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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to _________________
Commission File Number: 000-28871
SWITCHBOARD INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
Delaware 04-3321134
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
120 Flanders Road, Westboro, MA 01581
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (508) 898-8000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of Class Shares Outstanding as of August 31, 2002
-------------- ---------------------------------------
Common Stock, par value $0.01 per share 18,840,928
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 that are subject to a number of risks and
uncertainties. All statements, other than statements of historical fact,
included in this Quarterly Report on Form 10-Q regarding our strategy, future
operations, financial position, estimated revenues, projected costs, prospects,
plans and objectives of management are forward-looking statements. When used in
this Quarterly Report on Form 10-Q, the words "will", "believe", "anticipate",
"intend", "estimate", "expect", "project" and similar expressions are intended
to identify forward-looking statements, although not all forward-looking
statements contain these identifying words. We cannot guarantee future results,
levels of activity, performance or achievements and you should not place undue
reliance on our forward-looking statements. Our forward-looking statements do
not reflect the potential impact of any future acquisitions, mergers,
dispositions, joint ventures or strategic alliances. Our actual results could
differ materially from those anticipated in these forward-looking statements as
a result of various factors, including the risks described in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Factors Affecting Operating Results, Business Prospects and Market Price of
Stock" and elsewhere in this Quarterly Report on Form 10-Q. The forward-looking
statements provided by Switchboard in this Quarterly Report on Form 10-Q
represent Switchboard's estimates as of the date this report is filed with the
SEC. We anticipate that subsequent events and developments will cause our
estimates to change. However, while we may elect to update our forward-looking
statements in the future we specifically disclaim any obligation to do so. Our
forward-looking statements should not be relied upon as representing our
estimates as of any date subsequent to the date this report is filed with the
SEC.
WEB SITE ADDRESSES
Our Web site address is www.switchboard.com. References in this Quarterly
Report on Form 10-Q to www.switchboard.com, switchboard.com, any variations of
the foregoing or any other uniform resource locator or URL, are inactive textual
references only. The information on our Web site or at any other URL is not
incorporated by reference into this Quarterly Report on Form 10-Q and should not
be considered to be a part of this document.
1
SWITCHBOARD INCORPORATED
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I - Financial Information
Item 1. - Financial Statements
Consolidated Balance Sheets as of June 30, 2002 (unaudited)
and December 31, 2001 (audited).............................................. 3
Consolidated Statements of Operations for the Three and Six Months
Ended June 30, 2002 and 2001 (unaudited)..................................... 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2002 and 2001 (unaudited)..................................... 5
Notes to Consolidated Financial Statements................................... 6
Item 2. -- Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................................... 13
Item 3. -- Quantitative and Qualitative Disclosures About Market Risk........ 36
Item 4. -- Controls and Procedures........................................... 36
PART II - Other Information
Item 1. - Legal Proceedings.................................................. 36
Item 2. -- Changes in Securities and Use of Proceeds......................... 37
Item 4. - Submission of Matters to a Vote of Security Holders................ 38
Item 6. -- Exhibits and Reports on Form 8-K.................................. 38
Signatures................................................................... 39
Certifications............................................................... 40
2
PART I -- FINANCIAL INFORMATION
ITEM 1. - FINANCIAL STATEMENTS
SWITCHBOARD INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
June 30, 2002 December 31, 2001
------------- -----------------
(unaudited) (audited)
Assets:
- -------
Cash and cash equivalents $ 35,064 $ 4,212
Short-term marketable securities 9,404 36,547
Accounts receivable, net of allowance of $570 and $500, respectively 1,577 1,635
Unbilled receivables 130 623
Prepaid Directory Agreement, current portion 3,468 -
Other current assets 757 631
-------- --------
Total current assets 50,400 43,648
Long-term marketable securities 8,149 18,333
Restricted cash 2,036 874
Property and equipment, net 2,548 2,885
Prepaid Directory Agreement 8,483 -
Other assets, net 24 95
-------- --------
Total assets $ 71,640 $ 65,835
======== ========
Liabilities and stockholders' equity:
- -------------------------------------
Accounts payable $ 922 $ 2,279
Accrued expenses 1,236 3,253
Deferred revenue 507 761
Payable related to Directory Agreement 12,000 -
Note payable, current portion 2,999 2,000
Capital lease obligation, current portion - 357
-------- --------
Total current liabilities 17,664 8,650
Note payable, net of current portion 1,499 -
Capital lease obligation, net of current portion - 518
-------- --------
Total liabilities 19,163 9,168
Stockholders' equity:
- ---------------------
Common stock, $0.01 par value per share; authorized 85,000,000 shares, issued
19,202,534 shares as of June 30,
2002 and 18,265,065 shares as of December 31, 2001 192 183
Treasury stock, 386,302 shares as of June 30, 2002 and none as of
December 31, 2001 (1,255) -
Additional paid-in capital 162,404 160,681
Note receivable for issuance of restricted common stock (1,484) -
Unearned compensation (251) (334)
Accumulated other comprehensive income 54 923
Accumulated deficit (107,183) (104,786)
-------- --------
Total stockholders' equity 52,477 56,667
-------- --------
Total liabilities and stockholders' equity $ 71,640 $ 65,835
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
3
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except per share data)
For the three months For the six months
ended June 30, ended June 30,
------------------ -------------------
2002 2001 2002 2001
------- ------- ------- --------
(restated) (restated)
Gross revenue $3,014 $3,817 $7,037 $6,368
Consideration given to a customer (946) (1,012) (2,049) (2,024)
------- ------- ------- --------
Net revenue 2,068 2,805 4,988 4,344
Cost of revenue 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
Research and development 1,317 1,687 2,822 3,000
General and administrative 723 1,030 1,430 1,939
Amortization of goodwill, intangibles and
other assets - 212 - 457
------- ------- ------- --------
Total operating expenses 3,185 8,322 6,824 17,601
------- ------- ------- --------
Loss from operations (2,229) (6,356) (3,866) (14,947)
Other income (expense):
Interest income, net 874 877 1,469 1,959
Loss on disposal of fixed assets - - - (173)
------- ------- ------- --------
Total other income (expense) 874 877 1,469 1,786
------- ------- ------- --------
Net loss $(1,355) $(5,479) $(2,397) $(13,161)
======== ======== ======= ========
Basic and diluted net loss per share $(0.07) $(0.22) $(0.13) $(0.53)
====== ====== ====== ======
Shares used in computing basic and
diluted net loss per share 18,499 24,971 18,497 24,940
The accompanying notes are an integral part of these consolidated financial
statements.
4
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Six months ended June,
-----------------------
2002 2001
------- --------
Cash flows from operating activities: (restated)
Net loss $(2,397) $(13,161)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,140 1,385
Amortization of unearned compensation 83 5
Loss on disposal of property and equipment - 173
Non-cash interest income (35) -
Gain on sales of marketable securities (402) -
Non-cash advertising and promotion expense - 3,727
Other-than-temporary unrealized loss on available for sale investments 6 -
Amortization of AOL assets 2,049 2,024
Changes in operating assets and liabilities:
Accounts receivable 58 3,106
Unbilled receivables 493 764
Other current assets (126) (6,076)
Other assets 71 2,918
Accounts payable (1,357) 33
Accrued expenses (1,103) (511)
Payment on AOL Directory Agreement (2,000) -
Accrued restructuring (914) -
Deferred revenue (254) (457)
------- --------
Net cash used in operating activities (4,688) (6,070)
Cash flows from investing activities:
Purchases of property and equipment (803) (1,818)
Restricted cash (1,162) (1,043)
Net proceeds from (purchases of) investments 36,854 (2,397)
------- --------
Net cash provided by (used in) investing activities 34,889 (5,258)
Cash flows from financing activities:
Proceeds from issuance of common stock, net 283 59
Purchase of treasury stock (1,255) -
Proceeds from sales-type leases - 1,101
Proceeds from issuance of note payable 2,498 -
Payments on capital leases (875) (38)
------- --------
Net cash provided by financing activities 651 1,122
Net increase (decrease) in cash and cash equivalents 30,852 (10,206)
Cash and cash equivalents at beginning of period 4,212 18,772
------- --------
Cash and cash equivalents at end of period $35,064 $ 8,566
======= ========
Supplemental statement of non-cash financing activity:
Note receivable from officer for issuance of common stock $1,449 -
The accompanying notes are an integral part of these consolidated financial
statements.
5
SWITCHBOARD INCORPORATED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Switchboard Incorporated, a Delaware corporation (the "Company"), commenced
operations in February 1996. From the Company's inception (February 19, 1996)
until March 7, 2000, the Company was a unit and later a subsidiary of ePresence,
Inc. (formerly Banyan Worldwide, "ePresence"). As of June 30, 2002, ePresence
beneficially owned approximately 53.2% of the Company's common stock. The
Company 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. The Company 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. The Company's Web site,
Switchboard.com, is a showcase for the Company's technology and breadth of
directory product offerings, and is a resource for consumers and businesses
alike. The Company offers its users local information about people and
businesses across the United States and Canada. The Company operates in one
business segment as a provider of Web-hosted directory technologies and
customized yellow pages platforms.
The Company is subject to risks and uncertainties common to growing
technology-based companies, including rapid technological change, growth and
commercial acceptance of the Internet, acceptance and effectiveness of Internet
advertising, dependence on principal products and third-party technology, new
product development, new product introductions and other activities of
competitors, dependence on key personnel, security and privacy issues,
dependence on strategic relationships and limited operating history.
The Company has also experienced substantial net losses since its inception
and, as of June 30, 2002, had an accumulated deficit of $107.2 million. Such
losses and accumulated deficit resulted from the Company's lack of substantial
revenue and significantly increased costs incurred in the development of the
Company's products and services and in the preliminary establishment of the
Company's infrastructure. The Company expects to continue to incur significant
operating expenses in order to execute its current business plan, particularly
sales and marketing and product development expenses. The Company believes that
the funds currently available would be sufficient to fund operations through at
least the next 12 months.
2. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, that, in the
opinion of management, are necessary to present fairly the financial information
set forth therein. Certain information and note disclosures normally included in
6
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. Results of
operations for the three- and six-month periods ended June 30, 2002 are not
necessarily indicative of future financial results. Certain previously reported
amounts have been reclassified to conform to the current method of presentation.
Investors should read these interim consolidated financial statements in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's Amendment No. 1 to Annual Report on Form 10-K for the
fiscal year ended December 31, 2001, as filed with the Securities and Exchange
Commission on September 19, 2002.
3. ADOPTION OF EITF 01-9
Effective January 2002, the Company 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 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, the Company has reduced its merchant network
revenue by $946,000 and $1.0 million for the three months ended June 30, 2002
and 2001 and $2.0 million and $2.0 million 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 the
Company's capital resources. The following table illustrates the effect of the
application of EITF 01-9:
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2002 2001 2002 2001
------ ------ ------ -------
Gross revenue $3,014 $3,817 $7,037 $6,368
Less: Amortization of consideration given to AOL(a) (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.
7
4. NET LOSS PER SHARE
Basic net loss per share is computed using the weighted average number of
shares of common stock outstanding less any restricted shares. Diluted net loss
per share does not differ from basic net loss per share, since potential common
shares from conversion of preferred stock, stock options, warrants and
restricted stock are antidilutive for all periods presented and are therefore
excluded from the calculation. As of June 30, 2002 and 2001, options to purchase
3,668,247 and 4,536,480 shares of common stock, preferred stock convertible into
none and one share of common stock, warrants to purchase 918,468 and 1,451,937
shares of common stock, and 300,000 and 746,260 shares of restricted stock,
respectively, were not included in the computation of diluted net loss per share
since their inclusion would be antidilutive.
5. CONCURRENT TRANSACTIONS
The Company had advertising barter transactions totaling $361,000 and
$476,000, or 12.9% and 10.9% of net revenues, for the three- and six-month
periods ended June 30, 2001, respectively, in which the Company received
promotion in exchange for promotion on its Web site. There were no revenues from
barter transactions in the three and six months ended June 30, 2002. Revenue
from advertising barter has been valued based on similar cash transactions which
have occurred within six months prior to the date of the barter transaction. In
accordance with Emerging Issues Task Force Issue No. 99-17 "Accounting for
Advertising Barter Transactions" (EITF 99-17"), barter transactions are recorded
at the fair value of the goods or services provided or received, whichever is
more readily determinable. The Company had other concurrent transactions
totaling $42,000 for the six months ended June 30, 2001, in which the Company
received marketing assets in exchange for promotion on its Web site. There were
no revenues from other concurrent transactions in the three and six months ended
June 30, 2002. Revenue from other concurrent transactions is recorded at the
fair value of the goods or services provided or received, whichever is more
readily determinable.
6. COMPREHENSIVE LOSS
Other comprehensive loss includes unrealized gains or losses on the
Company's available-for-sale investments.
Six Months Ended June 30,
------------------------
2002 2001
------- -------
(restated)
(unaudited, in thousands)
Net loss $(2,397) $(13,161)
Other comprehensive (loss) income:
Unrealized (loss) gain on investment (869) 277
------- --------
Comprehensive loss $(3,266) $(12,884)
======= ========
Of the $869,000 change in other comprehensive loss in the six months
ended June 30, 2002, $402,000 results from realized gains resulting from the
Company's liquidiation of certain marketable securities as part of its
transition of its banking relationship from Fleet National Bank to Silicon
Valley Bank.
7. ADVERTISING EXPENSE
Advertising costs are expensed as incurred. For the three and six months
ended June 30, 2001, advertising expenses totaled $2.8 million and $7.5 million,
of which $1.2 million and $3.7 million was related to non-cash advertising
received from Viacom Inc. ("CBS non-cash advertising"), respectively. The
Company's advertising expense in the three and six months ended June 30, 2002
was $13,000 and $27,000, respectively, none of which was related to CBS non-cash
advertising.
8
8. CAPITAL LEASE
In March 2001, the Company entered into a computer equipment sale-leaseback
agreement with Fleet Capital Corporation ("FCC") under which the Company was
able to lease up to $3.0 million of equipment. Under the agreement, the Company
was to have leased computer equipment over a three-year period ending on June
28, 2004, and had utilized $1.1 million of this lease facility. The agreement
had an estimated effective annual percentage rate of approximately 7.90%. Under
the terms of the agreement, the Company 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. The Company had
accounted for the transaction as a capital lease.
In May 2002, the Company paid $794,000 to FCC to terminate its lease
obligations with FCC through an early buy-out. In exchange for the amount paid,
the Company assumed all right and title to the assets leased under the facility.
Additionally, the Company's requirement to maintain a compensating balance with
FNB was eliminated.
9. NOTES PAYABLE AND LINE OF CREDIT
Notes payable consisted of the following as of June 30, 2002 and December
31, 2001:
June 30, 2002 December 31, 2001
------------- ----------------
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, the Company entered into a loan and security agreement (the
"Agreement") with Silicon Valley Bank ("SVB"), under which the Company 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, the Company
had utilized $2.5 million of this facility. The Company 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
an interest rate equal to prime. At June 30, 2002, the Company had no
outstanding borrowings under the revolving line of credit. The Company has
recorded a note payable to SVB on its balance sheet totaling $2.5 million for
equipment financed as of June 30, 2002, of which $1.0 million is classified as a
current liability.
9
As a condition of the Agreement, the Company 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 the
Company to maintain in deposit or in investment accounts with SVB at least $20.0
million in unrestricted cash. Borrowings under the Agreement are collateralized
by all of the Company's tangible and intangible assets, excluding intellectual
property.
In November 2000, the Company 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 $2.0
million in cash to be paid on or before May 24, 2002, which the Company has
classified as a note payable within current liabilities. The Company has not
paid this amount, as it is in a contractual dispute with the previous owners of
Envenue. In June 2002, the Company placed into escrow $2.0 million, which will
be held in escrow until the contractual dispute has been resolved. The Company
has recorded this amount as restricted cash.
11. TREASURY STOCK
On February 27, 2002, Viacom Inc. exercised its warrant to purchase 533,468
shares of the Company'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 common stock. On March 12, 2002, the Company repurchased these 386,302
shares of common stock from Viacom at a price of $3.25 per share, for a total
cost of $1.3 million. The Company has recorded the value of these shares as
treasury stock at cost.
12. AMERICA ONLINE, INC.
In December 2000, the Company entered into a Directory Agreement with 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 agreement
were amended. Under the four-year term of the amended Directory Agreement (as so
amended), the Company shared with AOL specified directory advertisement revenue.
In general, the Company received a majority of the first $35.0 million of such
directory advertisement revenue and a lesser share of any additional directory
advertisement revenue. The Company paid AOL $13.0 million at the signing of the
Directory Agreement. Following the incorporation of the Directory Platform on
the AOL.com, the AOL Service and Digital City properties ("AOL Roll-In") in
January 2002, we recorded a second asset and a liability of $13.0 million. The
Company established an additional asset and liability of $1.0 million and paid
10
$2.0 million upon the execution of the April 2002 amendment. Under the
April 2002 amended agreement, the Company was scheduled to make six additional
quarterly payments of $2.0 million each, with the final payment due in October
2003. AOL has committed to pay the Company at least $2.0 million in consulting
or service fees under a payment schedule which ends in September 2002, of which,
AOL has paid $1.75 million and the Company has delivered $2.0 million in
services to AOL through June 30, 2002. The April 2002 amended Directory
Agreement had an initial term of five years, which term is 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 the Company is acquired by one of
certain third parties, or (c) if AOL acquires one of certain third parties and
AOL pays us a termination fee of $25.0 million.
In connection with entering into the Directory Agreement, in December 2000
the Company issued to AOL 746,260 shares of our 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 the Company renews the
Directory Agreement with AOL for at least an additional four years after the
initial term, the Company 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 $13.0 million 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. As of December 2001, the remaining
unamortized amounts were written down to zero as a result of an impairment
analysis as of December 31, 2001. The value of the $14.0 million asset which has
been recorded in 2002 is being amortized on a straight-line basis over the
remaining portion of the five-year term of the April 2002 amended agreement.
Amortization of assets related to AOL are reflected as a reduction of revenue in
accordance with EITF 01-9.
Under the August 2002 amendment, among other things, the Company 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 $12.0 million the Company owed
under the April 2002 amendment and amended the percentage schedule by which the
Company shares in directory advertising revenue with AOL.
Revenue recognized from AOL, net of amortization of consideration given to
AOL, was 20.5% and 27.0% of net revenue for the three and six months ended June
30, 2002, respectively. Revenue from AOL, net of amortization of consideration
given to AOL, was 7.7% and (11.2)% of net 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.
11
13. SPECIAL CHARGES
In December 2001, the Company recorded net pre-tax special charges of
approximately $17.3 million, comprised primarily of $15.6 million for the
impairment of certain assets, $1.0 million for costs related to facility
closures and $700,000 in severance costs related to the reduction of
approximately 21% of the Company's workforce. The restructuring resulted in 21
employee separations.
Of the total $1.7 million charge, the Company currently estimates that
$1.6 million is cash related. As of June 30, 2002, $1.0 million was expended.
The Company has recorded a remaining liability of $392,000 on its balance sheet
as of June 30, 2002. The Company expects to spend approximately $43,000 by
December 31, 2002, with the remainder to be paid through December 2005.
14. NOTE RECEIVABLE FOR THE ISSUANCE OF RESTRICTED COMMON STOCK
In January 2002, the Company recorded a note receivable from an officer and
member of its Board of Directors for approximately $1.5 million arising from the
issuance of 450,000 shares of its common stock as restricted stock to that
individual. 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%,
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, the Company recorded $1.5 million as a note receivable within
stockholders' equity. During the three and six month period ended June 30, 2002,
the Company recorded $18,000 and $35,000 in interest income resulting from this
note receivable.
