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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended June 30, 2002 Commission File Number 000-20364
EPRESENCE, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2798394
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
120 FLANDERS ROAD
WESTBORO, MASSACHUSETTS 01581
(Address of principal executive offices)
(508) 898-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
- ------------------------
Number of shares outstanding of each of the issuer's classes of Common Stock as
of August 31, 2002:
Class Number of Shares Outstanding
Common Stock, par value $.01 per share 22,654,227
EPRESENCE, INC.
INDEX
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
June 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations
Three and six months ended June 30, 2002 and 2001 4
Consolidated Statements of Cash Flows
Six months ended June 30, 2002 and 2001 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURE 25
EXHIBIT INDEX 26
This Quarterly Report on Form 10-Q contains forward-looking statements,
including information with respect to the Company's plans and strategy for its
business. For this purpose, any statements contained herein that are not
statements of historical fact may be deemed to be forward-looking statements.
Without limiting the foregoing, the words "believes", "anticipates", "plans",
"expects" and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause actual
events or the Company's actual results to differ materially from those indicated
by such forward-looking statements. These factors include, without limitation,
those set forth below under the caption "Factors Affecting Future Operating
Results" included under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in Part I, Item 2 of this Quarterly Report
on Form 10-Q.
2
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
================================================================================
EPRESENCE, INC.
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PAR AMOUNTS)
June 30, December 31,
2002 2001
(unaudited) (audited)
--------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 61,469 $ 33,022
Marketable securities 22,419 47,817
Accounts receivable, less allowances of $1,694
and $1,973, respectively 6,534 11,216
Prepaid Directory Agreement, current portion 3,468 -
Other current assets 3,184 6,658
--------- ---------
Total current assets 97,074 98,713
Marketable securities 25,759 40,362
Restricted cash 2,036 874
Property and equipment, net 4,442 6,139
Goodwill, net of accumulated amortization of $4,885 14,780 14,780
Prepaid Directory Agreement 8,483 -
Other assets, net of accumulated amortization of $3,183 1,987 2,083
--------- ---------
TOTAL ASSETS $ 154,561 $ 162,951
========= =========
LIABILITIES
Current liabilities:
Accounts payable $ 3,537 $ 7,304
Accrued expenses 9,549 11,609
Other current liabilities 702 757
Deferred revenue 2,190 4,983
Payable under Directory Agreement 12,000 -
Current portion of long-term debt 2,999 2,357
--------- ---------
Total current liabilities 30,977 27,010
Long-term debt, net of current portion 1,499 518
Minority interest in consolidated subsidiary 24,559 26,237
SHAREHOLDERS' EQUITY
Convertible preferred stock, $.01 par value; authorized -
1,000,000 shares; none issued - -
Common stock, $.01 par value; authorized - 100,000,000
shares; issued 26,332,027 and 26,316,039 shares,
respectively 263 263
Additional paid-in capital 172,713 173,140
Unearned compensation (1,040) (1,654)
Accumulated deficit (38,368) (28,712)
Accumulated other comprehensive income (98) 1,019
Treasury stock at cost; 3,667,800 and 3,393,300
shares, respectively (35,944) (34,870)
--------- ---------
Total shareholders' equity 97,526 109,186
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 154,561 $ 162,951
========= =========
The accompanying notes are an integral part of the consolidated
financial statements.
3
EPRESENCE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
(unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
(restated) (restated)
--------- --------- --------- ---------
Revenues:
Services $ 8,952 $ 13,115 $ 19,245 $ 29,082
Switchboard 2,068 2,805 4,988 4,344
-------- -------- -------- --------
Total revenues 11,020 15,920 24,233 33,426
-------- -------- -------- --------
Cost of Revenues:
Services 5,729 9,016 12,728 19,517
Switchboard 1,112 839 2,030 1,690
-------- -------- -------- --------
Total cost of revenues 6,841 9,855 14,758 21,207
-------- -------- -------- --------
Gross profit 4,179 6,065 9,475 12,219
Operating expenses:
Sales and marketing 3,855 10,233 8,300 22,240
Product development 1,317 1,687 2,822 3,000
General and administrative 3,646 5,065 7,575 10,061
Amortization of goodwill, intangibles
and other assets - 1,012 - 2,000
Restructuring charges - 4,000 4,000 4,000
-------- -------- -------- --------
Total operating expenses 8,818 21,997 22,697 41,301
-------- -------- -------- --------
Operating loss from operations (4,639) (15,932) (13,222) (29,082)
Other income/(expense):
Interest income, net 1,281 1,697 2,394 3,621
Minority interest in losses of
Switchboard 633 3,392 1,143 8,140
Gain on sale of Openwave, net - - - 33,378
Other, net 86 (163) 124 (1,468)
-------- -------- -------- --------
Total other income 2,000 4,926 3,661 43,671
-------- -------- -------- --------
Net (loss)/income from continuing
operations before income taxes and
cumulative effect of accounting change (2,639) (11,006) (9,561) 14,589
Provision/(benefit) for income taxes 83 (5,416) 95 7,529
-------- -------- -------- --------
Net (loss)/income before cumulative
effect of accounting change (2,722) (5,590) (9,656) 7,060
-------- -------- -------- --------
Cumulative effect of accounting change,
net of tax of $1,855 - - - 3,445
-------- -------- -------- --------
Net (loss)/income $ (2,722) $ (5,590) $ (9,656) $ 10,505
======== ======== ======== ========
Net (loss)/income per share:
Basic $ (0.12) $ (0.24) $ (0.43) $ 0.45
======== ======== ======== ========
Diluted $ (0.12) $ (0.24) $ (0.43) $ 0.43
======== ======== ======== ========
Weighted average number of common shares:
Basic 22,231 23,137 22,282 23,332
======== ======== ======== ========
Diluted 22,231 23,137 22,282 24,438
======== ======== ======== ========
The accompanying notes are an integral part of
the consolidated financial statements.
4
EPRESENCE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
Six Months Ended June 30,
2002 2001
(restated)
---------- ----------
Cash Flows from Operating Activities:
Net (loss)/income $ (9,656) $ 10,505
Adjustments to reconcile net (loss)/income to net cash used in
operating activities:
Gain on sale of investments (402) (33,378)
Cumulative effect of accounting change - (5,300)
Depreciation and amortization 1,706 4,181
Minority interest (1,143) (8,140)
Loss on disposal of assets 212 707
Loss on sale of subsidiary - 828
Restructuring and other charges, non-cash portion 800 -
Amortization of unearned compensation 614 831
Non-cash advertising and promotion - 3,727
Amortization of AOL assets 2,049 2,024
Deferred income taxes - (5,414)
Changes in operating assets and liabilities:
Accounts receivable 4,696 3,799
Income tax receivable 1,228 -
Other current assets 2,389 (5,757)
Other non-current assets 101 3,136
Accounts payable and accrued compensation and expenses (7,154) (4,252)
Payment on AOL Directory Agreement (2,000) -
Accrued costs for restructuring 1,075 3,326
Deferred revenue (2,793) (326)
--------- ---------
Net cash used in operating activities (8,278) (29,503)
Cash Flows from Investing Activities:
Capital expenditures (867) (3,351)
Proceeds from sales of investment - 39,266
Restricted cash (1,162) (1,043)
Acquisition of goodwill - (2,144)
Proceeds/(Purchases of) from marketable securities, net 39,141 (3,800)
--------- ---------
Net cash provided by investing activities 37,112 28,928
Cash Flows from Financing Activities:
Net proceeds from sales lease-back 1,623 1,063
Purchase of treasury stock (2,329) (4,111)
Proceeds from stock plan purchases, stock options and warrants 328 541
--------- ---------
Net cash used in financing activities (378) (2,507)
Effect of exchange rate changes on cash and cash equivalents (9) (240)
--------- ---------
Net increase/(decrease) in cash and cash equivalents 28,447 (3,322)
Cash and cash equivalents at beginning of the period 33,022 39,725
--------- ---------
Cash and cash equivalents at end of the period $ 61,469 $ 36,403
========= =========
Supplemental Disclosures of Cash Flow Information:
Non-cash investing activity:
Issuance of stock related to acquisition $ - $ 577
Non-cash financing activity:
Note receivable from officer for issuance of common stock of subsidiary $ 1,449 $ -
The accompanying notes are an integral part of
the consolidated financial statements.
