distributor represented 3% of accounts receivable. There were no
amounts due from eBay as of December 31, 2003.
On October 1, 2004, the license agreement dated January 12, 2001 (the "License
Agreement") between us and Homestore Virtual Tours, Inc. ("Homestore") was
terminated. Under the License Agreement, Homestore had the exclusive right to
sell our virtual tour technology to the U.S. residential real estate market and
11
was required to pay us a royalty for each virtual tour sold. A copy of the
license agreement was filed as Exhibit 10.16 to our quarterly report on Form
10-K filed with the Securities and Exchange Commission on April 2, 2001. As a
result of the termination, Homestore no longer has the exclusive right to sell
our virtual tour technology to the U.S. residential real estate market, and we
may sell, or license another third party to sell, our virtual tour technology
into this market. We mutually released each other from any further obligations
under the License Agreement.
12. LIQUIDATION PREFERENCE AND PREFERRED STOCK DIVIDENDS
On September 26, 2001, Image Investor Portfolio, a separate series of Memphis
Angels, LLC ("Image") and certain strategic investors completed the purchase of
1,115,080 shares of the Series B Preferred Stock for total consideration of
$22.3 million. Each share of the Series B Preferred Stock is convertible into
approximately 9.2 shares of our common stock and is entitled to vote on matters
submitted to holders of common stock on an as-converted basis. During the second
quarter of 2004, 613,483 shares of Series B Preferred stock plus accumulated
dividends were converted into 6,261,574 shares of common stock. During the third
quarter of 2004, 100,000 shares of Series B Preferred stock were converted into
920,749 shares of common stock. We did not receive any proceeds from these
conversions, but we paid $0.5 million for accumulated dividends associated with
the conversions. As of September 30, 2004, 290,347 shares of Series B Preferred
Stock remain outstanding with a Liquidation Preference, defined below, of $7.2
million, which includes $1.4 million in accrued dividends in arrears on the
Series B Preferred Stock.
Holders of Series B Preferred Stock, in preference to holders of any other
series of Preferred Stock and in preference to the holders of Common Stock
(collectively, "Junior Securities"), accrue dividends at the rate of eight
percent (8%) of the price paid per annum on each outstanding share of Series B
Preferred Stock ("Series B Dividends"). The Series B Dividends are cumulative,
accrue daily and shall be payable, when and if declared by the Board, upon
conversion or as an accretion to the Liquidation Preference, as defined below.
Accrued Series B Dividends may be paid in cash or common stock, at the election
of the Series B Preferred stockholder. Holders of Series B Preferred Stock
participate on an as-if converted basis in any common stock dividends. At any
time that the holders of the Series B Preferred Stock hold more than 50% of our
voting stock, a voluntary liquidation, dissolution or winding up of the Company
must be approved by at least five of the seven members of our board of
directors. Upon any liquidation event, before any distribution or payment shall
be made to the holders of any Junior Securities, the holders of Series B
Preferred Stock shall be entitled to be paid out of the assets of the Company
legally available for distribution, or the consideration received in such
Transaction, an amount per share of Series B Preferred Stock equal to the price
paid plus all accrued and unpaid Series B Dividends for each share of Series B
Preferred Stock held by them (the "Liquidation Preference"). If, upon any such
liquidation event, the assets of the Company are insufficient to make payment in
full to all holders of Series B Preferred Stock of the Liquidation Preference,
then such assets shall be distributed among the holders of Series B Preferred
Stock at the time outstanding, ratably in proportion to the full amounts to
which they would otherwise be respectively entitled.
13. RELATED PARTY TRANSACTIONS
Transactions with eBay, Inc.
In September 2001, eBay acquired Series B Preferred Stock from us and as a
result beneficially owned more than 10% of our common stock through April 2004.
Pursuant to an agreement dated April 19, 2000, as amended, we provided to eBay,
Inc. image management services to eBay's online auction Web sites. Pursuant to
that agreement, we issued eBay a warrant to purchase 60,000 shares of common
stock at an exercise price of $203.80 per share. The warrant expires on April
19, 2010. Under this agreement, as amended, we generated revenue of $5.6 million
and $16.6 million for the quarter and nine months ended September 30, 2003,
respectively. As announced in June 2003, we amended the then current commercial
agreement with eBay to include a one-time $8.0 million license fee from eBay for
our technology and other services. The license fee was recognized in the fourth
quarter of 2003 and we no longer provide any products or services to eBay.
Our visual content services agreement with eBay required us to pay marketing
fees to eBay of $16.0 million over a two-year period. As of September 26, 2001,
we had paid $9.5 million of the $16.0 million commitment and agreed to extend
the additional $6.5 million of payments through September 2003. The commitment
has been paid in full. In accordance with EITF 01-09, during the quarter and
nine months ended September 30, 2003, $0.5 million and $1.5 million,
respectively, of these fees was offset against revenue which amount represented
the excess over the fair value of the benefit received.
In 2001 and 2002, we sold to eBay, and eBay leased back to us, certain computer
equipment utilized to provide image management services to eBay and other
customers. The purchase price for the equipment was approximately $5.3 million.
The transactions resulted in no gain or loss to us. In the nine months ended
September 30, 2003, we paid eBay $1.5 million pursuant to these lease schedules.
In the fourth quarter of 2003, we returned the underlying equipment, with a net
carrying amount of $0.9 million, associated with these lease obligations and
eBay forgave the remaining balances due of $1.1 million.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion is intended to assist in the understanding and
assessment of significant changes and trends related to our results of
operations and our financial condition together with our consolidated
subsidiaries. This discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K. Historical results and percentage relationships set forth
in the statement of operations, including trends which might appear, are not
necessarily indicative of future operations.
