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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-QSB þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT
 Commission File Number: 00-19813 InfoNow Corporation  Delaware
    
    04-3083360(State of Incorporation)
    
    (I.R.S. Employer Identification No.)
 1875 Lawrence Street, Suite 1100, Denver, Colorado 80202 
  303-293-0212 
  Check whether the issuer: (1) has filed all reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 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. x o
 As of November 11, 2004, there were 9,978,626 shares of the Issuers common
stock outstanding. Transitional Small Business Disclosure Format (Check one): Yes o No x




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INFONOW CORPORATION INDEX  
 Page No.PART I. FINANCIAL INFORMATIONITEM 1.
    
    FINANCIAL STATEMENTSUnaudited Balance Sheet  September 30, 2004
    
    
    3Unaudited Statements of Operations  For the Three and Nine Months
Ended September 30, 2004 and September 30, 2003
    
    
    4Unaudited Statements of Cash Flows  For the Nine Months
Ended September 30, 2004 and September 30, 2003
    
    
    5Notes to Unaudited Financial Statements
    
    
    6ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
    
    
    13ITEM 3.
    
    CONTROLS AND PROCEDURES
    
    
    30PART II. OTHER INFORMATIONITEM 6.
    
    EXHIBITS AND REPORTS ON FORM 8-K
    
    
    31SIGNATURES
    
    
    32Rule 13a-14(a)/15d-14(a) CertificationsSection 1350 Certifications
  2




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements. 
 INFONOW CORPORATION
BALANCE SHEET
(In Thousands, Except Share Information)
(Unaudited) September 30,2004ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    3,944Accounts receivable:Billed, net of allowance of $31
    
    
    1,336Unbilled
    
    
    131Prepaid expenses and other current assets
    
    
    462Total current assets
    
    
    5,873Property and Equipment, net
    
    
    499Other Assets and Deferred Charges
    
    
    13Total Assets
    
    $
    6,385LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Capital leases
    
    $
    74Accounts payable
    
    
    523Payroll related liabilities
    
    
    352Other liabilities
    
    
    139Short-term deferred revenues
    
    
    972Total current liabilities
    
    
    2,060Long-term deferred revenues
    
    
    15Deferred rent
    
    
    167Commitments and Contingencies(Note 2)Stockholders Equity:Preferred stock, $.001 par value; 1,712,335 shares authorizedSeries A Convertible, 213,483 shares authorized, none
issued and outstanding.
    
    
    Series B Convertible Participating Preferred Stock,
550,000 shares authorized,
none issued and outstanding.
    
    
    Common stock, $.001 par value; 40,000,000 shares authorized;
9,969,759 issued and outstanding
    
    
    10Additional paid-in capital
    
    
    40,058Accumulated deficit
    
    
    (35,925
    )Total stockholders equity
    
    
    4,143Total Liabilities and Stockholders Equity
    
    $
    6,385
 See notes to the unaudited financial statements. 3




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INFONOW CORPORATION
STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Information)
(Unaudited) Three Months Ended September 30,
    
    Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003REVENUES:Service and other fees
    
    $
    2,462
    
    
    $
    2,440
    
    
    $
    7,197
    
    
    $
    7,337Implementation fees
    
    
    190
    
    
    
    399
    
    
    
    1,137
    
    
    
    1,984Software license fees
    
    
    (3
    )
    
    
    
    
    
    
    136
    
    
    
    78Total revenues
    
    
    2,649
    
    
    
    2,839
    
    
    
    8,470
    
    
    
    9,399COST OF REVENUES
    
    
    1,545
    
    
    
    1,319
    
    
    
    4,228
    
    
    
    4,373GROSS MARGIN
    
    
    1,104
    
    
    
    1,520
    
    
    
    4,242
    
    
    
    5,026OPERATING EXPENSES:Selling and marketing
    
    
    487
    
    
    
    552
    
    
    
    1,612
    
    
    
    1,844Product development
    
    
    216
    
    
    
    328
    
    
    
    660
    
    
    
    1,023General and administrative
    
    
    763
    
    
    
    561
    
    
    
    2,126
    
    
    
    2,046Total operating expenses
    
    
    1,466
    
    
    
    1,441
    
    
    
    4,398
    
    
    
    4,913INCOME (LOSS) FROM OPERATIONS
    
    
    (362
    )
    
    
    79
    
    
    
    (156
    )
    
    
    113OTHER INCOME (EXPENSE):Interest income
    
    
    9
    
    
    
    3
    
    
    
    20
    
    
    
    15Interest expense
    
    
    (2
    )
    
    
    (4
    )
    
    
    (7
    )
    
    
    (14
    )Total other income
    
    
    7
    
    
    
    (1
    )
    
    
    13
    
    
    
    1NET INCOME (LOSS)
    
    $
    (355
    )
    
    $
    78
    
    
    $
    (143
    )
    
    $
    114NET INCOME (LOSS) PER COMMON SHARE:Basic
    
    $
    (.04
    )
    
    $
    .01
    
    
    $
    (.01
    )
    
    $
    .01Fully diluted
    
    $
    (.04
    )
    
    $
    .01
    
    
    $
    (.01
    )
    
    $
    .01WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:Basic
    
    
    9,961
    
    
    
    9,325
    
    
    
    9,898
    
    
    
    9,320Fully diluted
    
    
    9,961
    
    
    
    9,750
    
    
    
    9,898
    
    
    
    9,580
 See notes to the unaudited financial statements. 4




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INFONOW CORPORATION
STATEMENTS OF CASH FLOWS
(in Thousands)
(Unaudited) Nine Months Ended September 30,2004
    
    2003Cash Flows from Operating Activities:Net income (loss)
    
    $
    (143
    )
    
    $
    114Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation and amortization
    
    
    314
    
    
    
    485Allowance for bad debt
    
    
    28
    
    
    
    (11
    )Loss on asset disposition
    
    
    13
    
    
    
    Stock based compensation
    
    
    
    
    
    
    12Changes in operating assets and liabilities:Accounts receivable
    
    
    25
    
    
    
    715Other current assets
    
    
    150
    
    
    
    284Other assets and deferred charges
    
    
    1
    
    
    
    86Accounts payable
    
    
    338
    
    
    
    28Payroll related and other liabilities
    
    
    (54
    )
    
    
    65Deferred revenue
    
    
    (200
    )
    
    
    (1,301
    )Net cash provided by operating activities
    
    
    472
    
    
    
    477Cash Flows from Investing Activities:Purchase of property and equipment
    
    
    (232
    )
    
    
    (151
    )Cash Flows from Financing Activities:Proceeds from exercise of stock options
    
    
    456
    
    
    
    13Principal payments on debt obligations
    
    
    (51
    )
    
    
    (54
    )Net cash provided by (used in) financing activities
    
    
    405
    
    
    
    (41
    )Net Increase in Cash and Cash Equivalents
    
    
    645
    
    
    
    285Cash and Cash Equivalents, beginning of period
    
    
    3,299
    
    
    
    2,490Cash and Cash Equivalents, end of period
    
    $
    3,944
    
    
    $
    2,775Supplemental Cash Flow Information:Cash paid for interest
    
    $
    7
    
    
    $
    12
 See notes to the unaudited financial statements. 5




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INFONOW CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Unaudited)  1.
    ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Organization and Business Activity Unless otherwise indicated, all
references in this Form 10-QSB to InfoNow, the Company, we, or our
refer to InfoNow Corporation. The Company was incorporated under the laws
of the State of Delaware on October 29, 1990. The Company provides Channel
Insight and Channel Management solutions, in the form of software and
services, to companies that sell their products through complex networks of
distributors, dealers, resellers, retailers, agents or branches (i.e.,
channel partners). Companies use InfoNows software and services to
collaborate with their channel partners to create demand, increase
revenues, lower operating costs, calculate sales commissions, and maximize
the return on investment of their channel strategies. The accompanying interim condensed financial statements are unaudited but,
in the opinion of management, reflect all adjustments (consisting of those
of a normal recurring nature) necessary in order to make the financial
statements not misleading. The results of operations for any interim period
are not necessarily indicative of results for the full year. These
condensed financial statements should be read in conjunction with the
financial statements and notes thereto contained in the Companys previous
filings with the U.S. Securities and Exchange Commission. Use of Estimates The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and the differences could
be material. Significant estimates include the estimate of a customer
life, over which deferred revenue and implementation expenses are
recognized; the percentage of completion on customer contracts; the
percentage of hours that technical staff devote to activities related to
the cost of revenues versus product development activities, which drives
the allocation of related costs; and the allowance for doubtful accounts. Cash and Cash Equivalents The Company considers all highly liquid
investments with original maturity dates of three months or less to be cash
equivalents. The Companys excess cash is maintained in a money market
fund. Property and Equipment Property and equipment are stated at cost.
Replacements, renewals and improvements are capitalized and costs for
repairs and maintenance are expensed as incurred. Depreciation is computed
using the straight-line method over estimated useful lives of three to five
years. During the third quarter of 2004 the Company elected to abandon the patent
application process related to its proprietary e-commerce cataloging
technology. Accordingly, the Company wrote off $13,000 in previously
capitalized patent costs associated with this 6