5
EPRESENCE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
ePresence, Inc., (the "Company"), has two reportable segments: services and
Switchboard. The Company's reportable segments are managed separately as they
are separately traded public companies, and market and distribute distinct
products and services. The Company's services segment delivers professional
services including enterprise directory and security services, information
technology platform services, electronic provisioning services, next
generation portal services and operations management services. Switchboard
Incorporated ("Switchboard"), the Company's majority owned subsidiary, is a
provider of web-hosted directory technologies and customized yellow pages
platforms to yellow pages publishers, newspaper publishers and Internet
portals that offer online local directory advertising solutions to national
retailers and brick and mortar merchants across a full range of Internet and
wireless platforms. Switchboard offers a broad range of functions, content
and services, including yellow and white pages, product searching,
location-based searching and interactive maps and driving directions.
Historically, Switchboard's results have been consolidated with the
Company's financial results, due to either the Company's majority ownership
of Switchboard or its control of the Switchboard Board of Directors as a
result of a Voting Rights Agreement by and among the Company, Switchboard and
Viacom Inc. ("Viacom"). However, in January 2001, as the Voting Rights
Agreement was terminated and the Company's ownership was then 38%, the
Company ceased to consolidate Switchboard's results with its results for the
first three quarters of 2001. In October 2001, Switchboard obtained approval
from its stockholders and closed a restructuring transaction with Viacom
resulting, in part, in a reduction in the number of outstanding shares of
Switchboard's common stock and the Company then owning approximately 54% of
Switchboard's outstanding common stock. For further discussion regarding the
Viacom transaction see Note 25, Viacom Alliance, in the Company's Notes to
Consolidated Financial Statements included in the Company's 2001 Form 10-K/A.
This change in ownership percentage resulted in the Company retroactively
consolidating Switchboard's revenues, expenses and other income and expense
in the Company's consolidated statement of operations, while the minority
interest in Switchboard was eliminated through consolidated other income and
expense, as of January 1, 2001. Accordingly, the results of operations for
the three and six months ended June 30, 2002 and 2001, respectively, are
presented consistently herein on a consolidated basis. In addition,
Switchboard's assets and liabilities are consolidated in the Company's
consolidated balance sheet as of June 30, 2002 and December 31, 2001. At June
30, 2002, the Company owned 9,802,421 shares or an approximate 53% equity
interest of Switchboard's outstanding common stock.
The accompanying unaudited consolidated financial statements include the
accounts of the Company and its subsidiaries as of June 30, 2002, and have
been prepared by the Company in accordance with accounting principles
generally accepted in the United States. In the opinion of management, the
accompanying unaudited consolidated financial statements contain all
adjustments, consisting only of those of a normal recurring nature, necessary
for a fair presentation of the Company's financial position, results of
operations and cash flows at the dates and for the periods indicated.
Intercompany accounts and transactions have been eliminated. Certain
previously reported amounts have been reclassified to conform to the current
method of presentation. While the Company believes that the disclosures
presented are adequate to make the information not misleading, these
consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Amendment No. 1 to Annual Report on Form 10-K/A filed with the Securities and
Exchange Commission on September 20, 2002.
The results of operations for the three months and six months ended June 30,
2002 are not necessarily indicative of the results expected for the full
fiscal year or any future interim period.
6
NOTE 2. RESTATEMENT OF FINANCIAL STATEMENTS
The restatement of the Company's consolidated financial statements for the
fiscal year ended December 31, 2001 is described in detail in Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," of Part II, and the Company's consolidated financial statements
and related notes, including, without limitation, Note 3, within Item 8 of
Part II of the Company's Amendment No. 1 to Annual Report on Form 10-K/A
filed with the Securities and Exchange Commission on September 20, 2002. In
addition the Company restated its consolidated unaudited financial statements
for the fiscal quarter ended March 31,2002. These restatements are described
in detail in Item 2 "Management's Discussions and Analysis of Financial
Condition and Results of Operations," of Part I and our consolidated
financial statements and related notes, including Note 2, within Item 1 of
Part I of the Company's Amendment No. 1 to Quarterly Report on Form 10-Q/A
filed with the Securities and Exchange Commissions on or about September 24,
2002.
Effective January 2002, Switchboard adopted Emerging Issues Task Force Issue
01-9 "Accounting for Consideration Given by a Vendor to a Customer (Including
a Reseller of the Vendor's Products)" ("EITF 01-9"), which became effective
for fiscal years beginning after December 15, 2001, and Switchboard has
concluded that EITF 01-9 is applicable to the accounting for its directory
and local advertising platform services agreement with AOL ("Directory
Agreement"). The 2001 quarterly results have been adjusted to conform to the
presentation required by EITF 01-9. Accordingly, Switchboard has reduced its
merchant network revenue by $946,000 and $1,012,000 for the three months
ended June 30, 2002 and 2001 and $2,049,000 and $2,024,000 for the six months
ended June 30, 2002 and 2001, respectively, and reduced its operating
expenses by a corresponding amount in the three and six months ended June 30,
2002 and 2001, respectively. The adoption of EITF 01-9 had no effect on net
income or capital resources of the Company or Switchboard. The following
table illustrates the effect of the application of EITF 01-9:
7
Switchboard:
- -----------
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2002 2001 2002 2001(a)
(restated) (restated)
---- ---------- ---- ----------
(in thousands)
Gross revenue $3,014 $ 3,817 $ 7,037 $ 6,368
Less: Amortization of
consideration given to AOL (946) (1,012) (2,049) (2,024)
------ ------- ------- -------
Net revenue $2,068 $ 2,805 $ 4,988 $ 4,344
====== ======= ======= =======
Operating expenses $4,131 $ 9,334 $ 8,873 $19,625
Less: Amortization of
consideration given to AOL (946) (1,012) (2,049) (2,024)
------ ------- ------- -------
Net operating expenses $3,185 $ 8,322 $ 6,824 $17,601
====== ======= ======= =======
(a) Amortization of consideration given to AOL exceeded revenue derived from AOL
by $487,000 in the six months ended June 30, 2001.
NOTE 3. GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board, ("FASB"), issued
Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" which requires the Company to discontinue amortization of
goodwill as of December 31, 2001. The Company adopted FAS 142 during the first
quarter of 2002 and ceased amortizing goodwill with a net book value of
$14,780,000 as of the beginning of fiscal 2002. The Company completed an
assessment of fair value of goodwill in the second quarter of 2002 and believes
the book value of goodwill at June 30, 2002 has not been impaired.
The following table presents net loss and net loss per share for the three and
six months ended June 30, 2001 on a pro forma basis as if FAS 142 had been
adopted on January 1, 2001:
Three months Six months
ended June 30, ended June 30,
2001 2001
(restated) (restated)
-------------- --------------
(in thousands)
Net (loss)/income - as reported ($ 5,590) $ 10,505
Amortization of goodwill 1,012 2,000
-------- --------
Net (loss)/income - as adjusted (4,578) 12,505
======== ========
Basic earnings per share - as reported $ (0.24) $ 0.45
Diluted earnings per share - as reported $ (0.24) $ 0.43
Basic earnings per share - as adjusted $ (0.20) $ 0.54
Diluted earnings per share - as adjusted $ (0.20) $ 0.51
8
NOTE 4. CLOSURE OF EUROPEAN OPERATIONS
In the quarter ended March 31, 2002, as part of the Company's plan to improve
operating results, the Company decided to close its operations in the United
Kingdom and Germany. The Company included the costs associated with the closures
in the Company's restructuring charge recorded in the first quarter of 2002.
NOTE 5. RESTRUCTURING CHARGES
During the three months ended March 31, 2002, as part of the Company's plan to
implement cost-cutting measures in its services business, the Company recorded a
pre-tax charge of $4,000,000 related to a workforce reduction of approximately
45 positions, office closures including the closure of the Company's offices in
Germany and the United Kingdom and asset write-offs. The Company expects to use
$3,210,000 of cash related to these activities.
The following is a table summarizing the restructuring charges of the Company's
services segment for the six months ended June 30, 2002:
(in thousands)
Accrual/
Total Cash Non-cash Reserve
Charges Payments Charges Balance
------- -------- ------- -------
Staff reductions $ 1,026 $ 898 $ - $ 128
Office closures and other costs 2,312 313 - 1,999
Asset write-offs 662 - 688 (26)
------- -------- -------- -------
$ 4,000 $ 1,211 $ 688 $ 2,101
======= ======== ======== =======
In 2001, the Company had recorded a pre-tax charge of $3,953,000 related to a
workforce reduction of approximately 100 positions, office closures and asset
write-offs. The Company expects to use $2,959,000 of cash related to these
activities.
At June 30, 2002, the Company had utilized approximately $5,122,000 in total of
the combined liability of the 2001 and 2002 restructures of which $2,864,000 was
severance-related costs, and the remainder related to office closures and asset
write-offs. The remaining combined liability at June 30, 2002 was approximately
$2,831,000, of which $2,344,000 is expected to be cash related expenditures. The
Company anticipates that it will utilize a substantial portion of the remaining
combined liability by the end of fiscal year 2002.