12
ITEM 2. -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion together with the condensed
consolidated financial statements and related notes appearing elsewhere in this
Quarterly Report on Form 10-Q. This Item contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities and Exchange Act of 1934 that involve risks and uncertainties.
Actual results may differ materially from those included in such forward-looking
statements. Factors which could cause actual results to differ materially
include those set forth under "Factors Affecting Operating Results, Business
Prospects and Market Price of Stock" commencing on page 23, as well as those
otherwise discussed in this section and elsewhere in this Quarterly Report on
Form 10-Q. See "Forward-Looking Statements."
OVERVIEW
Beginning in February 1996 when we commenced operations, we derived our
revenue principally from the sale of banner and site sponsorship advertising. We
now primarily derive revenue from our merchant network, which includes revenue
which we previously classified as merchant services and syndication and
licensing.
Net merchant network revenue includes revenue from various licensing
agreements with our merchant network alliance partners. These agreements
involve: engineering work to develop a Web-hosted platform for our alliance
partners which looks and feels like the alliance partner's own Web site and
includes our searching functionality; a license fee based upon the size and
complexity of the platform we create for the alliance partner; and a
per-merchant fee per month based upon the number of merchants they promote in
the platform. Net merchant network revenue also includes revenue from activities
in which we run trademark and display ads in the Switchboard.com yellow pages
directory, build and host Web sites for local merchants and send related direct
electronic mail-based promotions. In addition, included as an offset to revenue
are consideration given to customers, for which the benefits of such
consideration are not separately identifiable from the revenue obtained from
those customers. During the three months ended June 30, 2002, approximately
85.3% of our net revenue was derived from our local merchant network.
We also generate revenue from the sale of national advertising and site
sponsorship revenue, which is derived from banner advertisements, sponsorships,
direct electronic mail-based promotions and other forms of national advertising
that are sold on either a fixed fee, cost per thousand impressions or cost per
action basis. During the three months ended June 30, 2002, approximately 14.7%
of our net revenue was derived from the sale of national advertising and site
sponsorships.
Our cost of revenue consists primarily of expenses paid to third parties
under data licensing and Web site creation and hosting agreements, as well as
other direct expenses incurred to maintain the operations of our Web site. These
direct expenses consist of data communications expenses related to Internet
connectivity charges, salaries and benefits for operations personnel, equipment
costs and related depreciation, costs of running our data centers, which include
rent and utilities, and a pro rata share of occupancy and information system
expenses. Cost of revenue as a percentage of revenue has varied in the past,
primarily as a result of the amount of revenue recognized in the period, as well
as fluctuations in our Web site traffic, resulting in associated changes in
variable costs and, to a lesser extent, the cost of third-party content and
technology.
Our sales and marketing expense consists primarily of costs associated with
channel marketing programs, collateral production expenses, promotional
advertising, third-party commission costs, advertising and creative production
expenses, employee salaries and benefits, public relations, market research,
provision for bad debts and a pro rata share of occupancy and information system
expenses. A significant portion of our Web site promotion costs have resulted
from non-cash advertising expenses attributable to advertising provided to us by
Viacom Inc. under an advertising and promotion agreement with Viacom. In October
2001, we restructured our relationship with Viacom, under which, among other
things, we terminated our right to the placement of advertising on Viacom's CBS
properties with a net present value of approximately $44.5 million in exchange
for, primarily, the reconveyance by Viacom to us of approximately 7.5 million
shares of our capital stock and the cancellation of warrants held by Viacom to
purchase 533,469 shares of our common stock. As a result of that restructuring,
we anticipate sales and marketing expenses to decrease in both absolute dollars
and as a percentage of net revenue in 2002 when compared to the comparable
period in 2001.
13
Our research and development expense consists primarily of employee
salaries and benefits, fees for outside consultants, and related costs
associated with the development of new services and features on our Web site,
the enhancement of existing products, quality assurance, testing, documentation
and a portion of occupancy and information system expenses based on employee
headcount.
Our general and administrative expense consists primarily of employee
salaries and benefits and other personnel-related costs for executive and
financial personnel, as well as legal expenses, directors and officers insurance
and accounting costs, and a portion of occupancy and information system expenses
based on employee headcount.
Our amortization of goodwill, intangibles and other assets consists
primarily of amortization of goodwill resulting from our acquisition of Envenue,
Inc. in November 2000 and the amortization of other long-term assets.
We have experienced substantial net losses since our inception. As of June
30, 2002, we had an accumulated deficit of $107.2 million. These net losses and
accumulated deficit resulted from our lack of substantial revenue and the
significant costs incurred in the development of our Web site and the
establishment of our corporate infrastructure and organization. To date, we have
made no provision for income taxes.
14
ADOPTION OF EITF 01-9
Effective January 2002, we, in conjunction with our 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 concluded that
EITF 01-9 is applicable to the accounting for our 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, we have reduced our
merchant network revenue by $946,000 and $1.0 million for the three months ended
June 30, 2002 and 2001 and $2.0 million and $2.0 million for the six months
ended June 30, 2002 and 2001, respectively, and reduced our 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 our
capital resources. The following table illustrates the effect of the application
of EITF 01-9:
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2002 2001 2002 2001
------ ------ ------ -------
Gross revenue $3,014 $3,817 $7,037 $6,368
Less: Amortization of consideration given to AOL(a) (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.
SIGNIFICANT RELATIONSHIP
In December 2000, we entered into a Directory Agreement with 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 agreement were
amended. Under the four-year term of the amended Directory Agreement (as so
amended), we shared with AOL specified directory advertisement revenue. In
general, we received a majority of the first $35.0 million of such directory
advertisement revenue and a lesser share of any additional directory
advertisement revenue. We paid AOL $13.0 million at the signing of the Directory
Agreement. Following the incorporation of the Directory Platform on the AOL.com,
the AOL Service and Digital City properties ("AOL Roll-In") in January 2002, we
recorded a second asset and a liability of $13.0 million. We established an
additional asset and liability of $1.0 million and paid $2.0 million upon the
execution of the April 2002 amendment. Under the April 2002 amended agreement,
we were scheduled to make six additional quarterly payments of $2.0 million
each, with the final payment due in October 2003. AOL has committed to pay us at
least $2.0 million in consulting or service fees under a payment schedule which
ends in September 2002, of which, AOL has paid $1.75 million and we have
delivered $2.0 million in services to AOL through June 30, 2002. The amended
Directory Agreement had an initial term of five years, which term is 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 we are acquired by one of certain
third parties, or (c) if AOL acquires one of certain third parties and AOL pays
us a termination fee of $25.0 million.
15
In connection with entering into the Directory Agreement, in December 2000
we issued to AOL 746,260 shares of our 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 we renew the Directory
Agreement with AOL for at least an additional four years after the initial term,
we 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 $13.0 million 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. As of December 2001, the remaining
unamortized amounts were written down to zero as a result of an impairment
analysis as of December 31, 2001. The value of the $14.0 million asset which has
been recorded in 2002 is being amortized on a straight-line basis over the
remaining portion of the five-year term of the April 2002 amended agreement.
Amortization of assets related to AOL are reflected as a reduction of revenue in
accordance with EITF 01-9.
Under the August 2002 amendment, among other things, we 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 $12.0 million we owed under the April
2002 amendment and amended the percentage schedule by which we share in
directory advertising revenue with AOL.
In 2001 and the three and six months ended June 30, 2002, net revenue under
our Directory Agreement represented a significant portion of our total net
revenue. Net AOL revenue accounted for 20.5% and 27.0% of total net revenue in
the three and six months ended June 30, 2002, respectively. We anticipate that
AOL will represent a material portion our net revenue during the remainder of
2002 and will be a material component of our overall business.
RESULTS OF OPERATIONS
Net revenue. Net revenue decreased $737,000, or 26.3%, to $2.1 million for
the three-month period ended June 30, 2002, from $2.8 million for the comparable
period in 2001. Net revenue increased $644,000, or 14.8%, 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, for the three-month period ended June 30, 2002
consisted of decreases in both net merchant network revenue and national
advertising revenue. The increase 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.
Net merchant network revenue decreased $178,000, or 9.2%, to $1.8 million
in the three months ended June 30, 2002, as compared to $1.9 million in the
comparable period in 2001. Net merchant network revenue increased $1.7 million,
or 61.4%, to $4.4 million in the six months ended June 30, 2002, as compared to
$2.7 million in the comparable period in 2001. The decrease in net merchant
network revenue in the three months ended June 30, 2002 was due primarily to a
16
decrease in engineering services and other services revenues, offset in part by
an increase in merchant licensing revenues from our merchant network alliance
partners and a reduction of amortization of AOL assets which has been offset
against revenue. The increase in net merchant network revenue in the six months
ended June 30, 2002 was due primarily to new licensing agreements with merchant
network alliance partners, increased membership in our merchant network and
revenue attributable to additional services offered to existing local merchants,
offset in part by a decrease in engineering and other services revenue.
National advertising and site sponsorship revenue decreased $559,000, or
64.8%, to $304,000 for the three months ended June 30, 2002, as compared to
$863,000 in the comparable period in 2001. National advertising and site
sponsorship revenue decreased $1.0 million, or 63.0%, to $602,000 for the six
months ended June 30, 2002, as compared to $1.6 million in the comparable period
in 2001. The decrease in national advertising and site sponsorship revenue for
the three and six months ended June 30, 2002 resulted from a decrease in both
the number of advertisers on the site, as well as the per impression fee charged
to those customers. We attribute these decreases to a decline in demand for
Internet advertising services as well as the overall state of the U.S. economy.
Barter revenue, in which we received promotion in exchange for promotion on
our Web site, was 12.9% and 10.9% of total net revenue for the three- and
six-month periods ended June 30, 2001. There was no revenue from barter
transactions in the three and six months ended June 30, 2002.
Cost of revenue. Cost of revenue increased $273,000, or 32.5%, to $1.1
million, or 53.8% of net revenue, for the three months ended June 30, 2002, from
$839,000, or 29.9% of net revenue, for the three months ended June 30, 2001.
