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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, 2003
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 (I.R.S. Employer
of Incorporation or Organization) Identification No.)
120 Flanders Road, Westboro, MA 01581
(Address of Principal Executive Offices) (Zip Code)
(508) 898-8000
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
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 July 31, 2003
- --------------------------------------- --------------------------------------
Common Stock, par value $0.01 per share 18,902,935
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 are forward-looking statements,
including those regarding our strategy, future operations, financial position,
estimated revenues, projected costs, prospects, plans and objectives of
management. 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 us in this Quarterly Report on Form
10-Q represent our estimates as of the date this report is filed with the
Securities and Exchange Commission (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 ADDRESS
Our Web site address is www.switchboard.com. References in this report 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 herein and should not be considered to be a part of this document. We
make available through our Web site, free of charge our annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports, filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably
practicable after such reports are electronically filed with, or furnished to,
the SEC. These reports may be accessed through the Web site's investor
information page.
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, 2003 (unaudited) and
December 31, 2002 (audited).............................................. 3
Consolidated Statements of Operations (unaudited) for the Three and Six
Months Ended June 30, 2003 and 2002...................................... 4
Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended
June 30, 2003 and 2002................................................... 5
Notes to Consolidated Financial Statements................................... 6
Item 2. -- Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 11
Item 3. -- Quantitative and Qualitative Disclosures About Market Risk........ 29
Item 4. -- Controls and Procedures........................................... 29
PART II -- Other Information
Item 1. -- Legal Proceedings................................................. 29
Item 2. -- Changes in Securities and Use of Proceeds......................... 30
Item 4. -- Submission of Matters to a Vote of Security Holders............... 31
Item 6. -- Exhibits and Reports on Form 8-K.................................. 31
Signatures................................................................... 32
2
PART I -- FINANCIAL INFORMATION
ITEM 1. - FINANCIAL STATEMENTS
SWITCHBOARD INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
June 30, 2003 December 31, 2002
------------- -----------------
(unaudited)
Assets:
Cash and cash equivalents $ 39,334 $ 38,390
Short-term marketable securities 6,645 3,589
Restricted cash 36 1,640
Accounts receivable, net of allowance of $252 and $350, respectively 2,125 1,558
Unbilled receivables 133 160
Other current assets 850 330
--------- ---------
Total current assets 49,123 45,667
Long-term marketable securities 4,308 10,244
Property and equipment, net 1,297 1,877
--------- ---------
Total assets $ 54,728 $ 57,788
========= =========
Liabilities:
Accounts payable $ 973 $ 966
Accrued expenses 1,464 1,437
Deferred revenue 533 475
Payable related to acquisition - 1,600
Note payable, current portion - 1,099
--------- ---------
Total current liabilities 2,970 5,577
Note payable, net of current portion - 1,124
--------- ---------
Total liabilities 2,970 6,701
Stockholders' equity:
Preferred Stock, $0.01 par value per share; 5,000,000 shares authorized and
undesignated, none issued and outstanding - -
Common stock, $0.01 par value per share; authorized 85,000,000 shares.
Issued 19,280,229 and 19,227,230 shares as of June 30, 2003 and
December 31, 2002, respectively. 193 192
Treasury stock, 386,302 shares at cost (1,255) (1,255)
Additional paid-in capital 162,527 162,437
Note and interest receivable for issuance of restricted common stock (1,557) (1,520)
Unearned compensation (105) (178)
Accumulated other comprehensive income 117 156
Accumulated deficit (108,162) (108,745)
--------- ---------
Total stockholders' equity 51,758 51,087
--------- ---------
Total liabilities and stockholders' equity $ 54,728 $ 57,788
========= =========
See accompanying notes.