The following is a table summarizing the March 31, 2002 and 2001 restructuring
charges, collectively, of the Company's services segment for the six months
ended June 30, 2002:
(in thousands)
Accrual/ Accrual/
Reserve Reserve
Balance Total Cash Non-cash Balance
12/31/01 Charges Payments Charges 06/30/02
-------- ------- -------- ------- --------
Staff reductions $ 533 $ 1,026 $ 1,489 $ - $ 70
Office closures and other costs 885 2,312 367 - 2,830
Asset write-offs 130 662 - 861 (69)
-------- ------- --------- ------- --------
$ 1,548 $ 4,000 $ 1,856 $ 861 $ 2,831
======== ======= ======== ======= ========
9
NOTE 6. SPECIAL CHARGES
In December 2001, Switchboard recorded net pre-tax special charges of
approximately $17,300,000, comprised primarily of $15,600,000 for the impairment
of certain assets, $1,000,000 for costs related to facility closures and
$700,000 in severance costs related to the reduction of approximately 21% of
Switchboard's workforce. The restructuring resulted in 21 employee separations.
Of the total $1,700,000 charge related to facility closures and severance costs,
Switchboard currently estimates that $1,600,000 is cash related. As of June 30,
2002, $1,000,000 was expended by Switchboard. Switchboard has a remaining
liability of $392,000 on its balance sheet as of June 30, 2002. Switchboard
expects to spend approximately an additional $43,000 by December 31, 2002, with
the remainder to be paid through December of 2005.
NOTE 7. COMPREHENSIVE INCOME
Other comprehensive income includes unrealized gains or losses on the Company's
available-for-sale investments and foreign currency translation adjustments.
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
(restated) (restated)
---- ---- ---- ----
(in thousands)
Net (loss)/income $ (2,722) $ (5,590) $ (9,656) $ 10,505
Unrealized loss on marketable securities (432) (38) (1,117) (23,832)
Translation adjustment 35 (24) - (198)
-------- -------- --------- ---------
Comprehensive loss $ (3,119) $ (5,652) $ (10,773) $ (13,525)
======== ======== ========= =========
NOTE 8. FOREIGN CURRENCY TRANSLATION
Prior to January 1, 2002, the Company's subsidiaries generally used the local
currency as the functional currency, assets and liabilities were translated
into U.S. dollars at the period ended exchange rate and income and expense
amounts were translated using the average rate prevailing for the period.
Adjustments resulting from translation were included in accumulated other
comprehensive income.
As of January 1, 2002, the Company's subsidiaries began using the U.S. dollar
as the functional currency. As a result, the adjustments resulting from
translation were included in net income for the six months ended June 30, 2002.
NOTE 9. SALE OF INVESTMENT
In 1996, the Company made an equity investment of approximately $2,000,000 in
Software.com, Inc. On November 17, 2000, Software.com and Phone.com merged and
began doing business as Openwave Systems, Inc. ("Openwave").
On January 1, 2001, the Company was party to two separate hedging contracts
related to its investment in Openwave. Since the Company did not designate these
hedges, the fair market value $5,300,000 at January 1, 2001, was recorded
directly in operations. As a result, the Company recorded a cumulative effect in
accounting change, net of taxes, of $3,445,000, offset by a decrease in the
reported gain on the sale of Openwave of $5,300,000. These changes had no effect
on the consolidated net income of the Company.
10
In January 2001, the Company liquidated its Openwave position for gross proceeds
of approximately $44,000,000 and a realized gain of approximately $33,378,000.
The Company paid a fee of $4,740,000 as a result of the early liquidation of the
hedge contracts. The gain on sale of Openwave reported by the Company in its
statement of operations includes the effect of writing off the previously
recorded asset related to these hedges. As of December 31, 2001, the Company
held no shares of Openwave.
NOTE 10. SALE OF SUBSIDIARY
On March 22, 2001, the Company sold its Australian subsidiary to an
Australian-based company. The Company exchanged its shares in the Australian
subsidiary for a 10% interest in the acquiring company. The Company recorded a
$1,039,000 loss as a result of the transaction and valued the 10% interest
received at zero.
NOTE 11. BASIC AND DILUTED EARNINGS PER SHARE
Basic earnings per share are based upon the weighted average number of common
shares outstanding during the period. Diluted earnings per share include the
dilution of weighted average potential common shares outstanding during the
period. Potential equivalent shares result from the assumed exercise of
outstanding stock options and warrants, the proceeds of which are then assumed
to have been used to repurchase outstanding shares of common stock using the
treasury stock method, and the conversion of preferred stock using the
if-converted method. The following table reconciles basic and diluted shares
outstanding as shown in the Consolidated Statements of Operations:
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
(restated) (restated)
---- ---- ---- ----
(in thousands except per share data)
Net (loss)/income $ (2,722) $ (5,590) $ (9,656) $ 10,505
Weighted average common shares outstanding - basic 22,231 23,137 22,282 23,332
Weighted average potential common shares - - - 1,106
-------- -------- -------- --------
Weighted average shares outstanding - diluted 22,231 23,137 22,282 24,438
Basic earnings per share $ (0.12) $ (0.24) $ (0.43) $ 0.45
======== ======== ======== ========
Diluted earnings per share $ (0.12) $ (0.24) $ (0.43) $ 0.43
======== ======== ======== ========
Options and warrants to purchase 2,685,290 and 3,291,646 shares of common stock
outstanding during the three months ended June 30, 2002 and June 30, 2001,
respectively, were excluded from the calculation of diluted net loss per share,
as the effect of their inclusion would have been anti-dilutive. Options and
warrants to purchase 2,811,790 shares of common stock outstanding during the six
months ended June 30, 2002 were excluded from the calculation of diluted net
loss per share, as the effect of their inclusion would have been anti-dilutive.
Options and warrants to purchase 2,985,646 shares of common stock outstanding
during the six months ended June 30, 2001 were excluded from the calculation of
diluted net income per share because the exercise price of those options and
warrants outstanding exceed the average market price of the Company's common
stock during the respective periods.
NOTE 12. SEGMENT INFORMATION
As described in Note 1, the Company has two reportable segments: services and
Switchboard. Significant financial information relative to the Company's
reportable segments is as follows:
11
Three Months Ended Six Months Ended
June 30, June 30,
Services 2002 2001 2002 2001
(restated) (restated)
- -------- ---- ---- ---- ----
(in thousands)
Revenues $ 8,952 $ 13,115 $ 19,245 $ 29,082
Cost of Revenues 5,729 9,016 12,728 19,517
-------- -------- -------- ---------
Gross Profit 3,223 4,099 6,517 9,565
Operating Expenses:
Sales and marketing 2,710 4,840 5,728 10,035
General and administrative 2,923 4,035 6,145 8,122
Amortization of intangibles - 800 - 1,543
Restructuring and other charges - 4,000 4,000 4,000
-------- -------- -------- ---------
Operating Expenses 5,633 13,675 15,873 23,700
-------- -------- -------- ---------
Operating loss $ (2,410) $ (9,576) $ (9,356) $ (14,135)
======== ======== ======== =========
Three Months Ended Six Months Ended
June 30, June 30,
Switchboard: 2002 2001 2002 2001
(restated) (restated)
- ------------ ---- ---- ---- ----
(in thousands)
Revenues $ 2,068 $ 2,805 $ 4,988 $ 4,344
Cost of Revenues 1,112 839 2,030 1,690
-------- -------- -------- ---------
Gross Profit 956 1,966 2,958 2,654
Operating Expenses:
Sales and marketing 1,145 5,393 2,572 12,205
Product development 1,317 1,687 2,822 3,000
General and administrative 723 1,030 1,430 1,939
Amortization of goodwill and intangibles - 212 - 457
-------- -------- -------- ---------
Operating Expenses 3,185 8,322 6,824 17,601
-------- -------- -------- ---------
Operating loss $ (2,229) $ (6,356) $ (3,866) $ (14,947)
======== ======== ======== =========
13. AMERICA ONLINE, INC.
In December 2000, Switchboard entered into an agreement (the "Directory
Agreement") with America Online, Inc. ("AOL") to develop a new directory and
local advertising platform and product set to be featured across specified AOL
properties (the "Directory Platform"). In November 2001, in April 2002 and again
in August 2002, certain terms of the Directory Agreement were amended. Under the
four-year term of the amended Directory Agreement, Switchboard shared with AOL
specified directory advertisement revenue. In general, Switchboard received a
majority of the first $35,000,000 of such directory advertisement revenue and a
lesser share of any additional directory advertisement revenue. Switchboard paid
AOL $13,000,000 at the signing of the Directory Agreement. Following the
incorporation of the Directory Platform on the AOL.com, AOL Proper and Digital
City properties ("AOL Roll-In") in January 2002, Switchboard recorded an asset
and liability of $13,000,000. Switchboard established an additional asset and
liability of $1,000,000 and paid $2,000,000 upon the execution of the April 2002
amendment. Under the April 2002 amended agreement, Switchboard was scheduled to
make six additional quarterly payments of $2,000,000 each, with the final
payment due in October 2003. AOL has committed to pay Switchboard at least
$2,000,000 in consulting or service fees under a payment schedule which ends in
September 2002, of which, AOL has paid $1,750,000 and Switchboard has delivered
$2,000,000 in services to AOL through June 30, 2002. The April 2002 amended
Directory Agreement had an initial term of five years, which term was subject to
earlier termination upon the occurrence of specified events, including, without
limitation (a) after 34 months and again after 46 months if specified revenue
targets have not been achieved and neither party has made additional payments to
the other to prevent such termination, (b) if Switchboard is acquired by one of
certain third parties, or (c) if AOL acquires one of certain third parties and
AOL pays Switchboard a termination fee of $25,000,000.