Cost of revenue increased $340,000, or 20.1%, to $2.0 million, or 40.7% of net
revenue, for the six months ended June 30, 2002, from $1.7 million, or 38.9% of
net revenue, for the six months ended June 30, 2001. The dollar increase for the
three and six months ended June 30, 2002 was primarily the result of a shift in
the mix of revenue to lower margin merchant network services as well as
increases in depreciation associated with additional equipment necessary to
support our Web site and those of our merchant network alliance partners, data
communication expense and the cost of third-party data, offset in part by
decreases in equipment related expenses incurred to support our local merchant
network partners and third-party Web site creation and hosting expenses
associated with our merchant services programs.
Gross profit. Gross profit decreased $1.0 million, or 51.4%, to $1.0
million for the three months ended June 30, 2002 from $2.0 million for the
corresponding period in 2001. Gross profit increased $304,000, or 11.5%, 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 net revenue, gross profit for
the three and six months ended June 30, 2002 decreased to 46.2% and 59.3% from
70.1% and 61.1% for the corresponding periods in 2001, respectively. The
decreases 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
17
spread over lower net revenue, as well as a decrease in the gross profit
margins on engineering and other services revenue. The decrease in gross profit
dollars and percentage in the six months ended June 30, 2002 resulted primarily
from an increase in net merchant network revenue related costs.
Sales and marketing. Sales and marketing expense decreased $4.2 million, or
78.8%, to $1.1 million for the three months ended June 30, 2002 compared with
$5.4 million for the corresponding period in 2001. Sales and marketing expense
decreased $9.6 million, or 78.9%, 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 our former
agreement with Viacom, which accounted for $1.2 million and $3.7 million of our
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 our 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 55.4% and 51.6% for the three
and six months ended June 30, 2002 compared with 192.3% and 281.0% for the
corresponding periods in 2001.
Research and development. Research and development expense decreased
$370,000, or 21.9%, 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 $178,000, or 5.9%, 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 employee salaries and benefits resulting
primarily from actions taken during our corporate restructuring activities in
the three months ended December 31, 2001 and a decrease in outside consulting
expenses. As a percentage of net revenue, research and development expenses were
63.7% and 56.6% for the three and six months ended June 30, 2002 compared with
60.1% and 69.1% for the corresponding periods in 2001.
General and administrative. General and administrative expense decreased
$307,000, or 29.8%, to $723,000 for the three months ended June 30, 2002 as
compared to $1.0 million for the corresponding periods in 2001. General and
administrative expense decreased $509,000, or 26.3%, 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 salaries and benefits resulting primarily
from actions taken during our 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 net revenue, general and administrative expenses were 35.0% and 28.7% for the
three and six months ended June 30, 2002 compared with 36.7% and 44.6% for the
corresponding periods in 2001.
18
Amortization of goodwill, intangibles and other assets. After consideration
of the impact of EITF 01-9, 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 comparable periods in 2001. The decrease was due
primarily to the absence in 2002 of amortization of goodwill resulting from our
acquisition of Envenue and amortization expense associated with a software
license, which were written off in December 2001.
Other income (expense) net. Other income was $874,000 for the three months
ended June 30, 2002 as compared to $877,000 for the corresponding period in
2001. Other income decreased $317,000, or 17.7%, to $1.5 million for the six
months ended June 30, 2002 as compared to $1.8 million for the corresponding
period in 2001. The decrease in other income in the six months ended June 30,
2002 was due primarily to a decrease in interest income earned as a result of
reduced funds available for investment and a decline in interest rates, offset
in part by a loss on disposal of fixed assets in 2001.
Net loss. Our losses decreased $4.1 million, or 75.3%, to $1.4 million for
the three months ended June 30, 2002, from $5.5 million for the corresponding
period in 2001. Our losses decreased $10.8 million, or 81.8%, to $2.4 million
for the six months ended June 30, 2002, from $13.2 million for the corresponding
period in 2001. As of June 30, 2002, our accumulated deficit totaled $107.2
million.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002, we had cash and cash equivalents totaling $35.0
million. We also had short and long-term investments valued at $17.6 million and
restricted cash of $2.0 million. During the six months ended June 30, 2002, cash
increased by $30.9 million, primarily due to net cash provided by investing
activities of $34.9 million and net cash provided by financing activities of
$651,000, offset in part by net cash used in operating activities of $4.7
million.
19
Net cash used for operating activities for the six months ended June 30,
2002 was $4.7 million, primarily due to a net loss of $2.4 million, a payment of
$2.0 million to AOL related to our Directory Agreement, a decrease in accounts
payable of $1.4 million, a decrease in accrued expenses of $872,000 and a
decrease in accrued restructuring of $914,000, offset in part by amortization of
AOL assets of $2.0 million and depreciation and amortization of $1.1 million.
Under our Directory Agreement, we paid $13.0 million to AOL at the signing of
the directory agreement in December 2000 and $2.0 million upon the execution of
the April 2002 amendment to that agreement. Under the April 2002 amendment, we
previously had been required to make six additional quarterly payments of $2.0
million each, with the final payment due in October 2003. Under the August 2002
amendment to the Directory Agreement, the six additional quarterly payments were
eliminated.
Net cash provided by investing activities for the six months ended June 30,
2002 was $34.9 million. Investing activities for the period were primarily
related to net proceeds from investments of $36.9 million, offset in part by an
increase in restricted cash of $1.2 million and purchases of property and
equipment of $803,000.
Net cash provided by financing activities for the six months ended June 30,
2002 was $651,000, primarily due to the issuance of a note payable for $2.5
million related to the financing of equipment purchases and proceeds of $284,000
from the issuance of stock, offset in part by the purchase of $1.3 million in
treasury stock, and the payment of a capital lease of $875,000. In February
2002, Viacom Inc. exercised its warrant to purchase 533,468 shares of our common
stock pursuant to a cashless exercise provision in the warrant, resulting in the
net issuance of 386,302 shares of common stock. In March 2002, we repurchased
the 386,302 shares of our common stock from Viacom at $3.25 per share. The
repurchased shares are being held as treasury stock.
In May 2002, we paid $794,000 to Fleet Capital Corporation to terminate our
lease obligations with Fleet Capital Corporation through an early buy-out. In
exchange for the amount paid, we assumed all right and title to the assets
leased under the facility. Additionally, our requirement to maintain a
compensating balance with Fleet National Bank ("Fleet") was eliminated.
In June 2002, we entered into an equipment financing agreement with Silicon
Valley Bank, under which we have 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, we had utilized $2.5 million of this facility. We
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, we had no outstanding borrowings
under the revolving line of credit.
As a condition of the Agreement, we are required to maintain in deposit or
investment accounts at Silicon Valley Bank not less than 95% of our cash, cash
equivalents and marketable securities. Additionally, covenants in the agreement
require us 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, we liquidated $35.7 million in marketable securities
previously held at Fleet for transfer to SVB. As a result of this liquidation,
we recorded $402,000 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, we acquired Envenue, a wireless provider of advanced
searching technologies designed to drive leads to traditional retailers. The
total purchase price included consideration of $2.0 million in cash to be paid
on or before May 24, 2002. We have not paid this amount, as we are in a
contractual dispute with the previous owners of Envenue. In June 2002, we placed
into escrow $2.0 million, which will be held in escrow until the contractual
dispute has been resolved. We have recorded this amount as restricted cash.
Since our inception through December 2001, we have significantly increased
our operating expenses. While operating expenses have decreased in the three and
six months ended June 30, 2002 when compared to the corresponding periods in
2001, we anticipate that our operating expenses and capital expenditures will
20
continue to constitute a material use of our cash resources. For advertising, we
previously relied on our non-cash CBS-related advertising, which is no longer
available to us. We expect that we may need to incur advertising expense in
future periods, which will require us to spend cash in order to continue to
brand our name and increase traffic to our Web site. In addition, we may utilize
cash resources to fund acquisitions or investments in businesses, technologies,
products or services that are strategic or complementary to our business. We
believe that the cash and marketable securities currently available will be
sufficient to meet our anticipated cash requirements to fund operations for at
least the next 12 months.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have identified the policies below as critical to the understanding of
our results of operations. Note that our preparation of this Quarterly Report on
Form 10-Q requires us to make estimates and assumptions that affect the reported
amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of our financial statements, and the reported amounts of
revenue and expenses during the reporting period. On an ongoing basis,
management evaluates its estimates and judgments, including those related to
revenue recognition, bad debts, investments, intangible assets, compensation
expenses, third-party commissions, restructuring costs, contingencies and
litigation. Management bases its estimates and judgments on historical
experience and on various other factors that are believed to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. There can be no assurance that actual results will
not differ from those estimates.
Critical accounting polices are those policies that are reflective of
significant judgments and uncertainties and potentially result in materially
different results under different assumptions and conditions. We believe our
most critical accounting policies are as follows:
REVENUE RECOGNITION
We generate our revenue primarily from our merchant network and banner and
site sponsorship advertising. Generally, revenue is recognized as services are
provided, so long as no significant obligations remain and collection of the
resulting receivable is probable. We believe that we are able to make reliable
judgments regarding the creditworthiness of our customers based upon historical
and current information available to us. There can be no assurances that our
payment experience with our customers will be consistent with past experience or
that the financial condition of these customers will not decline in future
periods, the result of which could be our failure to collect on invoiced
amounts. Some of these amounts could be material, resulting in an increase in
our provision for bad debts.