OVERVIEW
Our Business
Over the past few years, we have restructured the Company around our higher
gross margin businesses. We are now organized into three market focused business
units: IPIX Security, IPIX AdMission and IPIX InfoMedia.
IPIX Security: Supplies Full-360 video surveillance technology for critical
government and commercial security applications. Patent protected technology is
used in digital video systems that provide complete and continuous situational
awareness.
IPIX AdMission: Enables local advertisers with the means to create rich, visual
ads showcasing their businesses, products and services. The AdMission platform
is implemented on a large scale for managing media across the Internet. It
allows advertisers and consumers to successfully conclude commercial
transactions by communicating the value of advertised goods and services through
accompanying media.
IPIX InfoMedia: Provides for creation of Full-360 degree panoramic photography
and movies content. Markets are professional photographers, ad and creative
media agencies, web developers and visual documentation.
Products
CommandView(TM) - Multi-mega-pixel network cameras, with fisheye lens, patented
Full-360 viewing technology and camera management software to provide a unique
award-winning `see everything' video surveillance and security camera system
that can see in all directions, simultaneously with no moving parts and no blind
spots.
AdMission(TM) - A hosted media platform enabling local advertisers to create
rich, visual ads showcasing their businesses, products and services. AdMission
enhanced ads are an upsell to print classified and display ads. They include
logos, photos, fast facts, printable coupons and information about the
advertiser's business, products and services. Consumers are rewarded with a
convenient informative presentation that appears directly within their search
results. AdMission ads communicate product and service offerings effectively and
result in better-qualified leads to advertisers.
Interactive Studio(TM) - A single integrated solution for panorama photographers
that can automate a wide variety of tasks previously requiring separate tools.
Makes creating multiple Full-360 degree images as simple as a drag-and-drop of
fisheye source images into the application, selecting the output file formats
desired and hitting the save button. Features include image editors, image
format converter tools and high dynamic range image compositors.
Target Markets
CommandView - Commercial facilities such as banks and retail outlets. Homeland
security infrastructure protection related to ports, harbors, waterways, dams,
conventional and nuclear power stations, utilities, airports and mass transit
rail systems. In the military, perimeter force protection, unmanned vehicles and
special operations.
AdMission - Newspaper classified and display advertising (online and print);
yellow page directories (online); and local search platforms (online).
Interactive Studio - Visual documentation markets such as facilities management;
private and government infrastructure management and service departments; and
vertical market data-warehouse solutions providers such as insurance and
mapping.
13
Business Models
IPIX Security: Sell camera systems via world-wide network of distributors.
Camera systems will retail from $1,000 to $25,000, depending upon configuration.
Traditional distributor discounts will apply (25 to 35%).
IPIX AdMission: Partner with publishers and software vendors of the publishing
industry. Recurring revenue share on premiums charged for visually enhanced ads.
Fixed infrastructure support costs, with very low marginal cost as volumes grow.
IPIX InfoMedia: Market software platform and supporting hardware products
primarily over the internet.
Business Trends and Conditions
On March 31, 2004, our Security business unit launched a new family of Full-360
degree real-time video camera systems. Shipment of these products to
distributors began in late June 2004. These new camera systems are expected to
generate revenues from their sale primarily to distributors. During the third
quarter of 2004, we received an order for the purchase of $3 million of
CommandView video surveillance cameras from our UK distributor. We shipped $0.5
million of cameras from this order in the third quarter of 2004 and expect that
the remaining cameras from this order will ship over the next three to six
months. We continue to develop additional products and features for the security
and surveillance market.
Substantially all of our recurring revenue in the past was derived from
transaction fees generated by our AdMission business unit. In particular, eBay
represented approximately 85% and 95% of total revenue for the quarter and nine
months ended September 30, 2003, respectively. We no longer provide any products
or services to eBay as of November 1, 2003. Since April 1, 2004, we have
continued to diversify and add additional AdMission customers and have launched
two new products: AdMission Classifieds and AdMission Directories which are
currently targeted at newspaper and yellow page publishers for online and
in-print classified advertising and other business opportunities.
Our Full-360 degree technology used by the InfoMedia business unit primarily
generates revenues in two ways: licenses of software and the resale of camera
equipment. In the past, we utilized "keys" to license our InfoMedia technology
to capture and save a single immersive image. With the launch of Interactive
Studios in the first quarter of 2004, we now offer time-based seat or user
licenses which permit an unlimited number of immersive images to be captured and
saved within a specific time period, usually a year. We sell our Full-360
products primarily into the real estate, travel and hospitality and visual
documentation markets. The cost of sales for our licenses is low in proportion
to the related revenue. The cost of sales for the sale of camera equipment has
generally been 50% to 75% of related revenues.
On October 1, 2004, the license agreement dated January 12, 2001 (the "License
Agreement") between us and Homestore Virtual Tours, Inc. ("Homestore") was
terminated. Under the License Agreement, Homestore had the exclusive right to
sell our virtual tour technology to the U.S. residential real estate market and
was required to pay us a royalty for each virtual tour sold. A copy of the
license agreement was filed as Exhibit 10.16 to our quarterly report on Form
10-K filed with the Securities and Exchange Commission on April 2, 2001. As a
result of the termination, Homestore no longer has the exclusive right to sell
our virtual tour technology to the U.S. residential real estate market, and we
may sell, or license another third party to sell, our virtual tour technology
into this market. IPIX and Homestore mutually released each other from any
further obligations under the License Agreement.