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effort. This cost is reflected in the Companys product development
expenses. The Company continues to pursue patent protection for its
Channel Insight technology and algorithms and expects that completing the
patent process for this technology will take three to five years. Revenue Recognition The Company offers its software and services to
clients in two forms. The first (and historical) method utilizes an
application service provider, or ASP, model. Under this business model the
Company sells the right to use its software for the term of a specific
agreement, and it implements and hosts that solution to meet specific
client requirements. Accordingly, the Company charges the client an
implementation fee, a managed service fee and, in many cases, variable
monthly fees. The implementation fee and related direct costs are deferred
and recognized ratably over the longer of the expected customer life or
contract term. Managed service fees and variable monthly fees are
recognized as services are performed. The second method of delivering our software and services is via a
license-hosted model. Under this model, the Company sells its clients a
perpetual license for its software. The client can install the software on
their own in-house systems, or, as is most often the case, the Company will
host the software and perform related services under a managed services
agreement. Sales of solutions under the license-hosted model typically include a
software license fee, an implementation fee, a software maintenance fee, a
managed service fee and, in many cases, variable monthly fees. The Company
establishes vendor specific objective evidence, or VSOE, of fair value for
the software maintenance fee and managed service fee elements of a contract
based on the following two considerations: 1) they are sold independently
of the other elements in a contract, and independently of each other; and
2) these services generally are, and have historically been, renewed in
subsequent years (independent of the other elements) at the same fees
charged when all elements are sold together. Therefore, the VSOE of fair
value for each of such services can be properly determined by reference to
the applicable customers contractual fee rates relating to those services.
The Company is not, however, currently able to establish VSOE of fair
value for the software license and implementation fee elements of its
contracts. Therefore, it uses the residual value method to recognize
revenue in accordance with Statement of Position 97-2, Software Revenue
Recognition(SOP 97-2). Using this method, revenue from the managed
service and software maintenance elements of a contract is recognized
ratably over the term of the managed service arrangement and the software
maintenance arrangement, respectively. Since the Company is currently
unable to establish VSOE of fair value for the software license fee and
implementation fee components of a contract and the installation services
are essential to the functionality of the software, the Company applies
contract accounting to both the software license and implementation
elements of the arrangement in accordance with Accounting Research Bulletin
No. 45, Long-Term Construction-Type Contracts(ARB 45) and Statement of
Position 81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts(SOP 81-1). Accordingly, license and
implementation revenues are recognized on a percentage of completion basis.
As changes occur in the estimate of completion percentage, revenue
recognition is adjusted accordingly. The estimate of completion percentage
is based on the ratio of the actual effort spent on a project as of the
financial statement date to the estimate of total effort to complete the
implementation. Losses are recognized immediately if
projected direct costs exceed anticipated revenues. Revenue from variable
monthly fees is recognized as services are performed. 7




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The Company recognized $587,000 in previously deferred revenue during the
first quarter of 2003 as a result of the Companys largest client
converting the term licenses related to its Referral/Locator and Lead
Management solutions to perpetual licenses. During the third quarter of
2003, the Company recognized $135,000 in previously deferred revenue as a
result of three clients converting their Referral/Locator solutions from an
ASP arrangement to a license-hosted arrangement. The Company has historically sold its solutions primarily through direct
sales efforts; however, when the Company sells solutions through a reseller
channel it recognizes revenue consistent with the methods described above. Income Taxes The Company accounts for its income tax assets and
liabilities in accordance with SFAS No. 109, Accounting for Income Taxes
(SFAS No. 109). SFAS No. 109 requires recognition of deferred tax assets
and liabilities for the expected future income tax consequences of
transactions. Under this method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax
basis of assets and liabilities using enacted tax rates in effect for the
year in which the differences are expected to reverse. Net deferred tax
assets are then reduced by a valuation allowance for amounts that do not
satisfy the realization criteria of SFAS No. 109. As a result of the
valuation allowance, the Company had no net deferred tax assets at
September 30, 2004. Stock Compensation Expense The Company records its stock compensation
expense in accordance with SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). SFAS No. 123 specifies a fair value based
method to measure compensation cost of issued stock options and similar
instruments issued using a Black-Scholes model or other comparable method.
However, the Company has elected an option under SFAS No. 123 that allows a
company to continue to recognize compensation cost for employees and
directors in accordance with the guidance in Accounting Principles Board
No. 25 and disclose the pro forma results of operations as if SFAS No. 123
had been applied to the financial statements. Transactions in which the
Company issues stock options or other equity instruments to acquire goods
or services from non-employees are accounted for in accordance with SFAS
No. 123. The Company accounts for stock compensation for employees via the
intrinsic value method and for non-employees via the fair value method.
The intrinsic value method results in no compensation expense for new stock
option grants because the market value and strike price of the stock option
grant are the same on the grant date. Had compensation cost for the
Companys plans been determined consistent with SFAS No. 123, the Companys
net loss and loss per share would have been increased to the pro forma
amounts indicated below: 8




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Three Months Ended September 30,2004
    
    2003(In thousands, except per share amounts)Net Income (Loss)As reported
    
    $
    (355
    )
    
    $
    78Add: Stock-based employee
compensation expense included in
reported net income, net of tax
effect
    
    
    
    
    
    
    Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards, net
of tax effect
    
    
    (417
    )
    
    
    (288
    )Pro forma
    
    $
    (772
    )
    
    $
    (210
    )Earnings (loss) per share:Basic and diluted-as reported
    
    $
    (.04
    )
    
    $
    .01Basic and diluted-pro forma
    
    $
    (.08
    )
    
    $
    (.02
    )
 Nine Months Ended September 30,2004
    
    2003(In thousands, except per share amounts)Net Income (Loss)As reported
    
    $
    (143
    )
    
    $
    114Add: Stock-based employee
compensation expense included in
reported net income, net of tax
effect
    
    
    
    
    
    
    12Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards, net
of tax effect
    
    
    (1,607
    )
    
    
    (997
    )Pro forma
    
    $
    (1,750
    )
    
    $
    (871
    )Earnings (loss) per share:Basic and diluted-as reported
    
    $
    (.01
    )
    
    $
    .01Basic and diluted-pro forma
    
    $
    (.18
    )
    
    $
    (.09
    )
 During the nine months ended September 30, 2004, the Company received
$456,000 of proceeds from the exercise of 329,260 options by employees and
former employees pursuant to the terms of the original options. During the
nine months ended September 30, 2003, the Company received $12,600 of
proceeds from the exercise of 13,417 options by employees and former
employees pursuant to the terms of the original options. 9




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Net Income (Loss) Per Common Share Earnings per share is presented in
accordance with the provisions of SFAS No. 128, Earnings Per Share.Basic
earnings per share (EPS) is calculated by dividing the income or loss
available to common stockholders by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock. Stock options,
warrants outstanding and their equivalents are included in diluted earnings
per share computations through the treasury stock method unless they are
antidilutive. The components of basic and diluted earnings per share were as follows: Three Months Ended September 30,2004
    
    2003(In thousands, except per share amounts)Net income (loss) available for
common shareholders (A)
    
    $
    (355
    )
    
    $
    78Weighted average common shares
outstanding (B)
    
    
    9,961
    
    
    
    9,325Dilutive effect of employee stock
based compensation
    
    
    
    
    
    
    425Common stock and common stock
equivalents (C)
    
    
    9,961
    
    
    
    9,750Earnings (loss) per share:Basic (A/B)
    
    $
    (.04
    )
    
    $
    .01Diluted (A/C)
    
    $
    (.04
    )
    
    $
    .01
 Nine Months Ended September 30,2004
    
    2003(In thousands, except per share amounts)Net income (loss) available for
common shareholders (A)
    
    $
    (143
    )
    
    $
    114Weighted average common shares
outstanding (B)
    
    
    9,898
    
    
    
    9,320Dilutive effect of employee stock
based compensation
    
    
    
    
    
    
    260Common stock and common stock
equivalents (C)
    
    
    9,898
    
    
    
    9,580Earnings (loss) per share:Basic (A/B)
    
    $
    (.01
    )
    
    $
    .01Diluted (A/C)
    
    $
    (.01
    )
    