In connection with entering into the Directory Agreement, in December 2000
Switchboard issued to AOL 746,260 shares of its common stock, which were
restricted from transfer until the AOL Roll-In, which occurred on January 2,
2002, and agreed to issue to AOL an additional 746,260 shares of common stock if
the Directory Agreement continued after two years and a further 746,260 shares
of common stock if the Directory Agreement continued after three years. Under
the amended agreement, the requirement to issue additional shares upon the two
and three-year continuations has been eliminated. If Switchboard renews the
Directory Agreement with AOL for at least an additional four years after the
initial term, Switchboard agreed to issue to AOL a warrant to purchase up to
721,385 shares of common stock at a per share purchase price of $4.32.
The value of the $13,000,000 paid and stock issued upon the signing of the
Directory Agreement was amortized on a straight-line basis over the original
four-year estimated life of the agreement by Switchboard. As of December 2001,
the remaining unamortized amounts were written down to zero by Switchboard as a
result of an impairment analysis as of December 31, 2001. The value of the
$14,000,000 asset which has been recorded in 2002 is being amortized on a
straight-line basis by Switchboard over the remaining portion of the five-year
term of the April 2002 amended agreement. Amortization of assets related to AOL
are reflected by Switchboard as a reduction of revenue in accordance with EITF
01-9.
Under the August 2002 amendment, among other things, Switchboard revised the
term of the agreement back to the original four-year term; eliminated the 34 and
46 month revenue targets and additional potential continuation payments; removed
the requirement to pay AOL the remaining $12,000,000 Switchboard owed under the
April 2002 amendment and amended the percentage schedule by which Switchboard
shares in directory advertising revenue with AOL.
Switchboard revenue recognized from AOL, net of amortization of consideration
given to AOL, was 20.5% and 27.0% of net Switchboard revenue for the three and
six months ended June 30, 2002, respectively. Switchboard revenue from AOL, net
of amortization of consideration given to AOL, was 7.7% and (11.2)% of net
Switchboard revenue, for the three and six months ended June 30, 2001,
respectively. Amounts due from AOL included in accounts receivable at June 30,
2002 and December 31, 2001 were $977,000 and $774,000, respectively. Unbilled
receivables related to AOL at June 30, 2002 and December 31, 2001 were $79,000
and $618,000, respectively.
12
NOTE 14. REPURCHASE OF SWITCHBOARD SHARES FROM VIACOM
On February 27, 2002, Viacom exercised its warrant to purchase 533,468
shares of Switchboard's common stock at $1.00 per share pursuant to a cashless
exercise provision in the warrant, resulting in the net issuance of 386,302
shares of Switchboard common stock. On March 12, 2002, Switchboard repurchased
these 386,302 shares of Switchboard common stock from Viacom at a price of $3.25
per share, for a total cost of $1,255,000. Switchboard has recorded the value of
these shares as treasury stock at cost.
NOTE 15. NOTE RECEIVABLE FOR THE ISSUANCE OF SWITCHBOARD RESTRICTED COMMON STOCK
In January 2002, Switchboard recorded a note receivable from an officer and
member of its Board of Directors for approximately $1,500,000 arising from the
issuance of 450,000 shares of Switchboard common stock as restricted stock. As
of June 30, 2002, 300,000 of such shares were unvested and restricted from
transfer. The note bears interest at a rate of 4.875% which is deemed to be fair
market value, compounding annually and is 100% recourse as to principal and
interest. The note is payable upon the earlier of the occurrence of the sale of
all or part of the restricted shares by the issuer of the note, or January 4,
2008. At June 30, 2002, Switchboard recorded $1,484,000 as a note receivable
within Switchboard's stockholders' equity. During the three and six month period
ended June 30, 2002, Switchboard recorded $18,000 and $35,000 in interest income
resulting from this note receivable.
NOTE 16. DEBT
In March 2001, Switchboard entered into a computer equipment sale-leaseback
agreement with Fleet Capital Corporation ("FCC") under which Switchboard was
able to lease up to $3,000,000 of equipment. Under the agreement, Switchboard
was to have leased computer equipment over a three-year period ending on June
28, 2004, and had utilized $1,100,000 of this lease facility. The agreement had
an estimated effective annual percentage rate of approximately 7.90%. Under the
terms of the agreement, Switchboard was required to maintain on deposit with
Fleet National Bank ("FNB") a compensating balance, restricted as to use, in an
amount equal to the principal outstanding under the lease. Switchboard had
accounted for the transaction as a capital lease.
In May 2002, Switchboard paid $794,000 to FCC to terminate its lease
obligations with FCC through an early buy-out. In exchange for the amount paid,
Switchboard assumed all right and title to the assets leased under the facility.
Additionally, Switchboard's requirement to maintain a compensating balance with
FNB was eliminated.
Switchboard's notes payable consisted of the following as of June 30, 2002 and
December 31, 2001:
June 30, 2002 December 31, 2001
------------- -----------------
(in thousands)
Note payable under loan and security agreement $ 2,498 $ -
Note payable to Envenue 2,000 2,000
------- -------
Total notes payable 4,498 2,000
Less current portion (2,999) (2,000)
------- -------
Notes payable, non-current $ 1,499 $ -
======= =======
In June 2002, Switchboard entered into a loan and security agreement (the
"Agreement") with Silicon Valley Bank ("SVB"), under which Switchboard has the
ability to borrow up to $4,000,000 for the purchase of equipment. Amounts
borrowed under the facility accrue interest at a rate equal to prime plus 0.25%,
and are repaid monthly over a 30 month period. As of June 30, 2002, Switchboard
had utilized $2,500,000 of this facility. Switchboard may utilize the facility
to fund additional equipment purchases of up to $1,500,000 through March 31,
2003. The agreement also provides for a $1,000,000 revolving line of credit at
an interest rate equal to prime. At June 30, 2002, Switchboard had no
outstanding borrowings under the revolving line of credit. Switchboard has
recorded a note payable to SVB on its balance sheet totaling $2,500,000 for
equipment financed as of June 30, 2002, of which $1,000,000 is classified as a
current liability.
As a condition of the Agreement, Switchboard is required to maintain in
deposit or investment accounts at SVB not less than 95% of its cash, cash
equivalents and marketable securities. Covenants in the Agreement require
Switchboard to maintain in deposit or in investment accounts with SVB at least
$20,000,000 in unrestricted cash. Borrowings under the Agreement are
collateralized by all of Switchboard's tangible and intangible assets, excluding
intellectual property.
In November 2000, Switchboard acquired Envenue, Inc. ("Envenue"), a
wireless provider of advanced searching technologies designed to drive leads to
traditional retailers. The total purchase price included consideration of
$2,000,000 in cash to be paid on or before May 24, 2002, which Switchboard has
classified as a note payable within current liabilities. Switchboard has not
paid this amount, as it is in a contractual dispute with the previous owners of
Envenue. In June 2002, Switchboard placed into escrow $2,000,000, which will be
held in escrow until the contractual dispute has been resolved. Switchboard has
recorded this amount as restricted cash.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
METHOD OF PRESENTATION
Historically, Switchboard's results have been consolidated with our
financial results, due to either our majority ownership of Switchboard or
our control of the Switchboard Board of Directors as a result of a Voting
Rights Agreement by and among us, Switchboard and Viacom. However, in
January 2001, as the Voting Rights Agreement was terminated and our
ownership was then 38%, we ceased to consolidate Switchboard's results with
our results for the first three quarters of 2001. In October 2001,
Switchboard obtained approval from its stockholders and closed a
restructuring transaction with Viacom resulting in, in part, a reduction in
the number of outstanding shares of Switchboard's common stock and us then
owning approximately 54% of Switchboard's outstanding common stock. For
further discussion regarding the Viacom transaction see Note 25, Viacom
Alliance, in our Notes to Consolidated Financial Statements included in our
2001 Form 10-K/A. This change in ownership percentage resulted in us
retroactively consolidating Switchboard's revenues, expenses and other
income and expense in our consolidated statement of operations, while the
minority interest in Switchboard was eliminated through consolidated other
income and expense, as of January 1, 2001. Accordingly, the results of
operations for the three and six months ended June 30, 2002 and 2001,
respectively, are presented consistently herein on a consolidated basis. In
addition, Switchboard's assets and liabilities are consolidated in our
consolidated balance sheet as of June 30, 2002 and December 31, 2001. At
June 30, 2002, we owned 9,802,421 shares or an approximate 53% equity
interest of Switchboard's outstanding common stock.