InfoMedia will now market and sell its virtual tour photography solution, the
IPIX Interactive Studio, directly to the U.S. real estate market and Homestore
will expand its hometour360 program to support in addition to us, a wider range
of imaging technologies. As a result, real estate agents and photographers will
benefit from a broader choice of panoramic imaging solutions and enhanced
marketing capabilities. The companies will continue to work together to grow the
adoption of virtual tours in the U.S. real estate industry. We also provide
professional services to customers that request specific customizations or
integrations of our products and services. Providing professional services is
labor intensive and our cost of sales for professional service tends to be 40%
to 60% of revenues.
MANAGEMENT CHANGE
On September 16, 2004, Donald W. Strickland resigned as our President, Chief
Executive Officer and as a Director. We entered into a separation agreement with
Mr. Strickland, which was filed on September 21, 2004 with the Securities and
Exchange Commission as Exhibit 99.1 to a Form 8-K. Under this agreement, we will
pay Mr. Strickland a severance payment of $0.2 million, which will be paid in
six monthly installments. Any stock options granted to Mr. Strickland will
continue to vest through March 31, 2005, and such options must be exercised
before June 30, 2005, at which time they will expire. The employment agreement
between us and Mr. Strickland dated July 1, 2001 was terminated, except that
certain obligations concerning confidentiality, non-solicitation and
non-disparagement will survive termination.
14
Effective September 16, 2004, the Board appointed Ms. Clara M. Conti President
and Chief Executive Officer of the Company. Ms. Conti was also elected to the
Board of Directors as a Class II director and will serve on the Executive
Committee of the Board. Ms. Conti will receive a base salary of $0.3 million per
annum and will be entitled to such bonus as the Board of Directors may
determine. In addition, we issued to Ms. Conti an option to purchase 500,000
shares of our common stock at an exercise price of $8.28 per share. On November
15, 2004, we entered into an employment agreement with Ms. Conti (the
"Agreement"), effective September 16, 2004, which contains the terms of Ms.
Conti's employment. The Agreement provides that Ms. Conti will serve as our
president and chief executive officer until such time as either the Board of
Directors or Ms. Conti terminates the Agreement. We may terminate Ms. Conti's
Agreement with or without cause; however, if we terminate the agreement without
cause, or if Ms. Conti resigns for good reason, she is entitled to a severance
payment of $0.23 million which will be paid in ten monthly installments. In the
event Ms. Conti is terminated without cause or resigns for good cause within two
(2) years of a change of control, Ms. Conti is entitled to payment of $0.23
million within ten (10) days of such termination or resignation, and all options
issued to Ms. Conti will vest and be fully exercisable.
Prior to joining us, Ms. Conti was President and Chief Executive Officer of
ObjectVideo, a object tracking software security business, Vice President of
eBusiness Solutions for DynCorp, an information technology and outsourcing
company, and President and Chief Executive Officer of Aurora Enterprise
Solutions, a business to business internet security products and services firm,
all headquartered in Reston, Virginia. Ms. Conti is based out of our new
Northern Virginia office.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations
is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to revenue recognition, uncollectible receivables and other long-lived
assets and contingencies. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting policies
affect our more significant judgments and estimates used in the preparation of
our consolidated financial statements: revenue recognition; valuation
allowances, specifically the allowance for doubtful accounts; and other
long-lived assets; and significant accruals. We believe that full consideration
has been given to all relevant circumstances that we may be subject to, and our
financial statements accurately reflect management's best estimate of the
results of operations, financial position and cash flows for the periods
presented.
Management has discussed the development and selection of the following critical
accounting policies, estimates and assumptions with the Audit Committee of our
Board of Directors and the Audit Committee has reviewed these disclosures. We
believe the following represent our critical accounting policies:
Revenue Recognition
We recognize revenue in accordance with SOP 97-2, "Software Revenue Recognition"
and Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial
Statements." We derive revenue from product sales and services we provide to
customers. Product revenue includes InfoMedia hardware and licenses, IPIX
Security hardware and licenses, as well as AdMission license revenue. Service
revenues are primarily from transactions where a seller uses IPIX AdMission to
enhance their on-line offering.
Product revenue is recognized upon shipment or delivery provided there are no
uncertainties surrounding product acceptance, persuasive evidence of an
arrangement exists, there are no significant vendor obligations, the fees are
fixed or determinable and collection is reasonably assured. Initial license fees
are recognized when a contract exists, the fee is fixed or determinable,
software delivery has occurred and collection of the receivable is reasonably
assured. If there are continuing obligations, then license fees are recognized
ratably over the life of the contract. Revenue from product sales to
distributors is generally recognized upon shipment ("sell-in") if the
distributor relationship does not create substantial uncertainty regarding fixed
or determinable fees and collectibility. If at the outset of an arrangement we
determine the arrangement fee is not, or is presumed to not be, fixed and
determinable, revenue is deferred and subsequently recognized as amounts become
due and payable.
Transaction hosting revenues are recognized ratably as transactions are
performed provided there was persuasive evidence of an arrangement, the fee was
fixed or determinable and collection of the resulting receivable was reasonably
assured. Revenues generated from professional services are recognized as the
related services are performed. When such professional services are combined
with on-going transaction services or are deemed to be essential to the
functionality of the delivered software product, revenue from the entire
arrangement is recognized while the transaction services are performed, on a
percentage of completion method or not until the contract is completed in
accordance with SOP 81-1, "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts," and ARB No. 45, "Long-Term Construction-Type
Contracts." Reimbursements received for out-of-pocket expenses incurred are
characterized as revenue in the statement of operations.
15
Where multiple elements exist in an arrangement, the arrangement fee is
allocated to the different elements based upon verifiable objective evidence of
the fair value of the elements, as governed under EITF 00-21, which is codified
in SEC Staff Accounting Bulletin No. 104 "SAB 104." Multiple element
arrangements primarily involve an arrangement with professional services and
transaction hosting. Revenue is recognized as each element is earned, namely
upon completion of the services, provided that the fair value of the undelivered
element(s) has been determined, the delivered element has stand-alone value,
there is no right of return on delivered element(s), and we are in control of
delivery of the undelivered element(s).