    $
    .01
 10




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As of September 30, 2004, options to purchase 5,684,865 shares of common
stock were outstanding, but were not included in the computation of loss
per share for the three and nine months ended September 30, 2004 because
their effect would have been antidilutive. For the three months ended
September 30, 2003, options to purchase 2,254,000 shares of common stock
were outstanding, but were not included in the computation of diluted EPS
because the options exercise price was greater than the average market
price of the common shares. For the nine months ended September 30, 2003,
options to purchase 3,464,000 shares of common stock were outstanding, but
were not included in the computation of diluted EPS because the options
exercise price was greater than the average market price of the common
shares. Reclassifications The Companys Statement of Cash Flows contains
categories for changes in Accounts Payable and Payroll Related and Other
Liabilities. In the Companys quarterly report filed on Form 10-QSB for
the nine months ended September 30, 2003, the change in Accounts Payable
included the change in Deferred Rent. In the Companys quarterly report
filed on Form 10-QSB for the nine months ended September 30, 2004, the
change in Deferred Rent has been included in the change in Payroll Related
and Other Liabilities. As a result, the change in Deferred Rent in the
prior year financial statements presented in this Form 10-QSB for the nine
months ended September 30, 2004 has been reclassified to the change in
Payroll Related and Other Liabilities in order to conform to the current
year classification. Concentrations of Credit Risk Financial instruments which potentially
subject the Company to concentrations of credit risk are cash equivalents
and accounts receivable. The Company attempts to limit its credit risk
associated with cash equivalents by placing the Companys financial
instruments with a major institution. A portion of the Companys cash and
cash equivalents balance at September 30, 2004 was in excess of federally
insured limits. The Companys customers are primarily large multi-national
entities located throughout the U.S. The Company grants credit, generally
without collateral, to these customers under specific contractual terms.
The Company has not experienced any material losses related to its accounts
receivable to date. During the three and nine months ended September 30, 2004, the Company
earned $1,429,000, or 54%, and $4,417,000, or 52%, of its revenue from one
global organization. During the three and nine months ended September 30,
2004, this revenue consisted of $1,134,000 and $3,367,000, respectively,
from Channel Insight solutions and $295,000 and $1,050,000, respectively,
from Channel Management solutions. No other organization accounted for
more than 10% of the Companys revenue during the three or nine months
ended September 30, 2004. As of September 30, 2004, that same organization
accounted for approximately 35%, or $473,000, of the Companys net accounts
receivable balance. The loss of this client, reduction in revenues from
this client, or its inability or failure to pay would have a material
adverse impact on the Companys financial condition and results of
operations. Two other clients accounted for more than 10% of the Companys
net accounts receivable balance, one of which represented $318,000, or 24%,
of net accounts receivable, and the other of which represented $140,000, or
10%, of net accounts receivable. No other customers accounted for more
than 10% of the Companys accounts receivable balance at September 30,
2004. During the three and nine months ended September 30, 2003, the Company
earned $1,480,000, or 52%, and $4,601,000, or 49%, respectively, of its
revenue from one global organization. No other organization accounted for more than 10% of the
Companys revenue during the three and nine months ended September 30,
2003. 11




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Approximately $370,000 of the Companys total monthly contracted managed service
fees of $804,000 is tied to the Channel Insight contract it entered into
with its largest client in 2001. $312,000 of the managed service fees
associated with this contract expired in October 2004, while the remaining
$58,000 is under contract through October 2005. In the fourth quarter of
2004, the Company reached an agreement with this client
to extend the services associated with the expired managed
service fees for six months at $90,000 per month, or a reduction of
$222,000 per month. As part of this arrangement, the Company mutually
agreed with the client
to negotiate in good faith towards an additional 36-month agreement. In
addition the Company continues to work with this client for purposes of selling new
solutions; however, there can be no assurance that it will be successful in
renewing, extending or expanding solutions for this client. Segment Information The Company operates in a single reportable segment
and all revenues from customers are primarily from the sale of the
Companys Channel Insight and Channel Management software and services.
The Company provides its solutions and services domestically to clients
that, in some cases, have an international presence. All solutions and
services are delivered from the Companys Denver, Colorado, office and two
data centers located in Denver and Thornton, Colorado. Recent Accounting Pronouncements In January 2003, the Financial
Accounting Standards Board issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51, and in December 2003 issued FIN 46R. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the
entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or
acquired after January 31, 2003. FIN 46R requires the adoption of either
FIN 46 or FIN 46R in financial statements of public entities that have
interests in structures that are commonly referred to as special purpose
entities for periods ending after December 15, 2003. Application for all
other types of variable interest entities is required in financial
statements for periods ending after March 15, 2004. The adoption of FIN 46
had no impact on the Companys financial position or results of operation. In August 2003, the EITF reached a consensus on Issue No. 03-05, Software
Revenue Recognition, Applicability of AICPA Statement of Position 97-2,
Software Revenue Recognition, to Non-Software Deliverables. This issue
focuses solely on whether non-software deliverables included in
arrangements that contain more-than-incidental software should be accounted
for in accordance with SOP 97-2. The Task Force confirmed that in an
arrangement that contains software that is more-than-incidental to the
products or services as a whole, only the software and software-related
elements are included within the scope of SOP 97-2. Software-related
elements include software-related products and services such as those
listed in paragraph 9 of SOP 97-2, as well as other deliverables for which
the software is essential to their functionality. EITF Issue No. 03-05 is
effective for revenue arrangements entered into in fiscal periods beginning
after August 13, 2003. The adoption of EITF Issue No. 03-05 did not have
an impact on the Companys financial position or results of operation. 12




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2.
    COMMITMENTS AND CONTINGENCIES From time to time the Company may be involved in litigation that arises in
the normal course of business operations. As of the date of this report,
the Company is not a party to any litigation that it believes could
reasonably be expected to have a material adverse effect on its business or
results of operations. The Company has contracts with certain of its customers that contain
indemnification clauses, which could require the Company to make payments
to the customer if it is determined that the solution provided under the
contract infringes any proprietary right of a third party, and such
infringement cannot be resolved by the Company. There is no liability
reflected in the accompanying balance sheet for these contingencies. In September 2004 the Company settled a dispute with a terminated employee
by agreeing to pay between $85,000 and $91,000, depending on the length of
time needed for the terminated employee to obtain other employment. The
Company expects to pay $85,000 of this obligation in November 2004. The
cost associated with this obligation is included in the Companys general
and administrative expenses for the three and nine months ended September
30, 2004. 
 Item 2. Managements Discussion and Analysis or Plan of Operation. The following discussion and analysis of the financial condition and results of
operations for InfoNow should be read in conjunction with our unaudited
financial statements and related notes appearing elsewhere in this report, and
our previous filings with the U.S. Securities and Exchange Commission. This
discussion contains statements that are not historical fact. These
forward-looking statements are based on our current expectations, assumptions,
estimates and projections about our industry and business and include
statements about markets for our software and services, planned development of
products and anticipated expense and revenue levels. These forward-looking
statements contain words such as anticipate, believe, plan, expect,
intends, predicts, or similar language. These forward-looking statements
are made subject to the Private Securities Litigation Reform Act of 1995 and
are subject to business and economic risks. Our actual results could differ
materially from those anticipated in such forward-looking statements as a
result of many factors, including those set forth in this discussion and in
other documents we have filed with the Securities and Exchange Commission. General Information and Overview InfoNow provides Channel Insight and Channel Management solutions, in the form
of software and services, to companies that sell their products through complex
networks of distributors, dealers, resellers, retailers, agents or branches
(i.e., channel partners). Companies use our software and services to
collaborate with their channel partners to create demand, increase revenues,
lower operating costs and maximize the return on investment of their channel
strategies. Our clients are generally companies with extensive channel partner
networks, and include companies such as Apple, Avaya, Bank of America,
Hewlett Packard, Lexmark, Maytag, The Hartford, Visa, Vision Service Plan (VSP)
and Wachovia Corporation. 13




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As of September 30, 2004, we had 43 managed services clients, compared to the
39 we reported as of September 30, 2003. The increase in our client base is
primarily attributable to sales of our Channel Insight solution. As a result
of the increase in our client count, our monthly contracted managed service fees, which
include fees that are currently in a month-to-month contract status, increased
from $786,000 as of September 30, 2003, to $804,000 as of September 30, 2004.
This was primarily due to sales of our Channel Insight solution through
contracts that contained managed service fees in excess of those managed
service fees lost through client contract terminations and renewals at reduced
rates. We will experience a reduction in our contracted monthly service
fees beginning in the fourth quarter of 2004 when certain of the agreements
with our largest client expire. For further discussion see
Related Business Risks and Assumptions. We have experienced extended sales cycles in recent years, which we believe
were caused primarily by the following factors: i) there has been a general
decline in IT spending in recent years and our past efforts to sell
enterprise-level solutions, which typically require a significant financial
commitment on the part of the customer, were inconsistent with this trend; ii)
the market for Channel Insight solutions is at an early stage of adoption; iii)
in many instances, our sales prospects have not budgeted for the solutions we
provide and, therefore, require a lengthy evaluation process prior to
purchasing; and iv) we are susceptible to competitive threats such as clients
or prospective clients outsourcing certain IT functions to other countries in
an effort to reduce costs, as well as companies attempting to implement
in-house solutions similar to those that we provide. As a result of these factors, it is difficult for us to accurately predict the
demand for our solutions, as well as the value we will receive upon selling
them. In addition, our implementation cycles have, in some cases, extended
substantially beyond our initial estimates, which has resulted in lower than
anticipated license, implementation and service fee revenue in certain periods.
As a result of these challenges, among other things, our revenues can
fluctuate substantially from quarter to quarter. Personnel-related costs1 comprised approximately 76% of our total costs in the
third quarter of 2004 and 2003. Because salaries and related costs are a
significant portion of our overall costs, variation in the need for technical
personnel based on the demand for our solutions, as well as fluctuations in the
cost of attracting and retaining qualified technical personnel, can
significantly impact our operating results. During the third quarter of 2003, we took steps to reduce our costs, which
resulted in a 14-person reduction in regular full-time personnel. The
reduction in full-time personnel consisted of an 11-person reduction in staff
related to software implementation, system operations and client support, a
2-person reduction in our marketing staff and a 1-person reduction in product
development personnel. The impact of these cost reductions on our operating
results is discussed more fully in Results of Operations. Early in the third quarter of 2004, we embarked on a growth
strategy to ensure sufficient resources to implement new client solutions,
maintain and expand the solutions provided to existing clients, support
strategic partnerships as they develop and maintain our   1 Personnel-related costs include salaries, vacation, fringe benefits, payroll
taxes and personnel support costs such as office supplies for employees. 14