As part of our continuing plan to improve operating results, we closed our
operations in the United Kingdom and Germany in the first quarter of 2002
and booked a charge as part of our restructuring and other charges.
14
RESTATEMENT OF FINANCIAL STATEMENTS
The restatements of our financial statements for the fiscal year ended
December 31, 2001 are described in detail in Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
of Part II, and our consolidated financial statements and related notes,
including, without limitation, Note 3, within Item 8 of Part II of the
Company's Amendment No. 1 to Annual Report on Form 10-K/A filed with the
Securities and Exchange Commission on September 20, 2002. In addition we
restated our consolidated unaudited financial statements for the fiscal
quarter ended March 31, 2002. These restatements are described in detail in
Item 2 "Management's Discussions and Analysis of Financial Condition and
Results of Operations," of Part I and our consolidated financial statements
and related notes, including Note 2, within Item 1 of Part I of the
Company's Amendment No. 1 to Quarterly Report on Form 10-Q/A filed with the
Securities and Exchange Commissions on or about September 24, 2002.
ADOPTION OF EITF 01-9
Effective January 2002, Switchboard, in conjunction with their newly
appointed independent auditors, Ernst & Young LLP, adopted Emerging Issues
Task Force Issue 01-9 "Accounting for Consideration Given by a Vendor to a
Customer (Including a Reseller of the Vendor's Products)" ("EITF 01-9"),
which became effective for fiscal years beginning after December 15, 2001,
and has concluded that EITF 01-9 is applicable to the accounting for
Switchboard's directory and local advertising platform services agreement
with America Online, Inc. ("AOL") (the "Directory Agreement"). The 2001
quarterly results have been adjusted to conform to the presentation required
by EITF 01-9. Accordingly, Switchboard has reduced its merchant network
revenue by $946,000 and $1,012,000 for the three months ended June 30, 2002
and 2001 and $2,049,000 and $2,024,000 for the six months ended June 30,
2002 and 2001, respectively, and reduced Switchboard's operating expenses by
a corresponding amount in the three and six months ended June 30, 2002 and
2001, respectively. The adoption of EITF 01-9 had no effect on our or
Switchboard's net income or capital resources. The following table
illustrates the effect of the application of EITF 01-9:
Switchboard:
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2002 2001 2002 2001(a)
(restated) (restated)
---- ------ ---- -------
(in thousands)
Gross revenue $3,014 $ 3,817 $ 7,037 $ 6,368
Less: Amortization of
consideration given to AOL (946) (1,012) (2,049) (2,024)
------ ------- ------- -------
Net revenue $2,068 $ 2,805 $ 4,988 $ 4,344
====== ======= ======= =======
Operating expenses $4,131 $ 9,334 $ 8,873 $19,625
Less: Amortization of
consideration given to AOL (946) (1,012) (2,049) (2,024)
------ ------- ------- -------
Net operating expenses $3,185 $ 8,322 $ 6,824 $17,601
====== ======= ======= =======
(a) Amortization of consideration given to AOL exceededed revenue derived
from AOL by $487,000 in the six months ended June 30, 2002.
RESULTS OF OPERATIONS
Services Revenues
Services revenues were $9.0 million and $19.2 million for the three-month and
six-month periods ended June 30, 2002, respectively, compared with $13.1
million and $29.1 million for the corresponding periods in 2001. The decrease
for both the three-month and six-month periods was principally due to lower
revenues from our web solutions business and the closure of our international
operations through the sale of our Australian subsidiary in March 2001, the
closure of our operations in The Netherlands in May 2001 and the closure of
our operations in the United Kingdom and Germany in January 2002. As a result
of the closure of our international operations, international revenues for
the three months and six months ended June 30, 2002 decreased 100% and 96%
respectively.
15
Services Gross Profit
Services gross profits were $3.2 million and $6.5 million for the three-month
and six-month periods ended June 30, 2002, respectively, compared with $4.1
million and $9.6 million for the corresponding periods in 2001. The decreases
in gross profit dollars in 2002 were primarily due to decreases in revenues
from consulting services as a result of lower revenues from our web solutions
business and the closure of our international operations. Services gross
profit as a percentage of revenues were 36% and 34% for the three-month and
six-month periods ended June 30, 2002, respectively, compared with 31% and
33% for the corresponding periods in 2001. The increases in services gross
profits as a percentage of revenues were primarily due to a decrease in
direct consulting costs as well as a decrease in third-party costs of
delivery. Cost of services revenues consists primarily of direct costs (i.e.
compensation) of consulting delivery personnel and third-party product costs.
Services Operating Expenses
Sales and marketing expenses were $2.7 million and $5.7 million for the
three-month and six-month periods ended June 30, 2002, respectively, compared
with $4.8 million and $10.0 million for the corresponding periods in 2001.
The decrease in 2002 was due primarily to cost reduction initiatives in our
domestic and international operations which included the sale of our
Australian subsidiary, the closing of our operations in Europe and staff
reductions in our web solutions business. Sales and marketing expenses as a
percentage of services revenues were 30% for both the three-month and
six-month periods ended June 30, 2002, respectively, compared with 37% and
35% for the corresponding periods in 2001. Sales and marketing expenses
consist primarily of salaries, associated employee benefits and travel
expenses of sales and marketing personnel and promotional expenses.
General and administrative expenses were $2.9 million and $6.1 million for
the three-month and six-month periods ended June 30, 2002, respectively,
compared with $4.0 million and $8.1 million for the corresponding periods
in 2001. The decrease in 2002 was primarily attributable to a reduction in
facility costs and lower depreciation expense as well as staff reductions
and related costs and lower bad debt expense. General and administrative
expenses as a percentage of services revenues were 33% and 32% for the
three-month and six-month periods ended June 30, 2002, respectively,
compared with 31% and 28% for the corresponding periods in 2001. General
and administrative expenses consist primarily of compensation, benefits and
travel costs for employees in management, finance, human resources,
information services and legal groups; recruiting and training costs for
delivery personnel; and facilities and depreciation expenses.
Services Amortization of Intangibles
Amortization of goodwill expenses for services was zero for the three
months and six months ended June 30, 2002, compared with $0.8 million and
$1.5 million for the corresponding periods in 2001. This decrease is due to
the adoption of Statement of Financial Accounting Standards ("SFAS") No.
142, "Goodwill and Other Intangible Assets". With the adoption of SFAS No.
142, goodwill is no longer subject to amortization over its estimated
useful life, but instead goodwill is subject to at least an annual
assessment for impairment by applying a fair-value-based test. We completed
an assessment of fair value of goodwill in the second quarter of 2002 and
believe the book value of goodwill at June 30, 2002 has not been impaired.
Services Restructuring and Other Charges
In the three months ended March 31, 2002, as part of our plan to implement
cost-cutting measures, we recorded a net pre-tax charge of $4.0 million for
services restructuring and other charges. These charges included a
workforce reduction of approximately 45 positions, office closures
including the closure of our offices in Germany and the United Kingdom and
asset write-offs. We expect to use $3.2 million of cash related to these
activities, of which $1.2 million was used at June 30, 2002.
In the second quarter of 2001, we recorded a pre-tax charge of $4.0 million
related to a workforce reduction of approximately 100 positions, office
closures and asset write-offs. We expect to use $2.9 million of cash
related to these activities.
At June 30, 2002, we had utilized approximately $5.1 million in total of
the combined liability of which $2.9 million was severance-related costs,
and the remainder related to office closures and asset write-offs. The
remaining combined liability at June 30, 2002 was approximately $2.8
million. We anticipate that we will utilize a substantial portion of the
remaining combined liability by the end of fiscal year 2002. See Note 5,
Restructuring
16
Charges, in our Notes to Consolidated Financial Statements for the three
months and six months ended June 30, 2002.