Royalties derived from desktop imaging products were recognized as revenues upon
receipt of the royalty sell-through reports from customers, which are generally
in the quarter following the quarter in which the sale by the customer took
place.
Payments received in advance are initially recorded as deferred revenue and
recognized as obligations are fulfilled.
Allowances for Doubtful Accounts
Significant management judgments and estimates must be made and used in
connection with establishing the doubtful account allowances in any accounting
period. Management specifically analyzes accounts receivable and historical bad
debts, customer concentrations, customer credit-worthiness, current economic
trends and changes in our customer payment terms when evaluating the adequacy of
the allowance for doubtful accounts. Material differences could result in the
amount and timing of expense recorded if management had different judgment or
utilized different estimates.
Goodwill
During the fourth quarter of 2003, certain events, including the end of the
agreement with eBay, led us to perform an impairment review of goodwill. The
eBay agreement ended in November 2003 and was the primary source of cash flows
for the technology associated with goodwill in the AdMission business unit. This
review indicated that goodwill was being carried at amounts in excess of the
fair value based on estimated discounted future cash flows of the AdMission
business unit. As a result, an impairment charge was recorded to expense in the
year ended December 31, 2003. No balance remains in goodwill.
Significant Accruals, including Restructuring Charges and Sales Tax
We recorded restructuring charges associated with vacated facilities. The key
assumptions associated with these charges include the timing and amount of
sub-lease income. In addition, in establishing and providing for sales tax
accruals, we make judgments based on the actual tax laws and guidance. While
management believes that its judgments and interpretations regarding tax
liabilities are appropriate, significant differences in actual experience may
materially affect our future financial results.
RESTRUCTURING ACTIONS
During the years ended December 31, 2000 thru December 31, 2003, the Company
executed several restructuring actions and recorded related charges during each
of those fiscal years. During the three and nine months ended September 30,
2004, $0.0 million and $0.2 million, respectively, of payments were made against
the Company's restructuring accrual. No additions were made to the accrual
during the three or nine months ended September 30, 2004. At September 30, 2004,
the remaining balance in the restructuring accrual was $0.2 million.
16
RESULTS OF OPERATIONS
Financial results from prior periods are not useful in comparison to 2004
results because of the previously announced amendment of our service agreements
with eBay to a one-time 2003 license fee and since we launched the security
business products in the second quarter of 2004. The following table presents,
for the periods indicated, the percent relationship to total revenues of select
items in our statements of operations.
Three months ended Nine months ended
September 30, September 30,
2003 2004 2003 2004
------- ------- ------- ------
Revenue:
Security.......................................................... 2.2% 41.6% 1.2% 30.0%
AdMission......................................................... 87.7 15.8 89.3 21.5
InfoMedia......................................................... 10.1 42.6 9.5 48.5
------- ------- ------ ------
Total revenue........................................................ 100.0 100.0 100.0 100.0
------ ------ ------ ------
Cost of revenue:
Security.......................................................... 1.1 30.2 0.8 21.6
AdMission......................................................... 28.3 32.7 27.7 48.0
InfoMedia......................................................... 6.1 17.3 5.3 23.8
------- ------ ------ ------
Total cost of revenue................................................ 35.5 80.2 33.8 93.4
------ ------ ------ ------
Gross profit......................................................... 64.5 19.8 66.2 6.6
------ ------ ------ ------
Operating expenses:
Sales and marketing............................................... 28.7 93.3 29.2 122.7
Research and development.......................................... 18.1 54.7 18.5 76.4
General and administrative........................................ 15.1 70.0 13.6 75.4
------ ------ ------ ------
Total operating expenses............................................. 61.9 218.0 61.3 274.5
------ ------ ------ ------
Income (loss) from operations........................................... 2.6 (198.2) 4.9 (267.9)
Other................................................................... (0.3) 1.8 (0.5) 1.4
------- ------ ------- ------
Net income (loss)....................................................... 2.3% (196.4)% 4.4.% (266.5)%
====== ======= ======== ========
Quarter Ended September 30, 2003 Compared to the Quarter Ended September 30,
2004
Three months ended
September 30,
-------------------
Percent
(Dollars in thousands) 2003 2004 Difference Change
--------- -------- ---------- ---------
Revenue:
Security................................................................. $ 146 $ 724 $ 578 396%
AdMission................................................................ 5,811 276 (5,535) (95)
InfoMedia................................................................ 666 741 75 11
--------- -------- --------- -----
Total revenue............................................................... 6,623 1,741 (4,882) (74)
--------- -------- ---------- -----
Cost of revenue:
Security................................................................. 75 525 450 600
AdMission................................................................ 1,876 570 (1,306) (70)
InfoMedia................................................................ 400 302 (98) 25
--------- -------- ---------- -----
Total cost of revenue....................................................... 2,351 1,397 (954) (41)
--------- -------- --------- -----
Gross profit................................................................ 4,272 344 (3,928) (92)
--------- -------- ---------- -----
Operating expenses:
Sales and marketing...................................................... 1,899 1,625 (274) (14)
Research and development................................................. 1,198 952 (246) (21)
General and administrative............................................... 1,001 1,220 219 22
--------- -------- --------- -----
Total operating expenses.................................................... 4,098 3,797 (301) (7)
--------- -------- --------- -----
Income (loss) from operations.................................................. 174 (3,453) (3,627) (2,084)
Other.......................................................................... (20) 32 52 (260)
---------- ------- ---------- ------
Net income (loss).............................................................. $ 154 $ (3,421) $ (3,575) (2,321)%
========= ========= ========== ========
17
Revenue.