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technology leadership in this emerging market. In support of this strategy, we
added headcount in the areas of services and development during the third
quarter, and we expect to continue hiring in these areas in the fourth quarter.
We expect that these actions will increase our costs more quickly than our
revenues in the near-term, which may require us to raise capital, modify our investment priorities
or alter our growth strategy. There can be no assurances that we could successfully
do these things. In an effort to accelerate the sales cycle for Channel Insight we developed a
modular delivery model for this solution during the third quarter of 2003,
wherein a prospective customer can access distinct modules related to specific
business needs at lower introductory price points, and add other applications
incrementally. Additionally, we are working on building leveraged access to
customers through strategic partner relationships, and are jointly engaging in
early stage selling activities with one potential partner. Our Channel Insight solution consists of a platform, a data collection solution
and six separate modules, as discussed on the Companys website at
www.infonow.com. During the fourth quarter of 2004 we launched a limited
Channel Insight offering targeted at mid-market companies. As a result of our
tiered delivery model and other ongoing sales efforts we have signed a number
of new Channel Insight agreements in 2004 and experienced an increase in sales relative to the first three quarters of 2003. However,
during the three months ended September 30, 2004, our sales levels declined
relative to the three months ended September 30, 2003. During the third quarter of this year, we elected to abandon the patent
application process associated with our proprietary e-commerce cataloging
technology since this technology is no longer relevant to our business model.
Accordingly, we wrote off $13,000 of previously capitalized patent costs
associated with this effort. This cost is reflected in our product development
expenses. We continue to pursue patent protection for our Channel Insight
technology and algorithms and we expect that completing the patent process for
this technology will take three to five years. Critical Accounting Policies We believe the following accounting policies, which are important to our
financial position and results of operations, require significant judgments and
estimates on the part of management. We believe that the following description
represents our critical accounting policies and estimates used in the
preparation of our financial statements. Revenue Recognition Our solutions are generally sold with annual or multi-year contracts. The
initial term of these agreements is typically one to three years and they are
generally renewable upon mutual agreement between InfoNow and the client. A typical contract fee could include the following six separate
revenue-producing components: Software license and implementation fees:  
    
    The software license fee applies to all configured
application software and related functionality used in the
clients application.
    
    The implementation fee applies to the configuration of
a tailored, client-specific software interface to the system and
the design and configuration of client business rules and
databases. 15




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Monthly service fees and software maintenance fees:  
    
    The managed service fee applies to hosting and
provision of the service, any reconfiguration or maintenance on
the software necessary during the contract term, as well as
performance of routine maintenance to client databases and core
systems.
    
    The variable monthly fee includes charges for system
usage in excess of contracted thresholds.
    
    A software maintenance fee (for customers utilizing a
licensed model) includes updates to the clients software. Other fees:  
    
    Variable fees included under this heading are
pass-through charges for voice recordings, faxes, geocoding, and
telecommunications charges, which are typically billed with an
incremental administrative fee in addition to the direct charge
we incur to provide these services. We offer our solutions to clients in two forms. The first (and historical)
method utilizes an application service provider, or ASP, model. Under this
business model we sell the right to use our software for the term of a specific
agreement, and we implement and host that solution to meet specific client
requirements. Accordingly, we charge the client an implementation fee, a
managed service fee and, in many cases, variable monthly fees. The
implementation fee and related direct costs are deferred and recognized ratably
over the longer of the expected customer life or contract term in accordance
with SAB 104. Because most of our initial sales contracts range from one to
three years in duration, the customer life is typically the longer deferral
period and is estimated to be three years. This estimate is based on a number
of factors, including customer turnover, the rate of change for the technology
underlying our solutions and the expectation that our customers will continue
to convert from the ASP model to our license-hosted model, under which
software, implementation fees and direct costs are not deferred, but are
recognized on a percentage of completion basis in accordance with ARB No. 45
and SOP 81-1. We evaluate the estimate of a customer life on an ongoing basis
in consideration of these factors and the estimate of three years has remained
constant since the adoption of SAB 104. If, based upon our evaluations, the
estimate of a customer life were to increase, deferred revenue balances would
be recognized over a longer time period. A reduction in the estimate of a
customer life would, conversely, result in accelerated recognition of deferred
revenues relative to prior years. Because our deferred revenues balances have
declined as a result of our selling more licensed solutions, this estimate has
decreased in significance relative to prior years. We expect to continue
selling primarily licensed solutions, therefore, we anticipate that the
estimate of a customer life will continue to decrease in significance in future
periods. Revenue from managed service fees and variable monthly fees is
recognized as services are performed. The second method of delivering our software and services is via a
license-hosted model. We began offering this model in 2001 and it has become
our predominant business model. Under this model, we sell our clients a
perpetual license for our software. They can install our software
on their own in-house systems, or, as is most often the case, we will host the
software and perform related services under a managed services agreement. 16




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Sales of our solutions under the license-hosted model typically include a
software license fee, an implementation fee, a software maintenance fee, a
managed service fee and, in many cases, variable monthly fees. We establish
vendor specific objective evidence, or VSOE, of fair value for the software
maintenance fee and managed service fee elements of a contract based on the
following two considerations: 1) they are sold independently of the other
elements in a contract, and independently of each other; and 2) these services
generally are, and have historically been, renewed in subsequent years
(independent of the other elements) at the same fees, or the current market
value of those fees, charged when all elements are sold together. Therefore,
the VSOE of fair value for each of such services can be properly determined by
reference to the applicable customers contractual fee rates relating to those
services. We are not, however, currently able to establish VSOE of fair value
for the software license and implementation fee elements of our contracts.
Therefore, we use the residual value method to recognize revenue in accordance
with SOP 97-2. Using this method, revenue from the managed service and
software maintenance elements of a contract is recognized ratably over the term
of the managed service arrangement and the software maintenance arrangement,
respectively. Since we are currently unable to establish VSOE of fair value
for the software license fee and implementation fee components of a contract
and our installation services are essential to the functionality of the
software, we apply contract accounting to both the software and implementation
elements of the arrangement in accordance with ARB No. 45 and SOP 81-1.
Accordingly, license and implementation revenues are recognized on a percentage
of completion basis. In the future, if we are able to establish VSOE of fair
value for the software license and implementation elements of our solutions,
license fees will generally be recognized at the time of contract signing,
assuming all revenue recognition criteria are met, instead of on a percentage
of completion basis. As changes occur in our estimate of completion
percentage, revenue recognition is adjusted accordingly. Our estimate of
completion percentage is based on the ratio of the actual effort spent on a
project as of the financial statement date to the estimate of total effort to
complete the implementation. Fluctuations in the estimate of total effort to
complete an implementation can significantly impact revenue recognition on a
project in a given period. The estimate of total effort to complete an
implementation involves significant judgment regarding the time required to
perform the tasks associated with a project, such as coding and testing the
solution. In many cases, our estimates are based on past experience; however,
because certain of our solutions are in an early stage of development and in
most cases involve client-specific configuration and/or customization, we may
not always have direct past experience to draw from, which could result in
increased volatility in the estimate of effort to complete an implementation.
In addition, implementing our solutions generally involves a high degree of
interaction with our clients; therefore, the level of client personnels
technical understanding and changes in a clients requirements or expectations
can also affect the estimate of effort to implement a solution. However, we
believe our prior experience in developing and implementing complex solutions
provides an appropriate basis for developing our estimates. Revenue from
variable monthly fees is recognized as services are performed. We have historically sold our solutions primarily through direct sales efforts
and reseller channels. When we sell solutions through a reseller channel we
recognize revenue consistent with the methods described above. 17




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Technical Personnel Cost Allocation Certain members of our technical staff have the necessary skills to contribute
in solution implementation and maintenance roles, as well as in product
development roles. As such, we distribute our technical resources among these
efforts based on the needs of the organization at a given time. The costs
associated with these employees is allocated either to the cost of revenues or
product development based on the estimate of hours devoted to each category in
a given month. The estimate of hours by category is derived from the data
maintained in our time tracking system, which reflects the time charged by each
employee to a particular project. For certain projects and ongoing system
maintenance efforts, we must use judgment in designating the effort as either a
cost of revenues or a product development expense. A misclassification in this
regard could result in a significant impact to our gross margin; however, we
believe we apply the necessary diligence in the process of designating projects
to provide a reasonable basis for our estimates. The following table summarizes the distribution of our employees as of
September 30, 2004 and September 30, 2003: September 30, 2004
    