Switchboard Net Revenues
Switchboard net revenue decreased to $2.1 million for the three-month period
ended June 30, 2002, from $2.8 million for the comparable period in 2001.
Switchboard net revenue increased to $5.0 million for the six-month period
ended June 30, 2002, from $4.3 million for the comparable period in 2001. The
decrease of $0.7 million for the three-month period ended June 30, 2002
consisted of decreases in both national advertising and net merchant network
revenue. The increase of $0.7 million for the six months ended June 30, 2002
was due to an increase in net merchant network revenue, offset in part by a
decrease in national advertising revenue.
Switchboard Gross Profit
Switchboard gross profit decreased to $1.0 million for the three months ended
June 30, 2002 from $2.0 million for the corresponding period in 2001.
Switchboard gross profit increased to $3.0 million for the six months ended
June 30, 2002 from $2.7 million for the corresponding period in 2001. As a
percentage of Switchboard net revenue, gross profit for the three and six
months ended June 30, 2002 decreased to 46% and 59% from 70% and 61% for the
corresponding periods in 2001, respectively. The decrease in both gross
profit dollars and percentage in the three months ended June 30, 2002 were
primarily the result of a relatively fixed cost base being spread over lower
net revenue, as well as a shift in revenue to lower net margin merchant
network revenue, and in particular, engineering and other services revenue
within the three months ended June 30, 2002. The decrease in gross profit
dollars in the six months ended June 30, 2002 resulted primarily from an
increase in merchant network revenue related costs. The decrease in gross
profit percentage in the six months ended June 30, 2002 was primarily the
result of an increase in the mix of lower margin merchant network revenue in
2002.
Switchboard Operating Expenses
Switchboard sales and marketing expense decreased to $1.1 million for the
three months ended June 30, 2002 compared with $5.4 million for the
corresponding period in 2001. Switchboard sales and marketing expense
decreased to $2.6 million for the six months ended June 30, 2002 compared
with $12.2 million for the corresponding period in 2001. The decrease for the
three and six months ended June 30, 2002 was primarily related to the
elimination of the non-cash advertising expense related to Switchboard's
former agreement with Viacom, which accounted for $1.2 million and $3.7
million of Switchboard's sales and marketing expense during the three and six
months ended June 30, 2001. The decrease for the three and six months ended
June 30, 2002 was also attributable to a decrease in other corporate
marketing programs expenses, a decrease in employee salaries and benefits
resulting primarily from actions taken during Switchboard's corporate
restructuring activities in the three months ended December 31, 2001 and a
decrease in merchant program expenses. As a percentage of net revenue, sales
and marketing expenses were 55% and 52% for the three and six months ended
June 30, 2002 compared with 192% and 281% for the corresponding periods in
2001.
Switchboard research and development expense decreased to $1.3 million for
the three months ended June 30, 2002 compared with $1.7 million for the
corresponding period in 2001. Research and development expense decreased to
$2.8 million for the six months ended June 30, 2002 compared with $3.0
million for the corresponding period in 2001. The decreases for the three and
six months ended June 30, 2002 were primarily due to a decrease in
Switchboard's employee salaries and benefits resulting primarily from actions
taken during Switchboard's corporate restructuring activities in the three
months ended December 31, 2001 and a decrease in outside consulting expenses.
As a percentage of revenue, research and development expenses were 64% and
57% for the three and six months ended June 30, 2002 compared with 60% and
69% for the corresponding periods in 2001, respectively.
Switchboard general and administrative expense decreased to $0.7 million for
the three months ended June 30, 2002 as compared to $1.0 million for the
corresponding period in 2001. General and administrative expense decreased
to $1.4 million for the six months ended June 30, 2002 as compared to $1.9
million for the corresponding period in 2001. The decreases for the three and
six months ended June 30, 2002 were primarily due to decreases in Switchboard
salaries and benefits resulting primarily from actions taken during
Switchboard's corporate restructuring activities in the three months ended
December 31, 2001 and a decrease in costs associated with leased facilities,
offset in part by an increase in insurance expense. As a percentage of
revenue, general and administrative expenses were 35% and 29% for the three
and six months ended June 30, 2002 compared with 37% and 45% for the
corresponding periods in 2001.
17
Switchboard Amortization of Goodwill, Intangibles and Other Assets
After consideration of the impact of EITF 01-9, Switchboard's amortization
of goodwill, intangibles and other assets was zero in the three and six
months ended June 30, 2002, as compared to $212,000 and $457,000 for the
comparable periods in 2001. The decrease was due primarily to the absence
in 2002 of amortization of goodwill resulting from Switchboard's
acquisition of Envenue and amortization expense associated with a
Switchboard software license, which was written off in December 2001.
Consolidated Other Income/(Expense) and Income Taxes
Consolidated other income/(expense) was $2.0 million and $3.7 million for the
three months and six months ended June 30, 2002, respectively, compared with
$4.9 million and $43.7 million for the corresponding periods in 2001. The
decrease in 2002 is due primarily to gains on sales of Openwave/Software.com
stock of approximately $33.4 million in 2001 and was also due to a decrease
in interest income earned as a result of reduced funds available for
investment.
We recorded no tax benefit on our operating losses in 2002 and 2001 due to
the uncertainty of its realization. The small provision for income taxes in
2002 is for taxes related to our securities as well as state taxes.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2002, consolidated cash, cash equivalents, marketable
securities and restricted cash were $111.7 million, of which $57.0 million
was held by us and $54.7 million was held by Switchboard. At
December 31, 2001, consolidated cash, cash equivalents, marketable
securities and restricted cash were $122.1 million, of which $62.1 million
was held by us and $60.0 million was held by Switchboard.
Consolidated working capital decreased from $71.7 million at December 31,
2001 to $66.1 million at June 30, 2002. Cash and cash equivalents increased
$28.4 million resulting in a consolidated balance, excluding restricted
cash of $2.0 million, of $61.5 million at June 30, 2002. This increase was
primarily due to net cash used in operating activities of $8.3 million and
cash used in financing activities of $0.4 million offset by cash provided
by investing activities of $37.1 million as follows.
Net cash used in operating activities for the six months ended June 30, 2002
of $8.3 million, was primarily due to: a net loss of $9.7 million, a decrease
in accounts payable and accrued expenses of $7.2 million, a decrease in
deferred revenues of $2.8 million, Switchboard's payment on AOL Directory
Agreement of $2.0 million and our minority interest of Switchboard's losses
of $1.1 million. These decreases were offset in part by a decrease in
accounts receivable of $4.7 million, a decrease in other current assets of
$2.4 million, depreciation and amortization of $1.7 million, a decrease in
income tax receivable of $1.2 million and an increase on accrued costs for
restructuring charges of $1.1 million.
Net cash provided by investing activities for the six months ended June 30,
2002 of $37.1 million was primarily related to the proceeds from investments
of $39.1 million. This increase was offset in part by an increase in
restricted cash of $1.2 million and by capital expenditures of $0.9 million.
Net cash used in financing activities for the six months ended June 30, 2002
of $0.4 million was primarily due to $2.3 million in stock repurchases, of
which $1.1 million was pursuant to our stock buyback program with the
remainder related to Switchboard's repurchase of its common stock. The cash
used in financing activity was further due to the payment of Switchboard's
capital lease of $0.8 million. These uses were offset in part by
Switchboard's issuance of a note payable for $2.5 million related to the
financing of equipment purchases.
On December 18, 2000, our Board of Directors authorized the repurchase of up
to $10.0 million of our common stock on the open market. Repurchases of stock
are at management's discretion, depending upon acceptable prices and
availability. Funds used in the repurchase of shares come from our existing
cash and investment balances along with cash generated from operations. As of
June 30, 2002, we have expended $7.4 million toward stock repurchases.
We have received a commitment letter from Silicon Valley Bank regarding a
$10.0 million working capital line of credit and providing for borrowings at
Silicon Valley Bank's prime rate. We are working with Silicon Valley Bank
toward the finalization of terms and conditions and the execution of
definitive loan documents. We had no borrowings under any credit facilities
outstanding at either June 30, 2002 or December 31, 2001.
In June 2002, Switchboard entered into an equipment financing agreement with
Silicon Valley Bank, under which Switchboard has the ability to borrow up to
$4.0 million for the purchase of equipment. Amounts borrowed under the
facility accrue interest at a rate equal to prime plus 0.25%, and are repaid
monthly over a 30-month period. As of June 30, 2002, Switchboard had utilized
$2.5 million of this facility. Switchboard may utilize the facility to fund
additional equipment purchases of up to $1.5 million through March 31, 2003.