Security: On March 31, 2004, the Security business unit launched its new
family of Full-360 degree security cameras. Prior to this launch, the
Security business unit had primarily been developing the products and
testing them in field beta trials. The first finished products were
shipped during late June, 2004. Revenues in 2003 were primarily from
the sale of beta units.
AdMission: Decreased in the quarter ended September 30, 2004 over the
quarter ended September 30, 2003 due to decreased volumes of images
processed, primarily related to the change in relationship with eBay as
of November 2003.
InfoMedia: Increased in the quarter ended September 30, 2004 over the
quarter ended September 30, 2003 primarily due to the increased sales
of the new software platform launched in the first quarter of 2004,
offset by lower camera kit sales.
Cost of Revenue.
Security: Cost of revenues consists of the costs to purchase and assemble
the components of the video cameras sold during the quarter. Gross
margins were 27% in the quarter ended September 30, 2004, down from 49%
in the same period in 2003. Cost of revenues includes the cost of
promotional cameras, which are sold at reduced margins. In addition,
the 2004 sales volumes were not yet sufficient to achieve targeted
margins of 40 to 50% in the Security business unit.
AdMission: Cost of revenue consists of our direct expenses associated with
the processing, hosting and distribution of digital content. With the
reduced volumes of images to process during the third quarter of 2004
relative to the third quarter of 2003, the AdMission business unit
decreased depreciation expense by reducing the capital committed to
image processing ($0.6 million), lowered its purchase of bandwidth and
managed care services from third party co-location facilities ($0.4
million) and reduced the number of personnel and other expenses
incurred in the management of the network ($0.3 million). Gross profit
in the third quarter of 2004 was negative because of fixed costs
associated with the running and management of the network.
InfoMedia: Cost of revenues consists of the costs of the digital camera
and related components included in an InfoMedia kit. Cost of revenue in
the third quarter of 2004 was lower than in 2003 primarily due to fewer
kit sales. Cost of revenue as a percent of revenue decreased from 60%
in the third quarter of 2003 to 41% in the third quarter of 2004
primarily because of the increase in software license sales due to the
launch of its new software platform in the first quarter of 2004 and
fewer kit sales, which have lower margins than software sales.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries
for marketing, sales and business development personnel. Sales and marketing
expenses also include commissions and related benefits for sales personnel and
consultants, traditional advertising and promotional expenses. Sales and
marketing expenses decreased in the quarter ended September 30, 2004 over the
quarter ended September 30, 2003, primarily due to the changed relationship with
eBay ($0.6 million) and a reduction of corporate marketing ($0.2 million),
offset by an increase in sales and marketing activities in our Security business
unit ($0.5 million).
Research and Development. Research and development expenses consist primarily of
personnel costs related to building and enhancing our digital media
infrastructure and immersive imaging technology. Research and development
expenses decreased in the quarter ended September 30, 2004 over the quarter
ended September 30, 2003, due to the changed relationship with eBay ($0.4
million), offset by an increase in research and development for our new family
of Full-360 degree security cameras ($0.2 million).
General and Administrative. General and administrative expenses consist
primarily of salaries and related benefits for administrative and executive
staff, fees for outside professional services and other costs associated with
being a public company. General and administrative expenses increased in the
quarter ended September 30, 2004 over the quarter ended September 30, 2003
primarily as a result of additional expenses incurred in association with
compliance with public company regulations, including Sarbanes-Oxley ($0.2
million). During the quarter ended September 30, 2004, severance for Mr.
Strickland, our former CEO, of $0.2 million was offset by lower year-over-year
professional fees ($0.1 million) for legal and auditing services and severance
paid in the third quarter of 2003 for our former VP of Human Resources ($0.1
million).
18
Nine Months Ended September 30, 2003 Compared to the Nine Months Ended
September 30, 2004
Nine months ended
September 30,
-------------------
Percent
(Dollars in thousands) 2003 2004 Difference Change
-------- --------- ---------- ---------
Revenue:
Security................................................................. $ 237 $ 1,130 $ 893 377%
AdMission................................................................ 17,471 810 (16,661) (95)
InfoMedia................................................................ 1,858 1,824 (34) (2)
-------- --------- ---------- -----
Total revenue............................................................... 19,566 3,764 (15,802) (81)
-------- --------- ---------- -----
Cost of revenue:
Security................................................................. 161 814 653 406
AdMission................................................................ 5,426 1,808 (3,618) (67)
InfoMedia................................................................ 1,025 896 (129) (13)
-------- --------- ---------- -----
Total cost of revenue....................................................... 6,612 3,518 (3,094) (47)
-------- --------- --------- -----
Gross profit................................................................ 12,954 246 (12,708) (98)
-------- --------- ---------- -----
Operating expenses:
Sales and marketing...................................................... 5,704 4,620 (1,084) (19)
Research and development................................................. 3,626 2,874 (752) (21)
General and administrative............................................... 2,664 2,837 173 6
-------- --------- --------- -----
Total operating expenses.................................................... 11,994 10,331 (1,663) (14)
-------- --------- --------- -----
Income (loss) from operations.................................................. 960 (10,085) (11,045) (1,151)
Other.......................................................................... (103) 52 155 150
--------- --------- --------- -----
Net income (loss).............................................................. $ 857 $ (10,033) $ (10,890) (1,271)%
======== ========== ========== ========
Revenue.
Security: On March 31, 2004, the Security business unit launched its new
family of Full-360 degree security cameras. Prior to this launch, the
Security business unit had primarily been developing the products and
testing them in field beta trials. The first finished products were
shipped during late June, 2004. Revenues in 2003 were primarily from
the sale of beta units.