3
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in thousands, except per share amounts)
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
------ ------- ------ -------
Revenue $3,974 $ 3,014 $7,315 $ 7,037
Consideration given to a customer - (946) - (2,049)
------ ------- ------ -------
Net revenue 3,974 2,068 7,315 4,988
Cost of revenue 814 1,112 1,521 2,030
------ ------- ------ -------
Gross profit 3,160 956 5,794 2,958
------ ------- ------ -------
Operating expenses:
Sales and marketing 685 1,145 1,527 2,572
Research and development 1,121 1,317 2,235 2,822
General and administrative 1,022 723 1,826 1,430
Revision of restructuring estimate (35) - (35) -
------ ------- ------ -------
Total operating expenses 2,793 3,185 5,553 6,824
------ ------- ------ -------
Income (loss) from operations 367 (2,229) 241 (3,866)
Other income (expense):
Interest income 207 581 435 1,237
Interest expense (32) (12) (74) (29)
Realized gain (loss) on sale of investments (1) 371 (1) 371
Other expense (2) (66) (6) (110)
------ ------- ------ -------
Total other income 172 874 354 1,469
------ ------- ------ -------
Income (loss) before income taxes 539 (1,355) 595 (2,397)
Provision for income taxes 12 - 12 -
------ ------- ------ -------
Net income (loss) $ 527 $(1,355) $ 583 $(2,397)
====== ======= ====== =======
Net income (loss) per share:
Basic $0.03 $(0.07) $0.03 $(0.13)
===== ====== ===== ======
Diluted $0.03 $(0.07) $0.03 $(0.13)
===== ====== ===== ======
Weighted average number of common shares:
Basic 18,658 18,499 18,643 18,497
Diluted 19,296 18,499 19,191 18,497
See accompanying notes.
4
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Six Months Ended June,
----------------------
2003 2002
------- -------
Cash flows from operating activities:
Net income (loss) $ 583 $(2,397)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 644 1,140
Amortization of unearned compensation 73 83
Non-cash interest income on note receivable (37) (35)
Gain on sales of marketable securities - (402)
Consideration given to a customer - 2,049
Changes in operating assets and liabilities:
Accounts receivable (566) 58
Unbilled receivables 27 493
Other current assets (519) (126)
Other assets - 71
Accounts payable 7 (1,357)
Accrued expenses 128 (2,011)
Payment on AOL Directory Agreement - (2,000)
Deferred revenue 58 (254)
------- -------
Net cash provided by (used in) operating activities 398 (4,688)
------- -------
Cash flows from investing activities:
Purchases of property and equipment (65) (803)
Decrease (increase) in restricted cash 1,602 (1,162)
Purchase of marketable securities (165) (7,693)
Proceeds from sales of marketable securities 3,006 44,547
------- -------
Net cash provided by investing activities 4,378 34,889
------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 91 283
Purchase of treasury stock - (1,255)
Proceeds from issuance of note payable - 2,498
Settlement of Envenue litigation (1,700) -
Payments on notes payable (2,223) (875)
------- -------
Net cash (used in) provided by financing activities (3,832) 651
------- -------
Net increase in cash and cash equivalents 944 30,852
Cash and cash equivalents at beginning of period 38,390 4,212
------- -------
Cash and cash equivalents at end of period $39,334 $35,064
======= =======
Supplemental statement of non-cash investing and financing activity:
Note receivable from officer for issuance of common stock - $1,449
Asset and liability related to Directory Agreement - $12,000
Unrealized loss on investments 39 869
See accompanying notes.
5
SWITCHBOARD INCORPORATED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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. ("ePresence"). As of June 30, 2003, ePresence beneficially owned
approximately 51.9% of the Company's common stock. The Company is a provider of
directory technology and Internet-based yellow pages. The Company provides
highly-targeted, online advertising solutions to national retailers and brick
and mortar merchants on its Web site, Switchboard.com. The Company provides
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 their 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, location based searching and interactive maps
and driving directions. The Company offers its users local information about
people and businesses across the United States. 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 and, as of June 30,
2003, had an accumulated deficit of $108.2 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
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, 2003 are not
necessarily indicative of future financial results.
Investors should read these interim consolidated financial statements in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2002, as filed with the Securities and Exchange Commission on March
28, 2003.
6
3. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the
intrinsic value method as prescribed by Accounting Principles Board ("APB") No.
25, "Accounting for Stock Issued to Employees," ("APB 25") and related
interpretations. Accordingly, no compensation expense is recorded for options
issued to employees in fixed amounts and with fixed exercise prices at least
equal to the fair market value of the Company's common stock at the date of
grant. The Company has adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," ("SFAS 123") through disclosure only. All stock-based awards to
non-employees are accounted for at their fair value in accordance with SFAS 123.
In January 2003, Financial Accounting Standards Board ("FASB") issued SFAS
No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure, an
amendment of FASB Statement No. 123" ("SFAS 148"), which provides alternative
methods of transition for a voluntary change to a fair value based method of
accounting for stock-based employee compensation. The Company has determined
that it will continue to account for stock-based compensation for employees
under APB 25, and elect the disclosure-only alternative under SFAS 123 and
provide the enhanced disclosures as required by SFAS 148.