The agreement also provides for a $1.0 million revolving line of credit. At
June 30, 2002, Switchboard had no outstanding borrowings under the revolving
line of credit. Switchboard is required to maintain in deposit or investment
accounts at Silicon Valley Bank not less than 95% of its cash, cash
equivalents and marketable securities. Additionally, covenants in the
agreement require Switchboard to maintain in deposit or in investment
accounts with Silicon Valley Bank ("SVB") at least $20.0 million in
unrestricted cash. As part of the transition to SVB, Switchboard liquidated
$35.7 million in marketable securities previously held at Fleet for transfer
to SVB. As a result of this liquidation, Switchboard recorded $0.4 million in
realized gains during the six months ended June 30, 2002. These amounts have
been transfered to SVB. Of this $35.7 million liquidated, $31.7 million is
currently held in an interest bearing money market fund.
In November 2000, Switchboard acquired Envenue. The total purchase price
included consideration of $2.0 million in cash to be paid on or before May
24, 2002. Switchboard has not paid this amount, as Switchboard is in a
contractual dispute with the previous owners of Envenue. In June 2002,
Switchboard placed into escrow $2.0 million, which will be held in escrow
until the contractual dispute has been resolved. Switchboard has recorded
this amount as restricted cash.
We believe that existing cash and marketable securities, combined with cash
expected to be generated from operations, will be sufficient to fund the
Company's operations through at least the next twelve months.
18
FACTORS AFFECTING FUTURE OPERATING RESULTS
Certain of the information contained in this Quarterly Report on Form 10-Q,
including, without limitation, information with respect to our plans and
strategy for our business, statements relating to the sufficiency of cash and
cash equivalent balances, anticipated expenditures, the anticipated effects
of our cost reduction measures including the discontinuation of our
operations in Europe and Australia, and our sales and marketing and product
development efforts, consists of forward-looking statements. Any statements
contained herein that are not statements of historical fact may be deemed to
be forward-looking statements. Without limiting the foregoing, the words
"believes," "expects," "anticipates," "plans," and similar expressions are
intended to identify forward-looking statements. Important factors that could
cause actual results to differ materially from the forward-looking statements
include the following factors:
The continuing stock market decline and broad economic slowdown has
affected the demand for services, lengthened the sales cycles and caused
decreased technology spending for many of our customers and potential
customers. If companies continue to cancel or delay their business and
technology consulting initiatives because of the current economic climate,
or for other reasons, our business, financial condition and results of
operations could be materially adversely affected.
During the first quarter of 2002 and in the second and third quarters of
2001, we restructured our operations through workforce reductions and office
closures. Such restructurings could have an adverse effect on our business,
including on our ability to attract and retain customers and employees, and
there can be no assurance that we will achieve the anticipated financial
benefits of these restructurings. In addition, there can be no assurance that
our workforce reductions will not have a material adverse effect on our
business and operating results in the future.
Our future success will depend in part upon our ability to continue to grow
our services business, enter into new strategic alliances, acquire additional
services customers and adapt to changing technologies and customer
requirements. Any failure to do so could have a material adverse effect on
us. We have a limited operating history as a services company. In addition,
the market for our consulting services and the technologies used in our
solutions have been changing rapidly and we expect this level of change to
continue. If we cannot keep pace with these changes in our marketplace, our
business, financial condition and results of operations will suffer. There
can be no assurance we will be successful in our strategic focus on services,
including e-services.
We sell our services principally through a direct sales force to customers in
a broad range of industries. We do not require collateral or other security
to support customer receivables. Conditions affecting any of our clients
could cause them to become unable or unwilling to pay us in a timely manner,
or at all, for services we have already performed. Our financial results and
condition could be adversely affected by credit losses.
We are a party to a number of partnerships and alliances with software
vendors under which we provide services around such vendors' products. Any
failure of these alliances to generate the anticipated level of sales, the
loss of one or more of these alliances, or the failure to enter into
additional strategic alliances, could have a material adverse effect on us.
We are dependent upon the continued services of our key management and
technical personnel. In addition, as a services company, our business is
particularly dependent on our employees. Competition for qualified personnel
is strong, and there can be no assurance we will be able to attract and
retain qualified management and other employees.
In 2001, we determined that the goodwill recorded in connection with two
prior acquisitions was impaired and recorded a charge. There can be no
assurance that we will not experience similar impairment losses in the
future. Any such loss could adversely and materially impact our results of
operations and financial condition.
In 2001 we terminated operations in Australia and The Netherlands and, during
the first quarter of 2002, we elected to close our operations in the United
Kingdom and Germany. There can be no assurance that the termination of our
international operations will positively affect our operating results.
We were not profitable during 2001 or in the first two quarters of 2002, and
there can be no assurance we will return to profitability in any future
period. Continued losses could have a material adverse effect on our
liquidity and capital resources.
Our operating expenses are largely based on anticipated revenue trends, and a
high percentage of our expenses, such as personnel and rent, are and will
continue to be fixed in the short-term. We may not be able to quickly reduce
spending if our revenues are lower than we had projected. As a result, an
unanticipated decrease in the number, or an unanticipated slowdown in the
scheduling, of our projects may cause significant variations in operating
results in any particular quarter
19
and could have a material adverse effect on operations for that quarter. If
we do not achieve our expected revenues, our operating results will be below
our expectations and the expectations of investors and market analysts,
which could cause the price of our common stock to decline. Our quarterly
operating results have varied significantly in the past and will likely vary
significantly in the future, making it difficult to predict future
performance. These variations result from a number of factors, many of which
are outside of our control. Because of this difficulty in predicting future
performance, our operating results will likely fall below the expectations
of securities analysts or investors in some future quarter or quarters. Our
failure to meet these expectations would likely adversely affect the market
price of our common stock.
The market for our products is highly fragmented and characterized by
continuing technological developments, evolving and competing industry
standards, and changing customer requirements. We expect competition to
persist and intensify in the future. Some of our competitors have longer
operating histories and significantly greater financial, technical,
marketing and other resources than we do. Many of these companies can also
leverage extensive customer bases, have broad customer relationships and
have broad industry alliances, including relationships with certain of our
current and potential customers. In addition, certain competitors may adopt
aggressive pricing policies or may introduce new services. Competitive
pressures may make it difficult for us to acquire and retain customers and
could require us to reduce the price of our services. We cannot be certain
that we will be able to compete successfully with existing or new
competitors. Our failure to maintain and enhance our competitive position
would limit our ability to retain and increase our market share, resulting
in serious harm to our business and operating results.
Our future success depends on the increased acceptance and use of advanced
technologies as a means for conducting commerce and operations. If use of
these advanced technologies does not continue to grow, or grows more slowly
than expected, our revenue growth could slow or decline and our business,
financial condition and results of operations could be materially adversely
affected. Businesses may delay adoption of advanced technologies for a
number of reasons, including:
. inability to implement and sustain profitable business models using
advanced technologies;
. inadequate network infrastructure or bandwidth;
. delays in the development or adoption of new technical standards and
protocols required to handle increased levels of usage;
. delays in the development of security and authentication technology
necessary to effect secure transmission of confidential information; and
. failure of companies to meet their customers' expectations in delivering
goods and services using advanced technologies.
Our services rely upon third-party technologies. Our business could be
harmed if providers of such software and technology utilized in connection
with our services ceased to deliver and support reliable products, enhance
their current products in a timely fashion or respond to emerging industry
standards. In addition, if we or our customers cannot maintain licenses to
key third-party software, provision of our services could be delayed until
equivalent software could be licensed and integrated into our services, or
we might be forced to limit our service offerings. Either alternative could
materially adversely affect our business, operating results and financial
condition.
Some of our contracts can be canceled by the customer with limited advance
notice and without significant penalty. Termination by any customer of a
contract for our services could result in a loss of expected revenues and
additional expenses for staff, which were allocated to that customer's
project. We could be required to maintain underutilized employees who were
assigned to the terminated contract. The unexpected cancellation or
significant reduction in the scope of any of our large projects could have a
material adverse effect on our business, financial condition and results of
operations.
20
A significant portion of our projects are based on fixed-price,
fixed-timeframe contracts, rather than contracts in which payment to us is
determined on a time and materials basis. Our failure to accurately estimate
the resources required for a project, or our failure to complete our
contractual obligations in a manner consistent with the project plan upon
which our fixed-price, fixed-timeframe contract was based, could adversely
affect our overall profitability and could have a material adverse effect on
our business, financial condition and results of operations. We have been
required to commit unanticipated additional resources to complete projects
in the past, which has resulted in losses on those contracts. We will likely
experience similar situations in the future and the consequences could be
more severe than in the past, due to the increased size and complexity of
our engagements. In addition, we may fix the price for some projects at an
early stage of the process, which could result in a fixed price that turns
out to be too low and, therefore, would adversely affect our business,
financial condition and results of operations.
