ICCSA : A True Floorless Convertible, Still Shortable Through Most Brokers
General Overview
ICCSA has been a development stage company for over 7 years, and during that time they have never been able to develop a viable product. In the process, they spent all their cash, then borrowed more cash and spent all that too. When internet commerce became a hot sector, the company changed its name from “Infosafe Systems” to “Internet Commerce”. The name change occurred on 25 September 1998. People who liked the new name bid it up from $1.50 to $8 where it has stabilized. For the past 4 months, the company has not met NASDAQ SmallCap requirements for continued listing, primarily because it has negative net tangible assets. The company has been unable to get equity financing under favorable terms, and now has agreed to a large floorless convertible with conversion at least at 25% below market prices.
1.304 millions shares outstanding, 40.0 million authorized
10/31/98 Balance sheet
$157,952 current assets
$2,019,666 current liabilities
$1,359,290 total tangible assets
$2,193,125 total liabilities
$ -833,825 net tangible assets (negative!)
Revenues
$9,296 for the Q ended 10/31/98
$637,940 total over the past 7 years
Products
Over the years, the company has developed several products, each of which failed miserably. They generated minimal sales and then were abandoned. The company has one last product called CommerceSense, which was launched on 30 April 1998 and has not generated significant sales. The product enables “electronic data interchange” and competes head-on with established giants such as Netscape, General Electric Information Services, IBM, AT&T, and MCI. From 30 April 1998 through 31 October 1998 CommerceSense generated total revenues of only $27,296. Now, the product is almost a year old and is becoming obsolete. ICCSA does not have the resources to update its product fast enough to keep up with the rapid changes in internet standards.
Losses
$1,091,130 for the Q ended 10/31/98
The company is burning cash at about $1 million per quarter.
Summary of NASDAQ SmallCap Delisting Pressure
To maintain listing on the NASDAQ SmallCap market, a company must meet one of the following:
1. Net tangible assets over $2 million
2. Market capitalization over $35 million
3. Net income of over $0.5 million in the most recent fiscal year or in 2 of the past 3 fiscal years
The company did not meet any of these conditions, and NASDAQ started threatening delisting on 8 July 1998. On 22 July 1998 the company submitted to NASDAQ a plan to raise net tangible assets above $2 million through an equity offering. The company was unable to sell equity under favorable terms, so on 22 October 1998 NASDAQ declared ICCSA would be delisted on 29 October 1998. On 27 October 1998 the company used a stalling technique of requesting a hearing with NASDAQ officials. This postponed the delisting until after the hearing scheduled for 7 January 1999. During the interim period, the company got serious and arranged for equity financing under any terms they could get. The only option was a floorless convertible with terms quite unfavorable to the company. This plan was presented to NASDAQ on 7 January 1999, and NASDAQ promised to make a decision within 30 days. Although no decision has been announced, I believe the listing will be maintained. It was the serious threat of delisting that forced the company to accept a death spiral convertible.
Summary of Series A Preferred Convertible Shares
$5.595 million in series A preferred convertible shares will be sold. On the balance sheet, preferred stock is treated as debt, so the sale of the preferred shares raises both cash and long term debt by equal dollar amounts. This does not affect the net tangible book value. Thus, in order to maintain a NASDAQ SmallCap listing, the company must encourage the preferred shareholders to convert their preferred shares into class A common shares.
The conversion price is the lower of $5 or 75% of the common stock market value.
The preferred shareholders will not take the risk of holding class A common shares. Instead they will first sell short, then convert, and finally use the newly issued shares to replace the shares borrowed to sell short. Since the conversion price is capped at $5, the preferred shareholder can get at least 1.119 million new shares. So, step 1 is to sell short 1.119 million shares, which is roughly equal to the float. Of course, all that selling would push the stock down to around $1, which would drop the conversion price to $0.75, which means the preferred shareholders can now get 7.46 million common shares, ... and the death spiral begins. There are 40 million shares of class A common authorized.
When all the conversion is finished, the share price will surely be below $1, which is another violation of the NASDAQ SmallCap continued listing requirements. Still, the net tangible book value will $5.595 million higher. On 10/31/98 it was -$833,825 and by the end of the current quarter (4/30/99) it will probably drop to -$2,833,825. Preferred conversion will take it up to $2,761,175 which does satisfy the listing requirements. However, that will last less than 3 months with a burn rate of about a million dollars per quarter.
Note that NASDAQ requires shareholder approval before a company makes a private placement resulting in issuance of new shares totaling more than 20% of the current number of shares issued. Although the officers and directors mostly don't own any shares, they do own a lot of options, which also carry a vote. Further, the directors have control over a “voting trust” which contains nearly of the class B shares that get 6 votes each. As a result, the officers and directors control the vote even though they personally own a tiny fraction of the shares outstanding. They have already stated that they will vote for approval of the new share issuance during an upcoming special shareholders' meeting in March.
Other Source of Dilution
As is typical of a company near bankruptcy, ICCSA has issued a myriad of warrants and options. Although millions of these are well out of the money, all of the following are in the money and are immediately excerciseable:
Providers of a recent bridge loan were given 778,500 warrants to buy common class A shares at $2.50
Employees have received a total of 1,779,536 options under the 1994 plan plus 4,000 under the 1992 plan, with exercise prices from $0.26 to $3.88
Consultants were paid with 500,000 warrants to buy class A common shares at $2.50
All of these in the money options and warrants are held by people smart enough to understand the impact of a floorless convertible on the stock price. In fact, all of the holders of the bridge warrants are accepting preferred shares in lieu of repayment of the bridge loan. I'm sure that these people will all want to exercise their warrants and options and sell the common shares that they receive prior to the start of the death spiral. If they don't do it, their in the money warrants and options become worthless. So, the number of class A common shares issued will probably run from 1.304 million to 4.366 million even before the death spiral begins.
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