At June 30, 2003, the Company had three stock-based employee compensation
plans. The Company accounts for those plans under the recognition and
measurement principles of APB 25 and related interpretations. The table below
illustrates the effect on the net loss if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation (in
thousands, except per share data). Because options vest over several years and
additional option grants are expected to be made in future periods, the
pro-forma effects detailed below are not necessarily indicative of the pro-forma
effects on future years.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
----- ------- ------- -------
Net income (loss) as reported $527 $(1,355) $583 $(2,397)
Add: Stock-based employee compensation
expense included in reported net loss, net
of related tax effects 36 36 73 83
Add: Adjustment for previously amortized
expense associated with the unvested
portion of options canceled in the period - 186 60 2,438
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects (425) (952) (1,000) (2,134)
----- ------- ------- -------
Pro-forma net income (loss) $ 138 $(2,085) $ (284) $(2,010)
===== ======= ======= =======
Pro-forma net income (loss) per share
Basic $0.01 $(0.11) $(0.02) $(0.11)
===== ====== ====== ======
Diluted $0.01 $(0.11) $(0.02) $(0.11)
===== ====== ====== ======
Shares used in computing pro-forma net
income (loss) per share
Basic 18,658 18,499 18,643 18,497
Diluted 19,296 18,499 18,643 18,497
7
4. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed using the weighted average
number of shares of common stock outstanding less any restricted shares. Diluted
income (loss) per share includes the dilutive effect of potential common shares
outstanding during the period. Potential common shares result from the assumed
exercise of outstanding stock options and warrants, the proceeds of which are
then assumed to have been used to repurchase outstanding common stock using the
treasury stock method. Potential common shares also include the unvested portion
of restricted stock.
For the three and six months ended June 30, 2003, options to purchase
1,958,890 and 2,441,190 shares of common stock, and 225,000 and no shares of
restricted stock were excluded from the calculation of diluted earnings per
share, respectively, as their inclusion would be antidilutive. This is due to
the fact that the exercise price of these options and the purchase price of
these restricted shares is in excess of the average price of the Company's
common stock of $3.38 and $3.03 per share for the three and six months ended
June 30, 2003. For the three and six months ended of June 30, 2002, options to
purchase 3,668,247 shares of common stock, warrants to purchase 918,468 shares
of common stock, and 300,000 shares of restricted stock, were not included in
the computation of diluted net loss per share since their inclusion would be
antidilutive.
5. COMPREHENSIVE LOSS
Other comprehensive loss includes unrealized gains or losses on the
Company's available-for-sale investments (in thousands).
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ------- ---- -------
Net income (loss) $527 $(1,355) $583 $(2,397)
Other comprehensive (loss):
Unrealized loss on investment (23) (422) (39) (869)
---- ------- ---- -------
Comprehensive income (loss) $504 $(1,777) $544 $(3,266)
==== ======= ==== =======
6. NOTES PAYABLE AND LINE OF CREDIT
In June 2002, the Company entered into a loan and security agreement (the
"SVB Financing Agreement") with Silicon Valley Bank ("SVB"), under which the
Company was able to borrow up to $4.0 million for the purchase of equipment.
Amounts borrowed under the facility accrued interest at a rate equal to prime
plus 0.25%, and were to have been repaid monthly over a 30-month period. The
Company had utilized $2.7 million of this facility through borrowings that
occurred in June 2002 and September 2002. The Company has recorded a note
payable to SVB on its balance sheet totaling $2.2 million for the equipment
financed as of December 31, 2002, of which $1.1 million is classified as a
current liability. The SVB Financing Agreement also provided for a $1.0 million
revolving line of credit at an interest rate equal to prime. The Company did not
borrow any amounts under the revolving line of credit. The Company's ability to
borrow additional amounts under the SVB Financing Agreement expired on May 30,
2003. In May 2003, the Company paid SVB $1.8 million in satisfaction of its
outstanding borrowings under the loan facility. The amount paid represented the
Company's outstanding principal and interest under the note at the time of the
repayment.