AdMission: Decreased in the nine months ended September 30, 2004 over the
nine months ended September 30, 2003 due to decreased volumes of images
processed, primarily related to the change in relationship with eBay as
of November 2003.
InfoMedia: During the first nine months of 2003, InfoMedia recognized $0.3
million in royalties while in the first nine months of 2004 the group
recognized $0.1 million of royalty revenues. In February 2004,
InfoMedia launched Interactive Studios to eventually replace the sale
of one-use keys, which generated royalty income in 2003. This decrease
in revenues in 2004 was offset by sales of the new products launched in
the first quarter of 2004.
Cost of Revenue.
Security: Cost of revenues consists of the costs to purchase and assemble
the components of the video cameras sold during the period. In 2003,
the business unit recognized virtually no revenues or cost of revenues.
Gross margins were 28% in the nine months ended September 30, 2004,
down from 32% in the same period in 2003. Cost of revenues includes the
cost of beta units and promotional cameras, which are sold at reduced
margins. In addition, the 2004 sales volumes were not yet sufficient to
achieve targeted margins of 40 to 50% in the Security business unit.
AdMission: Cost of revenue consists of our direct expenses associated with
the processing, hosting and distribution of digital content. With the
reduced volumes of images to process during the first nine months of
2004 relative to the first nine months of 2003, the AdMission business
unit decreased depreciation expense by reducing the capital committed
to image processing ($1.9 million), lowered its purchase of bandwidth
and managed care services from third party co-location facilities ($1.0
million) and reduced the number of personnel and other expenses
incurred in the management of the network ($0.7 million). Gross profit
in the first nine months of 2004 was negative because of fixed costs
associated with the running and management of the network.
InfoMedia: Cost of revenues consists of the costs of the digital camera
and related components included in an InfoMedia kit. Cost of revenue
declined in the first nine months of 2004 relative to 2003, primarily
due to fewer kit sales and change in product mix between hardware and
software. Cost of revenue as a percent of revenue decreased from 55% in
the first nine months of 2003 to 49% in the first nine months of 2004
primarily because of the change in product mix to relatively more
software sales, which have virtually no cost of revenues.
19
Sales and Marketing. Sales and marketing expenses consist primarily of salaries
for marketing, sales and business development personnel. Sales and marketing
expenses also include commissions and related benefits for sales personnel and
consultants, traditional advertising and promotional expenses. Sales and
marketing expenses decreased in the nine months ended September 30, 2004 over
the nine months ended September 30, 2003, primarily due to the changed
relationship with eBay ($1.8 million) and a reduction of corporate marketing
($0.4 million), offset by an increase in sales and marketing activities in our
Security business unit ($1.0 million) and in InfoMedia ($0.1 million).
Research and Development. Research and development expenses consist primarily of
personnel costs related to building and enhancing our digital media
infrastructure and immersive imaging technology. Research and development
expenses decreased in the nine months ended September 30, 2004 over the nine
months ended September 30, 2003, due to the result of the changed relationship
with eBay ($1.3 million), offset by an increase in research and development for
our new family of Full-360 degree security cameras ($0.5 million).
General and Administrative. General and administrative expenses consist
primarily of salaries and related benefits for administrative and executive
staff, fees for outside professional services and other costs associated with
being a public company. General and administrative expenses increased $0.2
million in the nine months ended September 30, 2004 over the nine months ended
September 30, 2003, due to the increased costs of being a public company ($0.5
million), partially offset by a decrease in personnel costs ($0.2 million) and a
decrease in outside professional services ($0.1 million).
CONTRACTUAL OBLIGATIONS
The table below shows our contractual obligations as of September 30, 2004:
(In thousands) Payments Due by Period
------------------------------------------------------
Remainder
Total of 2004 2005 2006 2007
-------- ------------ -------- -------- -------
Capital leases...................................................... $ 112 $ 112 $ -- $ -- $ --
Operating leases.................................................... 2,520 266 1,419 771 64
-------- -------- -------- ------ -------
Total............................................................... $ 2,632 $ 378 $ 1,419 $ 771 $ 64
======== ======== ======== ====== =======
At September 30, 2004, we had $0.6 million of cash deposits restricted as
collateral on a letter of credit for certain co-location facility leases
expiring in 2006 and, accordingly, classified as long term restricted cash. In
addition, as of September 30, 2004, we have prepaid $0.3 million of our
obligations to the co-location facility. As of September 30, 2004, we have
outstanding purchase orders from our lens and camera vendors valued at $1.6
million for delivery mostly in the fourth quarter of 2004.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations through our registered public
offerings, the private placements of capital stock, a convertible debenture, a
convertible promissory note and warrant and option exercises. At September 30,
2004, we had $20.1 million of cash, restricted cash and short term investments,
of which $1.4 million was restricted and $0.6 million was in short term
investments.
Summary Consolidated Cash Flow Data
Three months ended Nine months ended
September 30, September 30,
-------------------------- ----------------------
(In thousands) 2003 2004 2003 2004
------------- --------- --------- ---------
Net cash provided by (used in) operating activities............... $ 417 $ (3,135) $ 7,172 $ (9,840)
Net cash used in investing activities............................. (75) (70) (883) (159)
Net cash provided by (used in) financing activities............... (185) 7,816 (476) 17,822
Effect of exchange rate changes on cash........................... (1) -- 3 --
---------- --------- -------- --------
Net increase in cash and cash equivalents......................... 156 4,611 5,816 7,823
Cash and cash equivalents, beginning of period.................... 8,680 13,453 3,020 10,241
--------- --------- -------- --------
Cash and cash equivalents, end of period.......................... $ 8,836 $ 18,064 $ 8,836 $ 18,064
========= ========= ======== ========
20
Cash flows from operating activities in the third quarter of 2004, reflects a
net loss of $3.4 million, compared to net income of $0.2 million in the third
quarter of 2003. Our net income for the three months ended September 30, 2003
included $0.9 million of non-cash depreciation charges, whereas the three months
ended September 30, 2004 included $0.2 million of such charges. During the third
quarter of 2003, we invested $0.6 million in working capital. During the third
quarter of 2004, our working capital declined by $0.1 million.