Because our proposed credit facility with Silicon Valley Bank is subject to
final documentation, there can be no assurance such facility will be made
available to us.
On August 20, 2002, we received a Nasdaq staff determination letter
indicating that we do not comply with Nasdaq Marketplace Rule 4310(c)(14)
due to our failure to timely file our Quarterly Report on Form 10-Q for the
fiscal quarter ended June 30, 2002. As a result of this non-compliance our
common stock is subject to delisting from the Nasdaq National Market pending
the decision of the Nasdaq Listing Qualification Panel. Notwithstanding
that our Quarterly Report on Form 10-Q for the fiscal quarter ended June
30, 2002, is now on file, there can be no assurance that our common stock
will not be delisted from the Nasdaq National Market, as it was not filed
within the time period required by the Securities and Exchange Commission.
A delisting of our common stock from the Nasdaq National Market could
materially reduce the liquidity of our common stock and result in a
corresponding material reduction in the price of our common stock. In
addition, any such delisting would materially adversely affect our ability
to raise capital through alternative financing sources.
We own 9,802,421 shares of Switchboard's common stock, which is traded on
the Nasdaq National Market. The trading price of Switchboard's common stock
is likely to be volatile and may be influenced by many factors, including,
without limitation, variations in financial results, changes in earnings
estimates by industry research analysts, the failure or success of branding
and strategic initiatives and investors' perceptions. Volatility in the
trading price of Switchboard's common stock could have a material adverse
effect on our financial condition. In addition, due to our level of
ownership of Switchboard, the trading price of our common stock is likely to
be influenced by the trading price of Switchboard's common stock. If
Switchboard's trading price declines, the trading price of our common stock
will likely decline as well. On August 21, 2002, Switchboard announced that
it had received a Nasdaq staff determination letter regarding its failure to
timely file its Quarterly Report on Form 10-Q for the quarter ended June 30,
2002. As a result of this non-compliance and notwithstanding that such
Report is now on file, Switchboard's common stock is subject to delisting.
Switchboard's results of operations are consolidated as part of our results
of operations. Switchboard, which has a history of incurring net losses, has
incurred net losses through June 30, 2002 and may never achieve
profitability. In addition, Switchboard's quarterly results of operations
have fluctuated significantly in the past and are likely to fluctuate
significantly from quarter to quarter in the future. Factors that may cause
Switchboard's results of operations to fluctuate include:
. the success of Switchboard's relationship with AOL;
. the addition or loss of relationships with third parties that are
Switchboard's source of new merchants for its local merchant network or that
license Switchboard's services for use on their own web sites;
. Switchboard's ability to attract and retain consumers, local merchants and
national advertisers to its web site;
. the amount and timing of expenditures for expansion of Switchboard's
operations, including the hiring of new employees, capital expenditures and
related costs;
. technical difficulties or failures affecting Switchboard's systems or the
Internet in general;
. the cost of acquiring, and the availability of, content, including
directory information and maps;
. Switchboard's expenses, which are largely fixed, particularly in the
short-term, are partially based on expectations regarding future revenue;
and
. Switchboard's ability to attract and retain highly skilled managerial and
technical personnel.
In addition, Switchboard has only a limited operating history and until
March 2000 had no operating history as a stand-alone company and no
experience in addressing various business challenges without the support of
a corporate parent. It may not be successful as a stand-alone company.
William P. Ferry, our Chairman of the Board, President and Chief Executive
Officer, is Switchboard's Chairman of the Board, and Richard M. Spaulding,
our Senior Vice President and Chief Financial Officer, and Robert M.
Wadsworth, one of our directors, are directors of Switchboard. Serving as a
director of Switchboard and as either a director or an officer of ePresence
could create, or appear to create, potential conflicts of interest when
those directors and officers are faced with decisions that could have
different implications for us than for Switchboard. Such conflicts, or
potential conflicts, of interest could hinder or delay our management's
ability to make timely decisions regarding significant matters relating to
our business.
21
Because of the foregoing factors and the other factors we have disclosed
from time to time, we believe that period-to-period comparisons of our
financial results are not necessarily meaningful and you should not rely
upon these comparisons as indicators of our future performance. We expect
that our results of operations may fluctuate from period-to-period in the
future.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Marketable Securities and Interest Rates
We are exposed to financial market risks, including changes in interest
rates. Our marketable securities as of June 30, 2002, are invested in US
agencies, bonds and notes and repurchase agreements. The majority of our
investments are short-term and have maturities between one and five
years. A significant portion of our cash is invested in short-term
interest-bearing securities. While we have in the past used hedging
contracts to manage exposure to changes in the value of marketable
securities, we are not currently a party to any such contract. We may
use hedging contracts in the future. The fair value of our investment
portfolio or related income would not be significantly impacted by
either a 100 basis point increase or decrease in interest rates due
mainly to the short-term nature of our investment portfolio.
All the potential changes noted above are based on sensitivity analysis
performed on our balances as of June 30, 2002.
Foreign Currency
During 2001 and the first quarter of 2002, we closed or sold all of our
foreign entities excluding Canada. We do not believe that foreign
currency exchange rate fluctuations will have a material effect on our
operating results or financial condition. We do not currently use
foreign currency hedging contracts to manage exposure to foreign
currency fluctuations. To date, foreign currency exchange rate
fluctuations have not had a material effect on our operating results or
financial condition.
ITEM 4. CONTROLS AND PROCEDURES
Not applicable.
23
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders held on May 9, 2002, our
stockholders approved the following items:
1. The election of John J. Rando as a Class I Director to serve for
the ensuing three years.
2. The ratification and approval of an amendment to the Company's 2001
Stock Incentive Plan increasing from 1,200,000 to 1,950,000 the
number of shares of Common Stock of the Company authorized for
issuance under such plan.
The other directors of the Company whose terms of office continued after
the Annual Meeting are Albert A. Notini, John F. Burton, William P.
Ferry, Fontaine K. Richardson and Robert M. Wadsworth. There were
22,830,539 shares of our common stock issued, outstanding and eligible
to vote on the record date of March 22, 2002. The results of the voting
for each matter are set forth below. There were no broker non-votes for
any matter.
Election of Directors Votes For Votes Withheld
--------------------- --------- --------------
John J. Rando 20,706,094 301,204
Approval of the
Amendment to the 2001
Stock Incentive Plan Votes For Votes Against Abstentions
-------------------- --------- ------------- -----------
16,241,300 3,737,144 1,028,854
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The exhibits listed on the Exhibit Index immediately preceding such
exhibits are filed as part of this report.
During the quarter ended June 30, 2002, the Company filed one report on
Form 8-K, dated May 13, 2002. The Form 8-K was filed pursuant to Item 9
of Form 8-K regarding an analyst presentation. No other reports on Form
8-K were filed during the quarter ended June 30, 2002.
During the quarter that will end September 30, 2002, the Company has
filed two reports on Form 8-K. The first one dated July 3, 2002 was
filed pursuant to Item 4 regarding a Change in Certifying Accountant and
the other one dated July 25, 2002 was filed pursuant to Item 5 regarding
the re-audit of the Company's consolidated financial statements for the
fiscal year ended December 31, 2001 as a result of the Company's
consolidation of Switchboard's results and Switchboard's intent to
restate its financial statements for the fiscal year ended December 31,
2001.
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EPRESENCE, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EPRESENCE, INC.
Date: September 24, 2002 By: /s/ Richard M. Spaulding
----------------------------
Richard M. Spaulding
Senior Vice President and Chief
Financial Officer, Treasurer and Clerk
(Principal Financial Officer and
Principal Accounting Officer)
CERTIFICATIONS
I, William P. Ferry, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ePresence, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Date: September 24, 2002
/s/ William P. Ferry
-------------------------------------
William P. Ferry
President and Chief Executive Officer
(principal executive officer)
I, Richard M. Spaulding, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ePresence, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
Date: September 24, 2002
/s/ Richard M. Spaulding
-------------------------------------
Richard M. Spaulding
Chief Financial Officer
(principal financial officer)
25
EXHIBIT INDEX
Exhibit Number TITLE OF DOCUMENT
10.1 Form of Director Non-Statutory Stock Option Agreement,
under the 1992 Stock Incentive Plan, as amended.
10.2 Form of Director Non-Statutory Stock Option Agreement,
under the 1992 Stock Incentive Plan, as amended.
10.3 Amendment No. 1 to the 2001 Stock Incentive Plan.
99.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
********************************************************************************
+ Management contract or compensation plan or arrangement
required to be filed as an exhibit pursuant to Item
14(c) of Form 10-K.
26