8
7. PAYABLE RELATED TO ACQUISITION
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
classified as a payable related to acquisition within current liabilities. The
Company did not pay the $2.0 million on or before May 24, 2002, as it was
involved in a contractual dispute with the previous owners of Envenue. In June
2002, the Company placed $2.0 million into an escrow account, which was to be
held until the resolution of this dispute. In October 2002, the Company paid
$410,000 out of the escrowed funds, representing the undisputed portion of the
purchase price plus interest from the original maturity date to the former
stockholders of Envenue. The remaining $1.6 million of the purchase price was
classified separately in the accompanying financial statements as of December
31, 2002. The Company recorded $1.6 million as restricted cash at December 31,
2002 related to the cash held in escrow. In June 2003, the Company paid the
former owners of Envenue $1.7 million to settle all claims related to the
acquisition of Envenue. As a result, the Company no longer has funds in escrow
related to the matter.
8. AMERICA ONLINE, INC.
Amortization of AOL assets totaled $946,000 and $2.0 million in the three
and six months ended June 30, 2002, respectively. There was no amortization of
AOL assets in the three and six months ended June 30, 2003. Throughout the
remaining initial term of the amended agreement, the Company will no longer
record amortization of consideration given to AOL as these assets are now fully
amortized and no further consideration is due AOL. Amortization of assets
related to AOL has been reflected as a reduction of revenue in accordance with
Emerging Issues Task Force ("EITF") 01-9.
Net revenue recognized from AOL was $1.8 million, or 45.6% of net revenue,
and $3.4 million, or 47.0% of net revenue, for the three and six months ended
June 30, 2003, respectively. Net revenue recognized from AOL, including
amortization of consideration given to AOL, was $424,000, or 20.5% of net
revenue, and $1.3 million, or 27.0% of net revenue, for the three and six months
ended June 30, 2002, respectively. Net amounts due from AOL included in accounts
receivable at June 30, 2003 and December 31, 2002 were $1.1 million and
$549,000, respectively. As of June 30, 2003, AOL beneficially owned 7.9% of the
Company's outstanding common stock.
9. NOTE RECEIVABLE FOR THE ISSUANCE OF RESTRICTED COMMON STOCK
In January 2002, the Company recorded a note receivable from its Chief
Executive Officer, Mr. Greenlaw, who is also a member of its Board of Directors,
for approximately $1.4 million arising from the financing of a purchase of
450,000 shares of its common stock as restricted stock by that individual. As of
June 30, 2003, 225,000 of such shares were unvested and restricted from
transfer. On each of January 4, 2004, 2005 and 2006, 75,000 of these restricted
shares vest, respectively. The note bears interest at a rate of 4.875%, which
was deemed to be fair market value at the time of the issuance of the note,
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
shares by the issuer of the note, 90 days from the date Mr. Greenlaw ceases to
be affiliated with the Company or January 4, 2008. At June 30, 2003, the Company
has recorded $1.6 million in principal and interest as a note receivable
classified within stockholders' equity. During the three and six months ended
June 30, 2003, the Company recorded $19,000 and $37,000 in interest income
resulting from this note receivable, respectively. During the three and six
months ended June 30, 2002, the Company recorded $18,000 and $35,000 in interest
income resulting from this note receivable, respectively.
9
10. RELATED PARTIES
ePresence provided the Company with telephone service and support under
corporate services agreements during the three and six month periods ended June
30, 2003 and 2002. Under the current corporate services agreement, which expires
on December 31, 2003, the Company pays ePresence an amount of $75,000 per year
for these services. The Company recorded $19,000 and $38,000 in expense and paid
ePresence $19,000 and $38,000 under the agreements in the three and six months
ended June 30, 2003, respectively. The Company recorded $19,000 and $38,000 in
expense and paid ePresence $94,000 and $94,000 under the agreements in the three
and six months ended June 30, 2002, respectively. The Company had $6,000 and
$6,000 accrued under the agreements as of June 30, 2003 and December 31, 2002,
respectively.
The Company leased the space it occupied in 2002 from ePresence under a
sublease entered into in January 2001, which expired on December 31, 2002. The
Company leases the space it currently occupies from ePresence under a sublease
that expires on December 31, 2003. Under the current sublease agreement, the
Company pays an annual rent of $227,000. Under the lease agreements, the Company
recorded rent expense of $57,000 and $114,000 and paid ePresence $57,000 and
$138,000 in the three and six months ended June 30, 2003, respectively. Under
the lease agreements, the Company recorded rent expense and paid $129,000 and
$259,000 to ePresence in the three and six months ended June 30, 2002,
respectively. The Company had $19,000 and $43,000 accrued under the lease
agreements as of June 30, 2003 and December 31, 2002, respectively. The Company
believes that the amounts paid to ePresence under its services agreements and
leases with ePresence are competitive with amounts the Company would have paid
to outside third parties for the same or similar services and leased space.