    September 30, 2003Staff related to the Cost of
Revenues (including temporary
employees)
    
    
    82
    
    
    
    64Selling and Marketing
    
    
    10
    
    
    
    13Product Development
    
    
    7
    
    
    
    11General and Administrative
    
    
    11
    
    
    
    11Total Employees
    
    
    110
    
    
    
    99
 Included in the table above are 83 full-time employees, 25 temporary employees
and 2 part-time employees at September 30, 2004, and 87 full-time employees, 11
temporary employees, and one part-time employee at September 30, 2003. Our
pool of temporary resources has increased significantly in the last year in
order to support new and existing Channel Insight solutions, as well as to
support proofs of concept for prospective clients. 18




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The following table summarizes the Companys results of operations for the
periods indicated ($ amounts in thousands): Three Months Ended September 30,2004
    
    2003
    
    Change
    
    % ChangeRevenues:Software license fees
    
    $
    (3
    )
    
    $
    
    
    
    $
    (3
    )
    
    
    Implementation fees
    
    
    190
    
    
    
    399
    
    
    
    (209
    )
    
    
    (52
    %)Monthly service fees & software
maintenance fees
    
    
    2,441
    
    
    
    2,420
    
    
    
    21
    
    
    
    1
    %Other fees
    
    
    21
    
    
    
    20
    
    
    
    1
    
    
    
    5
    %Total revenues
    
    
    2,649
    
    
    
    2,839
    
    
    
    (190
    )
    
    
    (7
    %)Cost of Revenues
    
    
    1,545
    
    
    
    1,319
    
    
    
    226
    
    
    
    17
    %Gross Margin
    
    
    1,104
    
    
    
    1,520
    
    
    
    (416
    )
    
    
    (27
    %)Operating Expenses:Selling and marketing
    
    
    487
    
    
    
    552
    
    
    
    (65
    )
    
    
    (12
    %)Product development
    
    
    216
    
    
    
    328
    
    
    
    (112
    )
    
    
    (34
    %)General and administrative
    
    
    763
    
    
    
    561
    
    
    
    202
    
    
    
    36
    %Total operating expenses
    
    
    1,466
    
    
    
    1,441
    
    
    
    25
    
    
    
    2
    %Income (Loss) From Operations
    
    
    (362
    )
    
    
    79
    
    
    
    (441
    )
    
    
    (558
    %)Other Income (Expense):Interest income
    
    
    9
    
    
    
    3
    
    
    
    6
    
    
    
    200
    %Interest expense
    
    
    (2
    )
    
    
    (4
    )
    
    
    2
    
    
    
    50
    %Total other income (expense)
    
    
    7
    
    
    
    (1
    )
    
    
    8
    
    
    
    800
    %Net Income (Loss)
    
    $
    (355
    )
    
    $
    78
    
    
    $
    (433
    )
    
    
    (555
    %)
 Results of Operations Comparison of the Three Months Ended September 30, 2004 with the Three Months
Ended September 30, 2003. Revenues: Our revenues consist primarily of implementation fees, software
license fees and monthly service fees from new and existing customers. Total
revenues decreased by $190,000 or 7%, to $2,649,000 for the three months ended
September 30, 2004, from $2,839,000 for the three months ended September 30,
2003. Monthly Service Fees and Software Maintenance Fees Monthly service fees and
software maintenance fees were $2,441,000 during the third quarter of 2004, an
increase of $21,000, or 1%, from $2,420,000 in the third quarter of 2003. The
increase is primarily due to an $83,000 increase in variable monthly fees
related to one client whose system usage was higher in the third quarter of
2004 than in the third quarter of 2003. In addition, we experienced a $76,000
increase in monthly service fees as a result of sales of our Channel Insight
solution to new clients in the first quarter of 2004. These increases were
partially offset by approximately $138,000 lower monthly service fees as a
result of client contract terminations. Monthly service fees and software
maintenance fees
comprised 92% of total revenue during the three months ended September 30,
2004, compared to 85% during the three months ended September 30, 2003. 19




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Implementation Fees Revenues generated from implementation fees during the
three months ended September 30, 2004 decreased by $209,000, or 52%, to
$190,000 from $399,000 during the three months ended September 30, 2003. The
decrease in implementation fees is primarily attributable to a $102,000
decrease in the recognition of previously deferred implementation fees from
$110,000 during the three months ended September 30, 2003 to $8,000 during the
three months ended September 30, 2004. This change is mainly due to the
recognition of $135,000 of implementation fees for three of our clients who
obtained perpetual licenses for their Referral/Locator solutions during the
third quarter of 2003, which required the recognition of previously deferred
implementation fees. The remaining decrease in implementation fees is
primarily attributable to attaining lower levels of completion percentage on
existing Channel Insight projects in the third quarter of 2004 compared to the
third quarter of 2003, as well as lower sales during the quarter. The
reduction in completion levels was driven mainly by client needs and
requirements. In addition, for one of our ongoing solution implementations we
experienced a reduction in estimated completion percentage during the third
quarter of 2004, which resulted in a $22,000 reduction in implementation fees. Software License Fees Software license fees were ($3,000) in the third
quarter of 2004, which was primarily the result of a reduction in the estimated
completion percentage for one of our ongoing Channel Insight solution
implementations during the third quarter of 2004. We had no license fees in
the third quarter of 2003. Other Fees Other fees were $21,000 during the third quarter of 2004, an
increase of $1,000, or 5%, from $20,000 in the third quarter of 2003. The
revenue we recognize from these fees is driven primarily by the number of
contracts with charges for voice recordings, faxes, geocoding and
telecommunications charges, as well as interactive voice response transaction
volume. The increase in the third quarter of 2004 was driven primarily by fees
related to voice recordings for one of our interactive voice response locator
clients. Approximately $370,000 of our total monthly contracted managed service fees of $804,000
is tied to the Channel Insight contract we entered into with our largest client in 2001.
$312,000 of the managed service fees associated with this contract expired in
October 2004, while the remaining $58,000 is under contract through October
2005. In the fourth quarter of 2004, we reached an agreement with this client to extend
the services associated with the expired managed service fees for six months at
$90,000 per month, or a reduction of $222,000 per month. As part of this arrangement, we
mutually agreed with the client to negotiate in good faith towards an
additional 36-month agreement. In addition, we continue to work with this client for
purposes of selling new solutions; however, there can be no assurance that we
will be successful in renewing, extending or expanding solutions for this
client. Cost of Revenues: Our cost of revenues includes technical personnel salaries
and related personnel costs, data royalties, depreciation for server equipment,
reimbursable expenses such as telecommunications and contract labor related to
specific projects, co-location facility fees and other direct costs related to
operating our data centers, as well as the recognition of previously deferred
implementation expenses. Cost of revenues was 58% of revenues in the third
quarter of 2004 and 46% during the third quarter of 2003. Total cost of
revenues increased $226,000 to $1,545,000 during the three months ended
September 30, 2004 from $1,319,000 during the three months ended September 30,
2003. This was primarily due to a $192,000 increase in personnel 20




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related costs as a result of an increase in the number of technical staff to
support the implementation and maintenance of our clients solutions. We also
allocated certain of our technical staff that had previously been utilized in
product development efforts to support the ongoing implementation of new
Channel Insight solutions sold in the fourth quarter of 2003 and the first
quarter of 2004. Also contributing to the increase in our cost of sales was a
$58,000 increase in our contract labor costs. These resources were utilized to
assist with the implementation and maintenance associated with both Channel
Insight and Channel Management solutions. In addition, we experienced a
$28,000 increase in bad debt expense in the third quarter of 2004 compared to
the third quarter of 2003. The increases in our cost of sales associated with
personnel related costs, contract labor and bad debt were partially offset by a
$27,000 reduction in the recognition of implementation expense on contracts
that were deferred under ASP arrangements. Deferred implementation expense
recognition was higher in the third quarter of 2003 due to the recognition of
previously deferred implementation expense for three of our clients who
obtained perpetual licenses for their Referral/Locator solutions, which
required that we recognize the remaining deferred expenses associated with
those solutions. The remaining $25,000 decrease in our cost of sales was due
to a reduction in our data center costs primarily as a result of lower
depreciation expense as many of our older assets are now fully depreciated. Operating Expenses: Selling and Marketing Expenses Selling and marketing expenses consist of
sales, pre-sales, marketing and business development personnel costs and
related expenses, travel and entertainment, sales commissions, and advertising
and promotion costs. These costs decreased to 18% of revenues during the three
months ended September 30, 2004 from 19% of revenues during the three months
ended September 30, 2003. The total amount of selling and marketing expenses
decreased by $65,000, or 12%, to $487,000 during the three months ended
September 30, 2004 from $552,000 during the three months ended September 30,
2003. The change is primarily attributable to a $99,000 decrease in personnel
and personnel support costs partly as a result of attrition related to our
sales and marketing staff and partly due to the cost savings measures taken
during the third quarter of 2003. Partially offsetting the reduction in
personnel related costs was a $22,000 increase in recruiting costs due to the
hiring of a new sales representative in the third quarter of 2004. Commission
expense also increased $14,000 partly due to incremental commissions for our
Executive Vice President of Sales, Marketing and Business Development and
partly due to commission expense recognition in the third quarter of 2004
associated with sales of our Channel Insight solutions in the fourth quarter of
2003 and the first quarter of 2004. Since commission expense for our sales
executives is generally recognized when revenue for the related solution is
recognized, a portion of the commission expense associated with these sales was
recognized in the third quarter as implementation of the solutions took place.
The remaining $2,000 reduction in our selling and marketing expenses was
primarily due to lower contract labor costs related to the sales of our
solutions. Product Development Expenses Product development expenses consist of time
spent on development of our Channel Insight and Channel Management software
that is not specifically associated with a client contract. Product
Development expenses are primarily made up of salaries and related costs. For
the three months ended September 30, 2004, product development expenses
decreased $112,000, or 34%, to $216,000 from $328,000 during the three months
ended September 30, 2003. This change was primarily due to a reduction in
personnel and personnel support costs partly as a result of allocating more of
our existing resources to support
implementation efforts, as well as the cost reduction measures taken during the
third quarter of 2003. 21