21
Revenues earned under the merchant network consist of advertising and
platform services. Through our merchant network, we offer certain merchant
alliance partners the ability to sell Switchboard.com distribution to their
merchant advertisers. These efforts are reflected in our merchant network
advertising revenues. For these advertising services, the merchant network
alliance partners pay us a monthly fee based on the number of advertisements
placed into Switchboard.com. This monthly fee is recognized as revenue by us as
it is earned. Platform services relate to the our offerings to our merchant
network alliance partners, under which those alliance partners can enter into a
development and licensing arrangement with us whereby we create and/or modify a
private labeled web-hosted directory platform. Once the web-hosted directory
platform is operational, we also earn additional fees based on the number of
merchants promoted within the platform. Revenue received by us for such
development and licensing arrangements is deferred until such time the platform
is accepted by the customer. After acceptance by the customer, revenue from such
development and licensing agreements are recognized ratably over the life of the
agreement. Any additional engineering or other services fees earned through the
merchant promotions are recognized as earned due to their variable nature. In
addition, included as an offset to revenue is consideration given to customers,
for which the benefits of such consideration are not separately identifiable
from the revenue obtained from those customers.
Revenues earned under our banner and site sponsorships consist principally
of advertising revenue earned though our Switchboard.com web site. Specifically,
we offer both site-wide banner and category specific banner programs on the
Switchboard.com Web site.
Deferred revenue is principally comprised of billings in excess of
recognized revenue relating to advertising agreements and licensing fees
received pursuant to advertising or services agreements in advance of revenue
recognition. Unbilled receivables are principally comprised of revenues earned
and recognized in advance of invoicing customers, resulting from contractually
defined billing schedules.
CONCURRENT TRANSACTIONS
We had advertising barter transactions totaling $361,000, or 12.9% of net
revenues, and $476,000, or 10.9% of net revenues, for the three and six months
ended June 30, 2001, in which we received promotion in exchange for promotion on
our Web site. There were no revenues from barter transactions in the three and
six months ended June 30, 2002. Revenue from advertising barter has been valued
based on similar cash transactions which have occurred within six months prior
to the date of the barter transaction. In accordance with Emerging Issues Task
Force Issue No. 99-17 "Accounting for Advertising Barter Transactions" (EITF
99-17"), barter transactions are recorded at the fair value of the goods or
services provided or received, whichever is more readily determinable. The
Company had other concurrent transactions totaling $42,000 for the six months
ended June 30, 2001, in which the Company received marketing assets in exchange
for promotion on its Web site. Revenue from other concurrent transactions are
22
recorded at the fair value of the goods or services provided or received,
whichever is more readily determinable. Accounting rules applicable to
concurrent transactions continue to evolve. Any further changes to these
accounting rules could affect the valuation of any future concurrent
transactions.
IMPAIRMENT OF LONG-LIVED ASSETS
If facts and circumstances were to indicate that our long-lived assets
might be impaired, the estimated future undiscounted cash flows associated with
the long-lived assets would be compared to its carrying amount to determine if a
write-down to fair value is necessary. Any such write-down could have a material
negative effect on our results of operations.
RISKS, CONCENTRATIONS AND UNCERTAINTIES
We invest our cash and cash equivalents primarily in deposits, money market
funds and investment grade securities with financial institutions. We have not
experienced any realized losses to date on our invested cash. A potential
exposure is a concentration of credit risk in trade accounts receivable. We
maintain reserves for credit losses and, to date, such losses have been within
our expectations. These expectations are based on historical experience,
analysis of information currently available to us with respect to our customer's
financial position, as well as various other factors. While we believe we can
make reliable estimates of these matters, it is possible that these estimates
may change in the near future. A change in estimates could negatively affect our
results of operations.
FACTORS AFFECTING OPERATING RESULTS, BUSINESS PROSPECTS AND MARKET PRICE OF
STOCK
We caution you that the following important factors, among others, in the
future could cause our actual results to differ materially from those expressed
in forward-looking statements made by or on behalf of Switchboard in filings
with the Securities and Exchange Commission, press releases, communications with
investors, and oral statements. Any or all of our forward-looking statements in
this Quarterly Report on Form 10-Q and in any other public statements we make
may turn out to be wrong. They can be affected by inaccurate assumptions we
might make or by known or unknown risks and uncertainties. Many factors
mentioned in the discussion below will be important in determining future
results. Consequently, no forward-looking statement can be guaranteed. Actual
future results may vary materially. We undertake no obligation to publicly
update any forward-looking statements, whether as a result of new information,
future events or otherwise. You are advised, however, to consult any further
disclosures we make in our reports filed with the Securities and Exchange
Commission.
23
RISKS RELATED TO OUR BUSINESS
WE HAVE A HISTORY OF INCURRING NET LOSSES, WE EXPECT OUR NET LOSSES TO
CONTINUE FOR THE NEXT SEVERAL QUARTERS AND WE MAY NEVER ACHIEVE PROFITABILITY
We have incurred significant net losses in each fiscal quarter since our
inception. From inception to June 30, 2002, we have incurred net losses totaling
$107.2 million. As a result, we need to generate significant additional revenue
to fund our operations. It is possible that we may never achieve profitability
and, even if we do achieve profitability, we may not sustain or increase
profitability on a quarterly or annual basis in the future. If we do not achieve
sustained profitability, we will be unable to continue our operations.
IF THE DIRECTORY SERVICES AGREEMENT WE ENTERED INTO WITH AMERICA ONLINE, INC.
("AOL"), A SUBSIDIARY OF AOL TIME WARNER, INC., IS NOT SUCCESSFUL, IT COULD HAVE
A MATERIALLY NEGATIVE EFFECT ON OUR RESULTS OF OPERATIONS
The directory services agreement we entered into with AOL may not generate
anticipated revenues or other benefits. Even though we have recently amended the
agreement to resolve a payment schedule issue and extended its term, the
agreement may still be prematurely terminated by breach or otherwise fail to be
successful. Our revenue from AOL in recent quarters has been lower than
anticipated, due to AOL's longer-than-expected transition to a third-party
channel sales model in its directory advertising business, and it is possible
that this and other factors may lead to revenue from AOL being lower than
anticipated in future periods as well. Local merchants may not view the alliance
as an effective advertising vehicle for their products and services. Even if the
Directory Agreement is not successful, AOL may not have to return any of the
consideration, including cash and stock, which we have paid to AOL, and we may
have continuing contractual and other financial obligations to AOL under the
agreement.
In 2001 and the first six months of 2002, revenue derived from AOL
represented a significant portion of our revenue. AOL accounted for 27.0% of
total net revenue in the six months ended June 30, 2002. We anticipate that AOL
will represent an even greater percentage of our net revenue during the
remainder of 2002 and will be a material component of our overall business. The
termination of our agreement with AOL or the failure of our agreement with AOL
to generate these anticipated revenues would have a material adverse effect on
our results of operations and financial condition.
24
OUR QUARTERLY RESULTS OF OPERATIONS ARE LIKELY TO FLUCTUATE AND, AS A RESULT,
WE MAY FAIL TO MEET THE EXPECTATIONS OF OUR INVESTORS AND SECURITIES ANALYSTS,
WHICH MAY CAUSE THE PRICE OF OUR COMMON STOCK TO DECLINE
Our quarterly revenue and results of operations are volatile and are
particularly difficult to predict. Our quarterly results of operations have
fluctuated significantly in the past and are likely to fluctuate significantly
from quarter to quarter in the future. We do not believe that period-to-period
comparisons of our results of operations are necessarily meaningful and you
should not rely upon these comparisons as indicators of our future performance.
Factors that may cause our results of operations to fluctuate include:
* the addition, loss or success of relationships with third parties that
are our source of new merchants or that license our services for use on
their own Web sites;
* the amount and timing of expenditures for expansion of our operations,
including the hiring of new employees, capital expenditures and related
costs;
* technical difficulties or failures affecting our systems or the Internet
in general;
* the cost of acquiring, and the availability of, content, including
directory information and maps; and
* the fact that our expenses are only partially based on our expectations
regarding future revenue and are largely fixed in nature, particularly in
the short term.
As a result of these or other factors, results in any future quarter may be
below the expectations of securities analysts or investors. If so, the market
price of our common stock may decline significantly.
WE DEPEND ON ALLIANCE PARTNERSHIPS WITH THIRD PARTIES TO GROW OUR BUSINESS AND
OUR BUSINESS MAY NOT GROW IF THE ALLIANCE PARTNERSHIPS UPON WHICH WE DEPEND FAIL
TO PRODUCE THE EXPECTED BENEFITS OR ARE TERMINATED
Our business depends upon our ability to maintain and benefit from our
existing alliance partnerships and to establish additional alliance
partnerships. For our business to be successful, we must expand our merchant
network and generate significant revenue from that initiative. The success of
our merchant network depends in substantial part upon our ability to access a
broad base of local merchants. The merchant base is highly fragmented. Local
merchants are difficult to contact efficiently and cost-effectively.
Consequently, we depend on relationships with merchant network partners to
provide us with local merchant contacts and to provide billing and other
administrative services relating to our merchant services. The termination of
any strategic relationship with a channel partner would significantly impair our
ability to attract potential local merchant customers and deliver our merchant
services to our current customers. Furthermore, we cannot be certain that we
will be able to develop or maintain relationships with new channel partners on
terms acceptable to us or at all.
25
In addition to our relationship with AOL and our existing relationships
with merchant aggregators, we have entered into relationships with merchant
network alliance partners and third-party content providers. These parties may
not perform their contractual obligations to us and, if they do not, we may not
be able to require them to do so. Some of our strategic relationships may be
terminated by either party on short notice.
Our strategic relationships are in early stages of development. These
relationships may not provide us benefits that outweigh the costs of the
relationships. If any strategic partner demands a greater portion of revenue or
requires us to make payments for access to its Web site, we may need to
terminate or refuse to renew that relationship, even if it had been previously
profitable or otherwise beneficial. In addition, if we lose a significant
strategic partner, we may be unable to replace that relationship with other
strategic relationships with comparable revenue potential, content or user
demographics.
OUR COMMON STOCK COULD BE DELISTED FROM THE NASDAQ NATIONAL MARKET
On August 21, 2002, we announced that we had 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. As permitted by Nasdaq rules, we have requested a hearing
before the Nasdaq Listing Qualification Panel to review the staff determination
of our non-compliance. Our request for a hearing stays the delisting process,
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 on terms acceptable to us, or at all.