Net cash used in investing activities in the third quarter of 2004 and 2003 was
primarily related to the acquisition of computer software and hardware.
Net cash provided by financing activities in the third quarter of 2004 was
primarily related to $4.9 million of net proceeds from AIR exercises, $0.4
million of proceeds from the exercise of stock options, $0.2 million of
collections under our ESSP, $3.0 million of proceeds from the exercise of Series
B Preferred warrants, net of $0.2 million of payments made on capital lease
obligations and $0.5 million in dividends paid relating to the conversion of
Series B Preferred Stock. Net cash used in financing activities in the third
quarter of 2003 related to $0.4 million of proceeds from the exercise of stock
options, net of $0.6 million of payments on capital lease obligations. The
capital lease payments in 2003 were larger than in 2004 because in the fourth
quarter of 2003, we returned equipment under lease from eBay in exchange for the
retirement of the remaining obligations under the leases.
Cash flows from operating activities in the first nine months of 2004, reflects
net loss of $10.0 million, compared to a net income of $0.9 million the first
nine months of 2003. Our net income for the nine months ended September 30, 2003
included $2.7 million of non-cash depreciation charges, whereas the nine months
ended September 30, 2004 included $0.7 million of such charges. During the nine
months of 2003, the Company had positive net cash flows from working capital of
$3.6 million, primarily as a result of $3.0 million for the collection of
deferred revenue in the second quarter of 2003. During the first nine months of
2004, we invested $0.5 million in additional working capital.
Net cash used in investing activities in the first nine months of 2004 and 2003
was primarily related to the acquisition of computer software and hardware.
Net cash provided by financing activities in the first nine months of 2004 was
primarily related to $4.9 million of net proceeds from the private placement of
common stock in April 2004, $5.4 million of proceeds from AIR exercise, $5.2
million of proceeds from the exercise of stock options, $3.0 million of proceeds
from the exercise of Series B Preferred warrants, $0.3 million of proceeds from
the sale of common stock to employees under our ESPP, net of $0.5 million of
payments made on capital lease obligations and $0.5 million in dividends paid
relating to the conversion of Series B Preferred Stock. Net cash used in
financing activities in the first nine months of 2003 related to $1.4 million of
proceeds from the exercise of stock options, net of $1.9 million payments on
capital lease obligations. The capital lease payments in 2003 were larger than
in 2004 because in the fourth quarter of 2003, we returned equipment under lease
from eBay in exchange for the retirement of the remaining obligations under the
leases.
During the quarter ended September 30, 2004 and in prior fiscal periods, we have
experienced certain going concern issues related to cash flow and profitability.
During the first nine months of 2004, we have generated approximately $19
million in cash from the sale of common stock. In addition, management believes
that it will improve future operating cash flows through the sale of new
products launched in the first nine months of 2004.
During 2003, we changed our relationship with out largest customer, eBay, which
represented 87% of revenue for the year ended December 31, 2003. eBay licensed
technology from us that had previously been used by us to provide eBay with
recurring services. After 2003, we no longer provide any services to eBay. As a
result, we have a limited operating history as we will operate in 2004 and
beyond and upon which an evaluation of our business and prospects may be made.
In addition, we are subject to generally prevailing economic conditions and, as
such, our future operating results will be dependent upon our ability to provide
quality products and services, the success of our customers and the
appropriations processes of various commercial and governmental entities.
Management believes, however, that we have sufficient cash resources to meet our
funding needs through at least the next twelve months. We finished the third
quarter of 2004 with approximately $20.1 million in cash reserves (cash and cash
equivalents of $18.1 million, short term restricted investments of $0.8 million,
long term restricted cash of $0.6 million and short term investments of $0.6
million). We have three business units all at different stages in their
development. Management expects to continue to make significant investments in
the development, sale and marketing of new products for the security market and
in the image management business, which may consume some of our cash reserves.
21
Management's focus is to manage our cash requirements and focus our operations
on revenue generation and controlled spending. Our long term strategy remains
unchanged. We will continue to invest in research and development for our
Security and image management products and in the expansion of our distribution
channels for security and the offline publications and online classified
advertising businesses.
INFLATION
Inflation has not had a significant impact on our operations to date.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of September 30, 2004, we had $20.1 million of cash, cash equivalents, short
term and long term restricted cash and short term investments. Our interest
income is sensitive to changes in the general level of United States interest
rates, particularly since the majority of our investments are in short term
instruments. Due to the nature of our short term investments, we concluded that
we do not have material market risk exposure.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Under the supervision and
with the participation of our management, including our chief executive officer
and chief financial officer, we have evaluated the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in Exchange
Act Rule 13a-14(c)) as of the end of the period covered by this quarterly
report. Based on that evaluation, the chief executive officer and chief
financial officer have concluded that our disclosure controls and procedures are
effective to ensure that material information relating to the Company and our
consolidated subsidiaries is made known to such officers by others within these
entities, particularly during the period for which this quarterly report was
prepared, in order to allow timely decisions regarding required disclosure.