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General and Administrative Expenses General and administrative expenses
relate to the personnel costs of our executive management, finance, investor
relations, human resources and other corporate functions, general expenses such
as legal and accounting fees, insurance and costs related to our facilities.
These costs increased to 29% of revenues for the three months ended September
30, 2004, from 20% of revenues for the three months ended September 30, 2003.
The total amount of general and administrative costs over the same period
increased $202,000, or 36%, to $763,000 during the third quarter of 2004 from
$561,000 during the third quarter of 2003. The increase was primarily
attributable to a $182,000 increase in personnel related costs partly as a
result of salary increases for our general and administrative employees, and
partly due to an $85,000 accrual in the third quarter of 2004 for severance
expense associated with a terminated employee. We also experienced a $24,000
increase in our facilities costs because in the third quarter of 2003 we
received sales and use tax refunds related to certain of our asset purchases
from 1999 through 2003, which reduced our expense in that quarter. In
addition, Board of Directors expenses increased $8,000 as a result of a new
Board of Directors compensation plan that was implemented beginning in 2004.
Investor relations costs also increased $5,000 in the third quarter of 2004
compared to the third quarter of 2003. Partially offsetting the increases in
our general and administrative costs associated with personnel related costs,
facilities expenses, Board of Directors fees and investor relations costs, was
a $10,000 decrease in our accounting fees as a result of consulting provided by
our external accountants in 2003 related to sales and use tax issues. In
addition, our legal fees declined by approximately $7,000. In the future, we expect that our head count levels, and related costs, in all
functional areas will change commensurate with our needs as we execute against
our business strategy. Other Income/Expense: We had net other income of $7,000 during the three
months ended September 30, 2004, compared to net other expense of $1,000 for
the three months ended September 30, 2003. The increase of $8,000 is primarily
attributable to an increase in interest income on our cash and cash
equivalents, as well as lower interest expense due to a reduction in our
capital lease obligations. Net Income/Loss: Net loss for the three months ended September 30, 2004 was
$355,000 compared to net income of $78,000 for the three months ended September
30, 2003, a $433,000 decrease. This decrease is primarily attributable to a
$251,000, or 9%, increase in total costs and a $190,000, or 7%, decrease in
total revenues, which were partially offset by an $8,000 increase in other
income for the three months ended September 30, 2004, compared to the three
months ended September 30, 2003, as discussed above in this Item 2. 22




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The following table summarizes the Companys results of operations for the
periods indicated ($ amounts in thousands): Nine Months Ended September 30,2004
    
    2003
    
    Change
    
    % ChangeRevenues:Software license fees
    
    $
    136
    
    
    $
    78
    
    
    $
    58
    
    
    
    74
    %Implementation fees
    
    
    1,137
    
    
    
    1,984
    
    
    
    (847
    )
    
    
    (43
    %)Monthly service fees & software
maintenance fees
    
    
    7,140
    
    
    
    7,266
    
    
    
    (126
    )
    
    
    (2
    %)Other fees
    
    
    57
    
    
    
    71
    
    
    
    (14
    )
    
    
    (20
    %)Total revenues
    
    
    8,470
    
    
    
    9,399
    
    
    
    (929
    )
    
    
    (10
    %)Cost of Revenues
    
    
    4,228
    
    
    
    4,373
    
    
    
    (145
    )
    
    
    (3
    %)Gross Margin
    
    
    4,242
    
    
    
    5,026
    
    
    
    (784
    )
    
    
    (16
    %)Operating Expenses:Selling and marketing
    
    
    1,612
    
    
    
    1,844
    
    
    
    (232
    )
    
    
    (13
    %)Product development
    
    
    660
    
    
    
    1,023
    
    
    
    (363
    )
    
    
    (35
    %)General and administrative
    
    
    2,126
    
    
    
    2,046
    
    
    
    80
    
    
    
    4
    %Total operating expenses
    
    
    4,398
    
    
    
    4,913
    
    
    
    (515
    )
    
    
    (10
    %)Income (Loss) From Operations
    
    
    (156
    )
    
    
    113
    
    
    
    (269
    )
    
    
    (238
    %)Other Income (Expense):Interest income
    
    
    20
    
    
    
    15
    
    
    
    5
    
    
    
    33
    %Interest expense
    
    
    (7
    )
    
    
    (14
    )
    
    
    7
    
    
    
    50
    %Total other income (expense)
    
    
    13
    
    
    
    1
    
    
    
    12
    
    
    
    1,200
    %Net Income
    
    $
    (143
    )
    
    $
    114
    
    
    $
    (257
    )
    
    
    (225
    %)
 Comparison of the Nine Months Ended September 30, 2004 with the Nine Months
Ended September 30, 2003. Revenues: Total revenues decreased by $929,000 or 10%, to $8,470,000 for the
nine months ended September 30, 2004, from $9,399,000 for the nine months ended
September 30, 2003. Monthly Service Fees and Software Maintenance Fees Monthly service fees and
software maintenance fees were $7,140,000 during the nine months ended
September 30, 2004, a decrease of $126,000, or 2%, from $7,266,000 during the
nine months ended September 30, 2003. The decrease is primarily due to a
$403,000 reduction in service fees as a result of client contract terminations.
This reduction was partially offset by a $170,000 increase in monthly service
fees associated with new Channel Insight solutions that were sold in the first
quarter of 2004. The remaining $107,000 increase in service fees was generated
primarily by an increase in variable monthly fees for certain of our clients
whose system usage increased in 2004. Monthly service fees and software
maintenance fees comprised 84% of total revenue during the nine months ended
September 30, 2004, compared to 77% during the nine months ended September 30,
2003. Implementation Fees Revenues generated from implementation fees during the
nine months ended September 30, 2004 decreased by $847,000, or 43%, to
$1,137,000 from $1,984,000 during the nine months ended September 30, 2003.
The decrease in implementation fees is 23




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primarily attributable to an $855,000 decrease in the recognition of previously
deferred implementation fees from $893,000 during the nine months ended
September 30, 2003 to $38,000 during the nine months ended September 30, 2004.
This change is mainly due to the recognition of $587,000 of implementation fees
for our largest client in the first quarter of 2003 that were deferred in
previous years under the ASP model. During the first quarter of 2003, this
client converted the term licenses related to its Referral/Locator and Lead
Generation and Management solutions to perpetual licenses, which required the
recognition of previously deferred implementation fees. We also recognized
$135,000 of previously deferred implementation fees in the third quarter of
2003 when three of our other clients who obtained perpetual licenses for their
Referral/Locator solutions. In addition, implementation fees in the first half
of 2003 contained recognition of previously deferred revenue associated with
the adoption of SAB 104. Revenue recognition associated with the adoption of
SAB 104 was completed at the end of 2003, therefore, we experienced a reduction
in 2004. Software License Fees Software license fees were $136,000 during the nine
months ended September 30, 2004, an increase of $58,000 from the $78,000 of
license fees during the nine months ended September 30, 2003. This increase in
license fees is primarily attributable to an increase in the sales of our
Channel Insight solutions to new clients during the fourth quarter of 2003 and
the first quarter of 2004. Software license fees represented approximately 2%
of total revenue during the nine months ended September 30, 2004, compared to
1% of revenue during the nine months ended September 30, 2003. Other Fees Other fees decreased by $14,000, or 20%, to $57,000 during the
nine months ended September 30, 2004, from $71,000 during the nine months ended
September 30, 2003. The decrease in other fees is attributable to a decrease
in the number of contracts with charges for voice recordings, faxes, geocoding
and telecommunications charges, as well as a reduction in interactive voice
response transaction volume and negotiated rate reductions in our
telecommunications charges. Cost of Revenues: Cost of revenues was 50% of revenues for the nine months
ended September 30, 2004 compared to 47% for the nine months ended September
30, 2003. Total cost of revenues decreased $145,000 to $4,228,000 during the
nine months ended September 30, 2004 from $4,373,000 during the nine months
ended September 30, 2003. This was primarily due to a $104,000 reduction in
the recognition of implementation expense on contracts that were deferred in
previous periods under ASP arrangements as a result of the recognition of
implementation expense in 2003 associated with the conversion of our largest
client and three of our other clients from the ASP model to the license-hosted
model. In addition, our data center costs decreased $86,000 mainly due to a
decline in depreciation expense as many of our older assets are now fully
depreciated. Also contributing to the reduction in data center costs was a
decrease in data royalties expense mainly as a result of the transition to a
new provider for certain of the data used in delivering our solutions. We also
experienced a $51,000 reduction in personnel related costs primarily as a
result of the cost reduction measures taken during the third quarter of 2003,
as well as attrition in our technical staff. The impact of these cost
reduction measures was more significant during the first half of 2004, however,
we added headcount in the third quarter of 2004, thereby, increasing our costs
for the quarter and going forward. The decrease in personnel costs is net of
$93,000 of severance and benefit continuation expense associated with the
termination of our Executive Vice President, Development and Services in the
second quarter of 2004. The decreases in cost of sales associated with
deferred implementation expense recognition, data center costs and personnel
related costs was partially offset by a $63,000 24