OUR LIMITED OPERATING HISTORY AS A STAND-ALONE COMPANY MAKES IT DIFFICULT TO
EVALUATE OUR BUSINESS AND OUR ABILITY TO ADDRESS THE RISKS AND UNCERTAINTIES
THAT WE FACE
We have only a limited operating history on which you can evaluate our
business and prospects. Since commencing operations in 1996 and prior to our
initial public offering in 2000, we had been a subsidiary of ePresence, formerly
known as Banyan Worldwide. As of the October 2001 restructuring of our
relationship with Viacom, we are again a majority-owned subsidiary of ePresence;
however, we do not anticipate that the change in ePresence's ownership interest
in us will lead ePresence to increase its support, financial or otherwise, of
us. Consequently, we have a limited operating history as a stand-alone company
26
and limited experience in addressing various business challenges without the
support of a corporate parent. We may not successfully address the risks and
uncertainties which confront stand-alone companies, particularly companies in
new and rapidly evolving markets such as ours.
IF WE CANNOT DEMONSTRATE THE VALUE OF OUR MERCHANT SERVICES, LOCAL MERCHANT
CUSTOMERS MAY STOP USING OUR SERVICES, WHICH COULD REDUCE OUR REVENUE
We may be unable to demonstrate to our local merchant customers the value
of our merchant services. If local merchants cancel our various services, which
are generally provided on a month-to-month basis, our revenue could decline and
we may need to incur additional expenditures to obtain new local merchant
customers. We do not presently provide our local merchant customers with data
demonstrating the number of leads generated by our merchant services. Regardless
of whether our merchant services effectively produce leads, our local merchant
customers may not know the source of the leads and may cancel our merchant
services.
THE ATTRACTIVENESS OF OUR SERVICES COULD DIMINISH IF WE ARE NOT ABLE TO
LICENSE ACCURATE DATABASE INFORMATION FROM THIRD-PARTY CONTENT PROVIDERS
We principally rely upon single third-party sources to provide us with our
business and residential listings data, e-mail data, and mapping data. The loss
of any one of these sources or the inability of any of these sources to collect
their data could significantly and adversely affect our ability to provide
information to consumers. Although other sources of database information exist,
we may not be able to integrate data from these sources into our database
systems in a timely, cost-effective manner, or without an inordinate disruption
of internal engineering resources. Other sources of data may not be offered on
terms acceptable to us. Moreover, a consolidation by Internet-related businesses
could reduce the number of content providers with which we could form
relationships.
We typically license information under arrangements that require us to pay
royalties or other fees for the use of the content. In the future, some of our
content providers may demand a greater portion of advertising revenue or
increase the fees that they charge us for their content. If we fail to enter
into and maintain satisfactory arrangements with existing or substitute content
providers, we may be unable to continue to provide our services.
The success of our business depends on the quality of our services and that
quality is substantially dependent on the accuracy of data we license from third
parties. Any failure to maintain accurate data could impair the reputation of
our brand and our services, reduce the volume of users attracted to our Web
site, and diminish the attractiveness of our service offerings to our strategic
partners, advertisers and content providers.
27
ePRESENCE'S MAJORITY OWNERSHIP INTEREST IN US WILL PERMIT ePRESENCE TO CONTROL
MATTERS SUBMITTED FOR APPROVAL OF OUR STOCKHOLDERS, WHICH COULD DELAY OR PREVENT
A CHANGE IN CONTROL OR DEPRESS OUR STOCK PRICE
As of June 30, 2002, ePresence beneficially owned approximately 53.2% of
our common stock. Based upon this majority interest in us, ePresence is
generally able to control all matters submitted to our stockholders for approval
and our management and affairs, including the election and removal of directors
and any merger, consolidation or sale of all or substantially all of our assets.
Presently, three of the six members of our Board of Directors are officers or
directors of ePresence. ePresence's control over us could have the effect of
delaying or preventing a change of control of Switchboard that other
stockholders may believe would result in a more optimal return on investment. In
addition, this control could depress our stock price because purchasers will not
be able to acquire a controlling interest in us.
ePresence may elect to sell all or a substantial portion of its capital
stock to one or more third parties, in which case a third party with whom we
have no prior relationship could exercise the same degree of control over us as
ePresence presently does.
WE RELY ON A SMALL NUMBER OF CUSTOMERS, THE LOSS OF WHOM MAY SUBSTANTIALLY
REDUCE OUR REVENUE
We derive a substantial portion of our net revenue from a small number
customers. During the three and six months ended June 30, 2002, revenue derived
from our top ten customers accounted for approximately 56% and 60% of our total
net revenue, respectively. Additionally, revenue derived from AOL accounted for
27% of our total net revenue in the first six months of 2002. Consequently, our
revenue may substantially decline if we lose any of these customers. We
anticipate that our future results of operations will continue to depend to a
significant extent upon revenue from a small number of customers. In addition,
we anticipate that the identity of those customers will change over time.
28
IF WE DO NOT INTRODUCE NEW OR ENHANCED OFFERINGS TO OUR MERCHANT NETWORK
ALLIANCE PARTNERS, WE MAY BE UNABLE TO ATTRACT AND RETAIN THOSE MERCHANT NETWORK
ALLIANCE PARTNERS, WHICH WOULD SIGNIFICANTLY IMPEDE OUR ABILITY TO GENERATE
REVENUE
We need to introduce new or enhanced services to attract and retain
merchant network alliance partners, and remain competitive. Our industry has
been characterized by rapid technological change, changes in user and customer
requirements and preferences and frequent new product and service introductions
embodying new technologies. These changes could render our technology, systems
and Web site obsolete. If we do not periodically enhance our existing services,
develop new services and technologies that address sophisticated and varied
consumer needs, respond to technological advances and emerging industry
standards and practices on a timely and cost-effective basis and address
evolving customer preferences, our services may not be attractive to merchant
network alliance partners, which would significantly impede our revenue growth.
In addition, if any new product or service introduction, such as the Switchboard
Matrix system with enhanced search capabilities, is not favorably received, our
reputation and our brand could be damaged. We may also experience difficulties
that could delay or prevent us from introducing new services.
OUR BUSINESS MAY SUFFER IF WE LOSE THE SERVICES OF OUR CHIEF EXECUTIVE OFFICER
OR FOUNDER
Our future success depends to a significant extent on the continued
services and effective working relationships of our senior management and other
key personnel, including, but not limited to, Douglas Greenlaw, our Chief
Executive Officer, and Dean Polnerow, our founder and President. Our business
may suffer if we lose the services of Mr. Greenlaw, Mr. Polnerow or other key
personnel.
IF WE ARE NOT ABLE TO ATTRACT AND RETAIN HIGHLY SKILLED MANAGERIAL AND
TECHNICAL PERSONNEL WITH INTERNET EXPERIENCE, WE MAY NOT BE ABLE TO IMPLEMENT
OUR BUSINESS MODEL SUCCESSFULLY
We believe that our management must be able to act decisively to apply and
adapt our business model in the rapidly changing Internet markets in which we
compete. In addition, we rely upon our technical employees to develop and
maintain much of the technology used to provide our services. Consequently, we
believe that our success depends largely on our ability to attract and retain
highly skilled managerial and technical personnel. We may not be able to hire or
retain the necessary personnel to implement our business strategy. In addition,
we may need to pay higher compensation to employees than we currently expect.
29
THE MARKETS FOR INTERNET CONTENT, SERVICES AND ADVERTISING ARE HIGHLY
COMPETITIVE, AND OUR FAILURE TO COMPETE SUCCESSFULLY WILL LIMIT OUR ABILITY TO
INCREASE OR RETAIN OUR MARKET SHARE
Our failure to maintain and enhance our competitive position would limit
our ability to increase or maintain our market share, which would seriously harm
our business. We compete in the markets for Internet content, services and
advertising. These markets are new, rapidly evolving and highly competitive. We
expect this competition to intensify in the future. We compete, or expect to
compete, with many providers of Internet content, information services and
products, as well as with traditional media, for audience attention and
advertising and sponsorship revenue. We license much of our database content
under non-exclusive agreements with third-party providers which are in the
business of licensing their content to many businesses, including our current
and potential competitors. Many of our competitors are substantially larger than
we are and have substantially greater financial, infrastructure and personnel
resources than we have. In addition, many of our competitors have
well-established, large, and experienced sales and marketing capabilities and
greater name recognition than we have. As a result, our competitors may be in a
stronger position to respond quickly to new or emerging technologies and changes
in customer requirements. They may also develop and promote their services more
effectively than we do. Moreover, barriers to entry are not significant, and
current and new competitors may be able to launch new Web sites at a relatively
low cost. We therefore expect additional competitors to enter these markets.
Many of our current customers have established relationships with our
current and potential competitors. If our competitors develop content that is
superior to ours or that achieves greater market acceptance than ours, we may
not be able to develop alternative content in a timely, cost-effective manner,
or at all, and we may lose market share.
WE MAY NOT BE ABLE TO DEDICATE THE SUBSTANTIAL RESOURCES REQUIRED TO EXPAND,
MONITOR AND MAINTAIN OUR INTERNALLY DEVELOPED SYSTEMS WITHOUT CONTRACTING WITH
AN OUTSIDE SUPPLIER AT SUBSTANTIAL EXPENSE
We will have to expand and upgrade our technology, transaction-processing
systems and network infrastructure if the volume of traffic on our Web site or
our merchant network partners' Web sites increases substantially. We could
experience temporary capacity constraints that may cause unanticipated system
disruptions, slower response times and lower levels of customer service. We may
not be able to project accurately the rate or timing of increases, if any, in
the use of our services or expand and upgrade our systems and infrastructure to
accommodate these increases in a timely manner. Our inability to upgrade and
expand as required could impair the reputation of our brand and our services,
reduce the volume of users able to access our Web site, and diminish the
attractiveness of our service offerings to our strategic partners, advertisers
and content providers. Because we developed these systems internally, we must
either dedicate substantial internal resources to monitor, maintain and upgrade
these systems or contract with an outside supplier for these services at
substantial expense.