(b) Changes in Internal Controls. There have not been any significant changes in
our internal controls or in other factors during the period covered by this
quarterly report that materially affected or are reasonably likely to materially
affect our internal controls over financial reporting.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This quarterly report contains statements about future events and expectations
which are characterized as forward-looking statements. Forward-looking
statements are based on our management's beliefs, assumptions and expectations
of our future economic performance, taking into account the information
currently available to them. These statements are not statements of historical
fact. Forward-looking statements involve risks and uncertainties that may cause
our actual results, performance or financial condition to be materially
different from the expectations of future results, performance or financial
condition we express or imply in any forward-looking statements.
The words "believe", "may", "will", "should", "anticipate", "estimate",
"expect", "intends", "objective" or similar words or the negatives of these
words are intended to identify forward-looking statements. We qualify any
forward-looking statements entirely by these cautionary factors.
Although we believe that the expectations and assumptions reflected in these
statements are reasonable in view of the information currently available, there
can be no assurance that these expectations will prove to be correct. These
forward-looking statements involve a number of risks and uncertainties,
including those set forth below and in our 2003 Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 31, 2004 under Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" under the caption "Risk Factors." Actual results may differ
materially from the results discussed in the forward-looking statements. In
addition to the specific factors discussed in our 2003 Form 10-K, the following
are among the important factors that could cause actual results to differ
materially from the forward-looking statements:
- our loss of existing, or an inability to attract new customers,
- changes in the demand for our products and services,
- our rate of revenue growth,
22
- the burdens and costs of defending against potential infringement
claims,
- our ability to attract and retain personnel,
- our ability to control or affect reductions in costs,
- our ability to design, manufacture and deliver high quality products
in a timely fashion,
- uncertainty regarding our ability to continue as a going concern,
- our third-party supplier's ability to deliver high quality components
to us in a timely fashion,
- technological changes,
- general economic, financial or market changes or developments,
- the conversion of our Series B Preferred Stock into common stock,
- actions taken by government agencies,
- the ultimate impact of the Sarbanes-Oxley Act of 2002 and any future
changes in accounting regulations or practices in general with
respect to public companies or our operations specifically,
- - the enactment of new accounting standards, or interpretations of
existing accounting standards, by the Financial Accounting Standards
Board (FASB), or the SEC that could impact the way we record
revenues, assets and liabilities, which in turn could affect our
reported results of operations and
- - the enactment of new auditing standards, or interpretations of
auditing standards, by the Public Company Accounting Oversight Board
(PCAOB) which could adversely affect our ability to comply with the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002
(SOX 404).
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
See Item 3, Legal Proceedings in our Annual Report on Form 10-K. On April 7,
2004, the California Teachers' Retirement System ("CalSTRS") filed a notice of
appeal with the United States Court of Appeals for the Ninth Circuit appealing
the dismissal of the First Amended Consolidated Complaint for violation of
federal securities laws filed against Homestore.com, Inc, us and the other named
defendants. On July 22, 2004, CalSTRS and IPIX filed a Stipulation of Dismissal
with the Court of Appeals pursuant to which the appeal was dismissed, with
prejudice, against us.
Item 2. Changes In Securities And Use Of Proceeds
On April 5, 2004, we completed the sale of 909,090 shares of our common stock,
resulting in net proceeds received of approximately $4.9 million, and additional
investment rights ("AIR") to purchase another 888,180 shares of our unregistered
common stock in a private offering to accredited institutional investors
("PIPE"). The shares of common stock were sold at $5.50 per share and the shares
of common stock underlying the AIR are purchasable at $6.05 per share. The AIR
was exercisable until September 28, 2004. As of September 30, 2004, all of the
AIR's had been exercised: 799,361 shares of common stock in the third quarter
and 88,818 shares in the second quarter. Our proceeds from the AIR exercises
were $5.4 million. The common stock sold in the PIPE and from the AIR's has been
registered under the Securities Act of 1933, as amended, and may be offered or
sold in the United States. Our Form S-3 filed on May 5, 2004 provides a
description of this transaction and copies of the executed documents.
On May 14, 2001, we entered into a definitive agreement with Image Investor
Portfolio, a separate series of Memphis Angels, LLC ("Image") for an investment
by Image in the Company. Pursuant to the terms of a securities purchase
agreement between the Company and Image dated as of May 14, 2001, Image
purchased from us a $10 million convertible senior secured note and received
Tranche A and Tranche B warrants with the right to purchase up to $20 million of
our Series B Preferred Stock. Each share of the Series B Preferred Stock is
convertible into approximately 9.2 shares of common stock and is entitled to
vote on matters submitted to holders of common stock on an as-converted basis.
On September 26, 2001, the Company, Image and strategic investors completed the
Tranche B stage of the investment. At this time, we issued 1,115,080 shares of
Series B Preferred Stock for total consideration of $22.3 million, represented
by the conversion of the $10 million note, the conversion of $0.3 million of
interest on the Note and $12 million in cash through the exercise of Tranche B
warrants. The remainder of the Tranche B warrants expired.
At December 31, 2003, there were two Tranche A warrants ("Warrant 1" and
"Warrant 2"), outstanding. Warrant 1, which entitled the holders to purchase
150,000 shares of Series B Preferred Stock at $20 per share, has been exercised
in full. We issued 1,375,600 shares of common stock in the third quarter of 2004
and received $3.0 million in cash from the exercise of part of Warrant 1 and the
conversion of the underlying Series B Preferred Stock. During the second quarter
of 2004, 600 shares of the rest of Warrant 1 were converted into 4,372 shares of
23
common stock. We did not receive any proceeds from the second quarter Warrant 1
exercise. Warrant 2 entitles the holders to purchase 100,000 shares of Series B
Preferred Stock at $40 per share and is exercisable at any time before the
expiration date of May 14, 2006. During the second quarter of 2004, 400 shares
of Warrant 2 were converted into 2,914 shares of common stock. We did not
receive any proceeds from the second quarter Warrant 2 exercise.
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
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