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increase in our contract labor costs. These resources were utilized to assist
with the implementation and maintenance associated with both Channel Insight
and Channel Management solutions. We also experienced a $33,000 increase in
bad debt expense. Operating Expenses: Selling and Marketing Expenses Selling and marketing expenses decreased to
19% of revenues during the nine months ended September 30, 2004 from 20% of
revenues during the nine months ended September 30, 2003. The total amount of
selling and marketing expenses decreased by $232,000, or 13%, to $1,612,000
during the nine months ended September 30, 2004 from $1,844,000 during the nine
months ended September 30, 2003. The change is primarily attributable to a
$369,000 decrease in personnel and personnel support costs partly as a result
of attrition related to our sales and marketing staff and partly due to the
cost savings measures taken during the third quarter of 2003. We also
experienced a $15,000 reduction in public relations and advertising and
promotion consulting costs and a $9,000 decrease in trade show expenses. The
decreases in our selling and marketing expenses associated with personnel
costs, consulting expenses and trade show expenses was partially offset by a
$133,000 increase in commission expense as a result of an increase in the sales
of our solutions, as well as incremental commissions for our Executive Vice
President of Sales, Marketing and Business Development. In addition,
recruiting costs increased $22,000 due to the hiring of a new sales
representative in the third quarter of 2004. The remaining $6,000 increase in
our selling and marketing expenses was caused primarily by an increase in
travel and entertainment costs. Product Development Expenses For the nine months ended September 30, 2004,
product development expenses decreased $363,000, or 35%, to $660,000 from
$1,023,000 for the nine months ended September 30, 2003. This change was
primarily due to a reduction in personnel and personnel support costs as a
result of allocating more of our existing resources to support implementation
efforts, as well as the cost reduction measures taken during the third quarter
of 2003. General and Administrative Expenses General and administrative expenses
increased to 25% of revenues for the nine months ended September 30, 2004 from
22% of revenues for the nine months ended September 30, 2003. The total amount
of general and administrative costs increased $80,000, or 4%, to $2,126,000
during the nine months ended September 30, 2004 from $2,046,000 during the nine
months ended September 30, 2003. The increase was primarily attributable to a
$181,000 increase in personnel related costs partly as a result of salary
increases for our general and administrative employees, and partly due to an
$85,000 accrual in the third quarter of 2004 for severance expense associated
with a terminated employee. In addition, Board of Directors fees increased
$26,000 as a result of a new Board of Directors compensation plan that was
implemented beginning in 2004. Partially offsetting the increases in our
general and administrative expenses associated with personnel related costs and
Board of Directors fees was a $90,000 reduction in professional fees primarily
due to recruiting fees incurred during the nine months ended September 30, 2003
related to the hiring of our Executive Vice President of Sales, Marketing and
Business Development. The remaining $37,000 decrease in general and
administrative expenses was primarily attributable to a reduction in our
facilities costs mainly as a result of lower depreciation expense and property
taxes since many of our older assets are now fully depreciated. 25




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Other Income/Expense: We had net other income of $13,000 during the nine
months ended September 30, 2004, compared to net other income of $1,000 for the
nine months ended September 30, 2003. The increase of $12,000 is primarily
attributable to lower interest expense due to a reduction in our capital lease
obligations, as well as an increase in interest income on our cash and cash
equivalents. Income Taxes: InfoNow has paid no income taxes since its inception and has not
recorded a benefit for income taxes due to valuation allowances provided
against net deferred tax assets, which consist primarily of operating loss
carryforwards. Net Income/Loss: Net loss for the nine months ended September 30, 2004 was
$143,000 compared to net income of $114,000 for the nine months ended September
30, 2003, a $257,000 decrease. This decrease is primarily attributable to an
$929,000, or 10%, decrease in total revenue, which was partially offset by a
$660,000, or 7%, decrease in total costs, and a $12,000 increase in other
income for the nine months ended September 30, 2004, compared to the nine
months ended September 30, 2003, as discussed above in this Item 2. Liquidity and Capital Resources InfoNow has financed its operations primarily through the placements of private
equity securities and, to a lesser extent, through borrowing and equipment
leasing arrangements. We have received a total of approximately $13,800,000
from private offerings and have received an additional $3,565,000 from the
exercise of stock options and warrants since we began offering our Enterprise
Channel Management solutions in 1995. We also have a bank credit facility with
both a $1,000,000 revolving line of credit to support our future operating
needs and a $1,000,000 equipment facility to support our future investing
needs. The bank credit facility requires that we meet various covenants.
During the third quarter of 2004 we failed to meet certain of the financial
covenants; however, we have obtained waivers for all instances of
non-compliance. We are not permitted to draw on the bank credit facility if we
are out of compliance with any of the covenants. As of the date of this report
we have no outstanding debt under this facility. The interest rate on the
revolving line of credit is the prime rate plus 1 percent, and the interest
rate on the equipment facility is the U.S. Treasury note yield to maturity for
a term equal to 36 months as quoted in the Wall Street Journal plus 587 basis
points. We had cash and cash equivalents of $3,944,000 at September 30, 2004, compared
to $2,775,000 at September 30, 2003. Our total cash flow for the nine months
ended September 30, 2004 was $645,000 compared to $285,000 for the nine months
ended September 30, 2003. The increase of $360,000 was primarily due to a
$446,000 increase in cash provided by our financing activities primarily as a
result of an increase in stock option exercises in 2004. The increase in cash
provided by financing activities was partially offset by an $81,000 increase in
cash used in investing activities due to an increase in purchases of property
and equipment for our data centers and corporate office. In addition, cash
provided by operating activities decreased $5,000. The changes in our total
cash flow for the nine months ended September 30, 2004 compared to the nine
months ended September 30, 2003 are discussed below in more detail. Net cash generated by operating activities during the nine months ended
September 30, 2004, was $472,000, compared to $477,000 during the nine months
ended September 30, 2003. The decrease of $5,000 is generally due to a
reduction in cash collections from new Channel Insight sales as our days sales
outstanding increased to 46 days at September 30, 2004 compared to 34 26




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##### Table of Contents



days at September 30, 2003. This reduction in collections is a function of
extended payment terms granted to certain new clients, as well as an extended
implementation cycle associated with one of the Channel Insight solutions sold
in the first quarter of 2004. The reduction in cash collections was partially
offset by a decline in total costs. Despite the decline in total costs, our
net loss increased by $257,000 to $143,000 for the nine months ended September
30, 2004 compared to net income of $114,000 for the nine months ended September
30, 2003 as a result of the significant decrease in revenue discussed above in
this Item 2. Changes in the adjustments to reconcile net income to net cash
provided by operating activities are as follows:  
    
    $690,000 change in accounts receivable mainly due to a reduction in
collections from new sales;
    
    $171,000 reduction in depreciation and amortization since many of
our data center and corporate office assets have become fully
depreciated without proportionate asset purchases;
    
    $134,000 decline in other current assets mainly due to amortization
of prepaid expenses such as rent and insurance;
    
    $119,000 decrease in payroll related and other liabilities mainly
due to the reductions in our cost structure;
    
    $85,000 reduction in other assets and deferred charges due to a
reduction in the amortization of previously deferred implementation
expense;
    
    $1,101,000 reduction in deferred revenue, which was driven
primarily by the recognition of previously deferred implementation fees
in 2003 because our largest client and three of our other clients
obtained perpetual licenses for their Channel Management solutions,
which required the recognition of the deferred implementation fees
associated with those solutions. In addition, recognition of
previously deferred implementation fees associated with the adoption of
SAB 104 was complete at the end of 2003 and, accordingly, we
experienced a reduction in that element of our revenue recognition in
2004;
    