30
WE HAVE LIMITED EXPERIENCE ACQUIRING COMPANIES, AND ANY ACQUISITIONS WE
UNDERTAKE COULD LIMIT OUR ABILITY TO MANAGE AND MAINTAIN OUR BUSINESS, RESULT IN
ADVERSE ACCOUNTING TREATMENT AND BE DIFFICULT TO INTEGRATE INTO OUR BUSINESS
We have limited experience in acquiring businesses and have very limited
experience in acquiring complementary technologies. In May 1998, we acquired
MapsOnUs, and in November 2000, we acquired Envenue. In the future we may
undertake additional acquisitions. Acquisitions, in general, involve numerous
risks, including:
* diversion of our management's attention;
* future impairment of substantial goodwill, adversely affecting our
reported results of operations;
* inability to retain the management, key personnel and other employees of
the acquired business;
* inability to assimilate the operations, products, technologies and
information systems of the acquired business with our business; and
* inability to retain the acquired company's customers, affiliates, content
providers and advertisers.
OUR INTERNALLY DEVELOPED SOFTWARE MAY CONTAIN UNDETECTED ERRORS, WHICH COULD
LIMIT OUR ABILITY TO PROVIDE OUR SERVICES AND DIMINISH THE ATTRACTIVENESS OF OUR
SERVICE OFFERINGS
We use internally developed, custom software to provide our services. This
software may contain undetected errors, defects or bugs. Although we have not
suffered significant harm from any errors or defects to date, we may discover
significant errors or defects in the future that we may not be able to fix. Our
inability to fix any of those errors could limit our ability to provide our
services, impair the reputation of our brand and our services, reduce the volume
of users who visit our Web site and diminish the attractiveness of our service
offerings to our strategic partners, advertisers and content providers.
IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR
TECHNOLOGY AND INFORMATION MAY BE USED BY OTHERS TO COMPETE AGAINST US
We depend upon our internally developed and other proprietary technology.
If we do not effectively protect our proprietary technology, others may become
able to use it to compete against us. To protect our proprietary rights, we rely
on a combination of copyright and trademark laws, patents, trade secrets,
confidentiality agreements with employees and third parties and protective
contractual provisions. Despite our efforts to protect our proprietary rights,
unauthorized parties may misappropriate our proprietary technology or obtain and
31
use information that we regard as proprietary. We may not be able to detect
these or any other unauthorized uses of our intellectual property or take
appropriate steps to enforce our proprietary rights. In addition, others could
independently develop substantially equivalent intellectual property.
IF OUR SERVICES INFRINGE ON INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WE MAY BE
REQUIRED TO EXPEND SUBSTANTIAL RESOURCES TO REENGINEER OUR SERVICES AND TO INCUR
SUBSTANTIAL COSTS AND DAMAGES RELATED TO INFRINGEMENT CLAIMS
We are subject to the risk of claims alleging infringement of third-party
proprietary rights. If we are subject to claims of infringement of, or are
infringing on, the rights of third parties, we may not be able to obtain
licenses to use those rights on commercially reasonable terms. In that event, we
may need to undertake substantial reengineering to continue our service
offerings. Any effort to undertake such reengineering might not be successful.
In addition, any claim of infringement could cause us to incur substantial costs
defending against the claim, even if the claim is invalid, and could distract
our management. Furthermore, a party making such a claim could secure a judgment
that requires us to pay substantial damages. A judgment could also include an
injunction or other court order that could prevent us from providing our
services.
WE MAY EXPERIENCE DIFFICULTY ESTABLISHING THE SWITCHBOARD BRAND WITHOUT THE
ABILITY TO USE VIACOM'S CBS TRADEMARKS
We used CBS trademarks in association with our own trademarks in our
brand-building efforts beginning in June 1999. Our use of those CBS trademarks
may have been a significant contributing factor in establishing our brand. Our
license to use the CBS trademarks terminated on January 26, 2002. Our efforts to
maintain and further develop our brand may not be as effective since our
trademarks are no longer associated with the CBS trademarks. Any harm to these
efforts could have a material adverse effect on our business.
TERMINATION OF OUR AGREEMENTS WITH VIACOM MAY NEGATIVELY AFFECT OUR
ADVERTISING INITIATIVES
Upon the termination of the advertising and promotion agreement pursuant to
the terms of our restructuring agreement with Viacom, our advertising rights
under our former advertising and promotion agreement with Viacom have
terminated, including our right to order from Viacom advertising and promotion
through June 2006 with an estimated net present value of $44.5 million.
Therefore, we will no longer benefit from the large advertising resources
previously available to us from Viacom at no cash cost, and will have to expend
other resources to obtain advertising. We have limited experience in obtaining
advertising outside the scope of our advertising and promotion agreement with
Viacom. Advertising from third parties may be more costly, difficult to obtain
or less effective than we anticipate.
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RISKS RELATED TO THE INTERNET
IF THE ACCEPTANCE AND EFFECTIVENESS OF INTERNET ADVERTISING DOES NOT BECOME
FULLY ESTABLISHED, THE GROWTH OF OUR YELLOW PAGES, BANNER AND SITE SPONSORSHIP
ADVERTISING REVENUE WILL SUFFER
Our business model is heavily dependent upon increasing our sales of yellow
pages advertising to local merchants. If use of Internet yellow pages by
consumers does not increase, Internet yellow pages advertising will not become
more attractive to merchants and our yellow pages advertising revenue growth
will suffer.
Similarly, if Internet banner and site sponsorship advertising fails to
gain wide acceptance and to grow from year to year, our banner and site
sponsorship revenue will be affected. Even though we anticipate that revenue
from banner and site sponsorship advertisements will decline as a percentage of
our future revenue, our future success still depends, in part, on an increase in
the use of the Internet as an advertising medium. We generated 33.1% and 57.2%
of our net revenue from the sale of banner and site sponsorship advertisements
during the years ended December 31, 2001 and 2000, and 14.7% and 12.1% of our
net revenue in the three and six months ended June 30, 2002 , respectively. The
Internet advertising market is new and rapidly evolving, and cannot yet be
compared with traditional advertising media to gauge its effectiveness. As a
result, demand for and market acceptance of Internet advertising is uncertain.
Many of our current and potential local merchant customers have little or no
experience with Internet advertising and have allocated only a limited portion
of their advertising and marketing budgets to Internet activities. The adoption
of Internet advertising, particularly by entities that have historically relied
upon traditional methods of advertising and marketing, requires the acceptance
of a new way of advertising and marketing.
These customers may find Internet advertising to be less effective for
meeting their business needs than traditional methods of advertising and
marketing. In addition, there are some software programs that limit or prevent
advertising from being delivered to a user's computer. Widespread adoption of
this software could significantly undermine the commercial viability of Internet
advertising. If the market for Internet advertising fails to develop or develops
more slowly than we expect, our advertising revenue will suffer.
There are currently no generally accepted standards for the measurement of
the effectiveness of Internet advertising. Standard measurements may need to be
developed to support and promote Internet advertising as a significant
advertising medium. Our advertising customers may challenge or refuse to accept
either our or third-party measurements of advertisement delivery.
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IF WE ARE SUED FOR CONTENT DISTRIBUTED THROUGH, OR LINKED TO BY, OUR WEB SITE,
WE MAY BE REQUIRED TO SPEND SUBSTANTIAL RESOURCES TO DEFEND OURSELVES AND COULD
BE REQUIRED TO PAY MONETARY DAMAGES
We aggregate and distribute third-party data over the Internet. In
addition, third-party Web sites are accessible through our Web site. As a
result, we could be subject to legal claims for defamation, negligence,
intellectual property infringement and product or service liability. Other
claims may be based on errors or false or misleading information provided on our
Web site. Other claims may be based on links to sexually explicit Web sites and
sexually explicit advertisements. We may need to expend substantial resources to
investigate and defend these claims, regardless of whether we successfully
defend against them. While we carry general business insurance, the amount of
coverage we maintain may not be adequate. In addition, implementing measures to
reduce our exposure to this liability may require us to spend substantial
resources and limit the attractiveness of our content to users.
WE MAY NEED TO EXPEND SIGNIFICANT RESOURCES TO PROTECT AGAINST ONLINE SECURITY
RISKS THAT COULD RESULT IN MISAPPROPRIATION OF OUR PROPRIETARY INFORMATION OR
CAUSE INTERRUPTION IN OUR OPERATIONS
Our networks may be vulnerable to unauthorized access, computer viruses and
other disruptive problems. Someone who is able to circumvent security measures
could misappropriate our proprietary information or cause interruptions in our
operations. Internet and online service providers have experienced, and may in
the future experience, interruptions in service as a result of the accidental or
intentional actions of Internet users, current and former employees or others.
We may need to expend significant resources protecting against the threat of
security breaches or alleviating problems caused by breaches. Eliminating
computer viruses and alleviating other security problems may require
interruptions, delays or cessation of service.
WE MAY BE SUED FOR DISCLOSING TO THIRD PARTIES PERSONAL IDENTIFYING
INFORMATION WITHOUT CONSENT
Individuals whose names, addresses and telephone numbers appear in our
yellow pages and white pages directories have occasionally contacted us because
their phone numbers and addresses were unlisted with the telephone company.
While we have not received any formal legal claims from these individuals, we
may receive claims in the future for which we may be liable. In addition, if we
begin disclosing to third parties personal identifying information about our
users without consent or in violation of our privacy policy, we may face
potential liability for invasion of privacy.