    $310,000 increase in accounts payable primarily as a result of an
increase in accruals for severance expense, data royalties and contract
labor;
    
    $39,000 increase in our allowance for bad debt;
    
    $1,000 change in other non-cash charges. Cash used in investing activities increased to $232,000 for the nine months
ended September 30, 2004 compared to $151,000 for the nine months ended
September 30, 2003. The change of $81,000 is due to an increase in purchases
of computer hardware and software for our data centers and corporate office.
We have plans to increase our capital expenditures throughout the remainder of
2004 primarily to upgrade or replace existing data center hardware and
software, as well as to add new equipment to support our customer base and
anticipated growth. Net cash provided by financing activities during the nine months ended
September 30, 2004 was $405,000 compared to cash used in financing activities
of $41,000 during the nine months ended September 30, 2003. The increase of
$446,000 was caused primarily by a $443,000 increase in cash received from
stock option exercises, as well as a $3,000 decrease in principal payments on
debt obligations due to a reduction in our capital lease liabilities. In order to meet our fiscal management needs we may, from time to time,
accelerate or defer payments on our trade payables and accrued liabilities,
and, in some cases, we may prepay certain of our future operating expenses.
Variation in the timing of our cash receipts and 27




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disbursements can significantly impact our overall cash flow for a given period
and there can be no assurance that our current cash balance will be sufficient
to fund operations. If we believe it is advisable, we may seek additional funding to continue our
operations. Our ability to successfully complete an offering to obtain
additional funding is dependent on a number of factors. There can be no
assurances that we can successfully complete an equity or debt placement, or
that a placement can be concluded on the terms and conditions that would be
acceptable to us. The following table summarizes the Companys contractual payments and
obligations by period (amounts in thousands): Contractual Obligations
    
    Payment Due by PeriodTotal
    
    Less Than 1 year
    
    1-3 years
    
    4-5 years
    
    After 5 yearsCapital Lease Obligations
    
    $
    74
    
    
    $
    74
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating Leases
    
    
    1,460
    
    
    
    469
    
    
    
    991
    
    
    
    
    
    
    
    Minimum Royalties
    
    
    144
    
    
    
    12
    
    
    
    24
    
    
    
    24
    
    
    
    84Total Contractual Cash Obligation
    
    $
    1,678
    
    
    $
    555
    
    
    $
    1,015
    
    
    $
    24
    
    
    $
    84
 We lease approximately 27,000 square feet of office space at a rate of $17.00
per square foot through September 2005. The rate increases to $18.00 per
square foot from October 2005 through September 2007, when the lease expires.
Rent expense is recognized on a straight-line basis over the term of the lease.
The difference between cash payments for rent and the straight-line rent
expense is recorded as deferred rent on the Companys balance sheet. Recent Accounting Pronouncements In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51(FIN 46), and in
December 2003 issued FIN 46R. The adoption of this standard did not have an
impact on our financial position or results of operations. In August 2003, the EITF reached a consensus on Issue No. 03-05, Software
Revenue Recognition, Applicability of AICPA Statement of Position 97-2,
Software Revenue Recognition, to Non-Software Deliverables. The adoption of
EITF Issue No. 03-05 did not have an impact on our financial position or
results of operation. 28




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Related Business Risks and Assumptions Our actual results may vary materially from the forward-looking statements made
above, which have been made pursuant to the Private Securities Litigation
Reform Act of 1995. We intend that such statements be subject to the safe
harbor provisions of the Securities Act of 1933 and the Securities Exchange Act
of 1934. Our forward-looking statements include the plans and objectives of
management for future operations and relate to a variety of factors, including
managements assumptions about our ability to:  
    
    Gain market acceptance of our services;
    
    Retain existing customers, none of whom are obligated to renew,
modify or extend their contractual relationships with the Company, and
attract new customers;
    
    Accurately forecast and meet demands for our services, including
our ability to maintain technical performance of the system as new
clients are added;
    
    Maintain and improve our network assets as necessary;
    
    Continue to serve new and existing customers;
    
    Improve our operational and financial systems in order to address
planned growth in our operations;
    
    Develop cost-effective delivery processes for our new solutions;
    
    Maintain or develop adequate pricing and profit margins on our products and services;
    
    Retain and attract qualified technical personnel;
    
    Develop future enhancements to our services and control development
costs of those enhancements;
    
    Operate our business in accordance with our operating budget;
    
    Obtain patent protection for our intellectual property;
    
    Respond to competitive threats, including the possibility of our
customers migrating to lower cost solutions, such as offshore IT
development and service functions; and
    
    Raise additional capital, if needed. If we are unable to manage the risks enumerated above, or those discussed in
our Annual Report filed with the Securities and Exchange Commission on Form
10-KSB for the year ended December 31, 2003, our financial condition and
results of operations could be materially adversely affected. Our assumptions are based on judgments with respect to, among other things,
future economic, competitive and market conditions, and future business
decisions, all of which are difficult or impossible to predict accurately and
many of which are beyond our ability to control. We believe that the assumptions underlying our forward-looking statements are
reasonable. However, our assumptions may prove to be inaccurate and therefore
there can be no assurance that the results contemplated in forward-looking
statements will be realized. You should not regard any statements made in this
report on Form 10-QSB as a representation by InfoNow or any other person that
we will achieve our objectives. 29




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##### Table of Contents



In March 2004 the Financial Accounting Standards Board (FASB) issued an
Exposure Draft, Share-Based Payment, an Amendment of FASB Statements No. 123
and 95, which proposes a
change in accounting for stock-based compensation to replace existing guidance
under SFAS No. 123 and APB No. 25 and require companies to treat share-based
compensation the same as other forms of compensation by recognizing the related
cost in the companys income statement. We do not currently recognize an
expense in our income statement for stock-based compensation issued to our
employees and directors. If we are required to do so in the future, we believe
it would have a material adverse impact on our results of operations. Approximately $370,000 of our total monthly contracted managed service fees of $804,000
is tied to the Channel Insight contract we entered into with our largest client in 2001.
$312,000 of the managed service fees associated with this contract expired in
October 2004, while the remaining $58,000 is under contract through October
2005. In the fourth quarter of 2004, we reached an agreement with this client to extend
the services associated with the expired managed service fees for six months at
$90,000 per month, or a reduction of $222,000 per month. As part of this arrangement, we
mutually agreed with the client to negotiate in good faith towards an additional
36-month agreement. In addition, we continue to work with this client for purposes of
selling new solutions; however, there can be no assurance that we will be
successful in renewing, extending or expanding solutions for this client. In September 2004 we settled a dispute with a terminated employee by agreeing
to pay between $85,000 and $91,000, depending on the length of time needed for
the terminated employee to obtain other employment. We expect to pay $85,000
of this obligation in November 2004. The cost associated with this obligation
is included in our general and administrative expenses for the three and nine
months ended September 30, 2004. For a more comprehensive discussion of the risk factors associated with our
business, please refer to the section entitled Related Business Risks and
Assumptions: beginning on page 29 of our Annual Report filed with the
Securities and Exchange Commission on Form 10-KSB for the fiscal year ended
December 31, 2003. 
 Item 3. Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed by us in the reports that we file or
submit to the Securities and Exchange Commission under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported within
the time periods specified by the SECs rules and forms, and that information
is accumulated and communicated to our management, including our principal
executive and principal financial officers (whom we refer to in this periodic
report as our Certifying Officers), as appropriate to allow timely decisions
regarding required disclosure. Our management evaluated, with the
participation of our Certifying Officers, the effectiveness of our disclosure
controls and procedures as of September 30, 2004, pursuant to Rule 13a-15(b)
under the Exchange Act. Based upon that evaluation, our Certifying Officers
concluded that, as of September 30, 2004, our disclosure controls and
procedures were effective. There were no changes in our internal control over financial reporting that
occurred during our fiscal quarter ended September 30, 2004 that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. 30




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PART II. OTHER INFORMATION 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits Exhibit Number
    
    Exhibit Description31
    
    Rule 13a-14(a)/15d-14(a) certifications32
    
    Section 1350 certifications
  (b)
    
    Reports on Form 8-K. On August 5, 2004, the Company furnished a Form 8-K to the SEC
under item 12 (Results of Operations and Financial Condition). 31




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SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized. INFONOW CORPORATIONDate: November 12, 2004
    
    By: /s/ Michael W. JohnsonMichael W. Johnson, Chief Executive Officer
 Date
    
    Title
    
    SignatureNovember 12, 2004
    
    Chief Financial Officer and Executive Vice President(Principal Financial Officer)
    
    /s/ Harold R. HerbstHarold R. HerbstNovember 12, 2004
    
    Vice President, Controller and Treasurer(Principal Accounting Officer)
    
    /s/ James L. MedinaJames L. Medina
 32




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Exhibit Index Exhibit Number
    
    Exhibit Description31
    
    Rule 13a-14(a)/15d-14(a) certifications32
    
    Section 1350 certifications