34
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATION AND LEGAL
UNCERTAINTIES, WHICH COULD LIMIT OUR GROWTH
Laws and regulations directly applicable to Internet communications,
commerce and advertising are becoming more prevalent. Laws and regulations may
be adopted covering issues such as user privacy, pricing, content, taxation and
quality of products and services. Any new legislation could hinder the growth in
use of the Internet and other online services generally and decrease the
acceptance of the Internet and other online services as media of communications,
commerce and advertising. Various U.S. and foreign governments might attempt to
regulate our transmissions or levy sales or other taxes relating to our
activities. The laws governing the Internet remain largely unsettled, even in
areas where legislation has been enacted. It may take years to determine whether
and how existing laws such as those governing intellectual property, privacy,
libel and taxation apply to the Internet and Internet advertising and directory
services. In addition, the growth and development of the market for electronic
commerce may prompt calls for more stringent consumer protection laws, both in
the United States and abroad, that may impose additional burdens on companies
conducting business over the Internet.
IF WE CANNOT PROTECT OUR DOMAIN NAMES, OUR ABILITY TO SUCCESSFULLY BRAND
SWITCHBOARD WILL BE IMPAIRED
We currently hold various Web domain names, including Switchboard.com and
MapsOnUs.com. The acquisition and maintenance of domain names generally is
regulated by Internet regulatory bodies. The regulation of domain names in the
United States and in foreign countries is subject to change. Governing bodies
may establish additional top-level domains, appoint additional domain name
registrars or modify the requirements for holding domain names. As a result, we
may be unable to acquire or maintain relevant domain names in all countries in
which we conduct business. This problem may be exacerbated by the length of time
required to expand into any other country and the corresponding opportunity for
others to acquire rights in relevant domain names. Furthermore, it is unclear
whether laws protecting trademarks and similar proprietary rights will be
extended to protect domain names. Therefore, we may be unable to prevent third
parties from acquiring domain names that are similar to, infringe upon or
otherwise decrease the value of our trademarks and other proprietary rights. We
may not be able to successfully carry out our business strategy of establishing
a strong brand for Switchboard if we cannot prevent others from using similar
domain names or trademarks.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to financial market risks, including changes in interest
rates. We typically do not attempt to reduce or eliminate our market exposures
on our investment securities because the majority of our investments have
maturities within two years. We do not have any derivative instruments.
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.
ITEM 4. CONTROLS AND PROCEDURES
Not applicable.
PART II -- OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
On May 31, 2002 we were sued in the Superior Court of Suffolk County,
Massachusetts by the former stockholders of Envenue, Inc., from whom we
purchased all of the stock of Envenue in November 2000. The suit, styled
Douglass J. Wilson et al v. Switchboard Incorporated et al, Civil Action No.
02-2370 BLS, alleges that we breached our agreement with the plaintiffs by
failing to pay the purchase price of the Envenue stock when it became due on May
24, 2002. The complaint also alleges intentional interference with a contract,
and asserts a claim for treble damages (i.e., the contract price of $2,000,000
multiplied by three) under Massachusetts General Laws chapter 93A. We believe
that we had a contractual right to withhold the payment in dispute, and
accordingly believe the plaintiffs' suit is without merit. Accordingly, we filed
a motion to dismiss the suit on July 2, 2002. While it is too early to predict
the outcome of the suit, we intend to mount a vigorous defense.
On November 21, 2001, a class action lawsuit was filed in the United States
District Court for the Southern District of New York naming as defendants
Switchboard, the managing underwriters of Switchboard's initial public offering,
Douglas J. Greenlaw, Dean Polnerow, and John P. Jewett. Mr. Greenlaw and Mr.
Polnerow are officers of Switchboard, and Mr. Jewett is a former officer of
Switchboard. The complaint is captioned Kristina Ly v. Switchboard Incorporated,
et al., 01-CV-10595. The complaint alleges that the registration statement and
final prospectus relating to Switchboard's initial public offering contained
material misrepresentations and/or omissions related, in part, to excessive and
undisclosed commissions allegedly received by the underwriters from investors to
36
whom the underwriters allegedly allocated shares of the initial public offering.
The complaint seeks an unspecified amount of damages. An Amended Class Action
Complaint was filed on April 20, 2002 ("Amended Complaint"). The Amended
Complaint, captioned In re Switchboard, Inc. Initial Public Offering Securities
Litigation, alleges violations of the federal securities laws in connection with
the Company's initial public offering conducted on or about March 2, 2000, and
the trading of the Company's common stock in the aftermarket from the date of
the initial public offering through December 6, 2000. This class action lawsuit
is similar to over 300 others filed recently against companies that went public
between 1998 to 2000. Switchboard believes the claims against it and its
officers, former officers and directors are without merit and intends to defend
them vigorously.
From time to time, we are involved in various legal proceedings incidental
to the conduct of our business.
ITEM 2. -- CHANGES IN SECURITIES AND USE OF PROCEEDS
(a.) Not applicable.
(b.) Not applicable.
(c.) Not applicable.
(d.) On March 2, 2000, we made an initial public offering of up to 6,325,000
shares of common stock registered under a Registration Statement on Form S-1
(Registration No. 333-90013), which was declared effective by the Securities and
Exchange Commission on March 1, 2000.
Our total net proceeds from the offering were approximately $86.3 million,
of which $74.8 million was received in March 2000 and $11.5 million was received
in April 2000. All payments of the offering proceeds were to persons other than
directors, officers, general partners of Switchboard or their associates,
persons owning 10% or more of any class of equity securities of Switchboard or
affiliates of Switchboard. Through June 30, 2002, we used approximately $20.7
million of the proceeds from the offering for working capital purposes, of which
approximately $4.5 million was for the purchase of fixed assets. In December
2000 we paid $13.0 million of the proceeds to America Online, Inc. pursuant to
the terms of our Directory and Local Advertising Platform Services Agreement
entered into with America Online on that date. In April 2002, we paid America
Online $2.0 million upon the execution of the Second Amendment to the Directory
and Local Advertising Platform Services Agreement. In addition, in March 2002,
we used $1.3 million of the proceeds for the purchase of 386,302 shares of our
common stock from Viacom Inc. as treasury stock. As of June 30, 2002, we have
invested the remaining net proceeds in interest-bearing, investment-grade
securities.
37
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 16, 2002, the Company held its 2002 Annual Meeting of Stockholders.
At the meeting, the votes cast for each matter presented to the Company's
stockholders were as follows:
1. Election of two Class II directors to serve for the ensuing three years and
until their respective successors are elected and qualified.
For Withheld
---------- --------
(i) Richard M. Spaulding 15,142,808 301,341
(ii) David N. Strohm 15,356,326 87,823
ITEM 6. -- EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
The Exhibits filed as part of this Quarterly Report on Form 10-Q are listed
on the Exhibit Index immediately preceding such Exhibits, which Exhibit Index is
incorporated herein by reference. Documents listed on such Exhibit Index, except
for documents identified by footnotes, are being filed as exhibits herewith.
Documents identified by footnotes are not being filed herewith and, pursuant to
Rule 12b-32 under the Securities Exchange Act of 1934, reference is made to such
documents as previously filed as exhibits filed with the Securities and Exchange
Commission. Switchboard's file number under the Securities Exchange Act of 1934
is 000-28871.
b. Reports on Form 8-K.
On July 3, 2002, Switchboard filed a Current Report on Form 8-K dated June
28, 2002, as amended on July 8, 2002, reporting under Item 4 (Changes in
Registrant's Certifying Accountants) that on June 28, 2002 Switchboard had
dismissed Arthur Andersen LLP and had engaged Ernst & Young LLP, as its
independent accountants.
On August 22, 2002, Switchboard filed a Current Report on Form 8-K dated
August 21, 2002, reporting under Item 5 (Other Events) that it had issued a
press release announcing that it had received a determination letter from Nasdaq
notifying it that it is not in compliance with Nasdaq's continuing listing
requirements.
On August 22, 2002, Switchboard filed a Current Report on Form 8-K dated
August 21, 2002, reporting under Item 5 (Other Events) that it had entered into
a Third Amendment to the Directory and Local Advertising Platform Services
Agreement between it and America Online, Inc. dated December 11, 2000.
38
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SWITCHBOARD INCORPORATED
Date: September 20, 2002 By: /s/ Robert P. Orlando
---------------------
Robert P. Orlando
Vice President and Chief
Financial Officer
(principal financial officer and
principal accounting officer)
39
CERTIFICATIONS
I, Douglas J. Greenlaw, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Switchboard
Incorporated;
2. Based on my knowledge, this Quarterly Report on Form 10-Q 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 on Form
10-Q; and
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report on Form 10-Q, fairly
present in all material respects the financial condition, results of
operations and cash flows of Switchboard Incorporated as of, and for,
the periods presented in this Quarterly Report on Form 10-Q.
Date: September 20, 2002 /s/Douglas J. Greenlaw
----------------------
Douglas J. Greenlaw
Chief Executive Officer
(principal executive officer)
I, Robert P. Orlando, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Switchboard
Incorporated;
2. Based on my knowledge, this Quarterly Report on Form 10-Q 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 on Form
10-Q; and
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report on Form 10-Q, fairly
present in all material respects the financial condition, results of
operations and cash flows of Switchboard Incorporated as of, and for,
the periods presented in this Quarterly Report on Form 10-Q.
Date: September 20, 2002 /s/Robert P. Orlando
----------------------------
Robert P. Orlando
Vice President and Chief Financial
Officer (principal financial
officer)
40
EXHIBIT INDEX
Exhibit No. Description
10.1 Loan and Security Agreement between Silicon Valley Bank and
Switchboard Incorporated dated May 31, 2002.
10.2 Negative Pledge Agreement between Silicon Valley Bank and
Switchboard Incorporated dated May 31, 2002.
10.3 Security Agreement between Silicon Valley Bank and Switchboard
Securities Corporation dated May 31, 2002.
10.4 Unconditional Guarantee between Silicon Valley Bank and
Switchboard Securities Corporation dated May 31, 2002.
10.5+ Third Amendment dated August 21, 2002 to Directory and Local
Advertising Platform Services Agreement between America Online,
Inc. and Switchboard Incorporated dated December 11, 2000.
+ Confidential treatment requested as to certain portions, which
portions are omitted and filed separately with the Securities
and Exchange Commission pursuant to a Confidential Treatment
Request.
41