Certain directors of the Company hold positions as officers or directors of
ePresence. The Chairman of the Board of Directors of the Company is also
Chairman of the Board of Directors, President and Chief Executive Officer of
ePresence. One director of the Company is Senior Vice President and Chief
Financial Officer of ePresence. Another director of the Company is also a
director of ePresence. In the three and six months ended June 30, 2003 and 2002,
no compensation was paid to these directors by the Company for their services
other than option grants under the Company's equity incentive plans in the six
months ended June 30, 2002.
11. REVISION OF RESTRUCTURING ESTIMATE
In the three months ended June 30, 2003, the Company recorded the reversal
of $35,000 in excess restructuring reserves. The reversal resulted primarily
from a change in estimate with respect to a compensation amount for a terminated
employee that had been provided for as part of the Company's 2001 special
charges. As of June 30, 2003, the Company had a remaining liability of $14,000
for the 2001 special charges related primarily to its remaining net lease
obligations for a closed facility.
12. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS No.
150"). SFAS No. 150 affects the issuer's accounting for three types of
freestanding financial instruments. SFAS No. 150 also requires disclosures about
alternative ways of settling the instruments and the capital structure of
entities, all of whose shares are mandatorily redeemable. This statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatorily redeemable financial
instruments of nonpublic entities, for which it is effective for the first
fiscal period beginning after December 31, 2003. It is to be implemented by
reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance date of the statement and
still existing at the beginning of the interim period of adoption. Restatement
10
is not permitted. The Company does not expect the adoption of SFAS No. 150 to
have a material impact on its consolidated results of operations, financial
position and cash flows.
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. 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 20, as well as those
otherwise discussed in this section and elsewhere in this quarterly report. See
"Forward-Looking Statements."
Overview
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.
Net merchant network revenue includes revenue from various licensing
agreements with our merchant network alliance partners. These agreements
involve, generally, (1) engineering work to develop a Web-hosted platform for
our merchant network alliance partners which looks and feels like the merchant
network alliance partner's own Web site and includes our searching functionality
and (2) a per-merchant fee per month (in the form of a fixed fee per merchant or
a percentage of revenue) based upon the number of merchants our alliance partner
promotes 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, and build and host Web sites for local merchants. In
addition, included as an offset to merchant network revenue is consideration
given to customers, if any, for which the benefits of such consideration are not
separately identifiable from the revenue obtained from those customers. During
both the three and six months ended June 30, 2003, approximately 88.5% of our
net revenue was derived from our local merchant network as compared to 85.3% and
87.9% in the three and six months ended June 30, 2002.
Our largest and most significant merchant network alliance partner is
America Online, Inc. Under our amended agreement with AOL, which expires in
December 2004, we paid AOL $13.0 million in December 2000 and $2.0 million in
April 2002, issued 746,260 shares of our common stock and share directory
advertisement revenue with AOL. We account for consideration given to AOL as an
offset to revenue. In addition, if requested by AOL, we are required to provide
up to 300 hours of engineering services per month to AOL at no charge, for the
term of the agreement. Any engineering services provided by us in excess of 300
hours per month are charged to AOL on a time and materials basis. In the three
and six months ended June 30, 2003, AOL consulting and service fees totaled
$641,000 and $1.3 million, respectively. In the three and six months ended June
30, 2002, AOL consulting and service fees totaled $491,000 and $547,000,
respectively. Revenue recognized from AOL, including consulting and service
fees, was $1.8 million, or 45.6% of net revenue, and $3.4 million, or 47.0% of
net revenue, for the three and six months ended June 30, 2003, respectively.
Revenue recognized from AOL, net of amortization of consideration given to AOL
and including consulting and services fees, was $424,000, or 20.5% of net
revenue, and $1.3 million, or 27.0% of net revenue, for the three and six months
ended June 30, 2002, respectively. We anticipate that AOL will continue to
represent a significant percentage of our revenue throughout the remainder of
11
2003 and will be a material component of our overall business. As of June 30,
2003, AOL beneficially owned 7.9% of our outstanding common stock.
We also generate revenue from the sale of national advertising and site
sponsorship revenue on white and yellow pages, as well as maps pages, across
both Switchboard.com and the Switchboard alliance partner network. Such revenue
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 both the three and six months ended June 30, 2003, approximately 11.5% of
our net revenue was derived from the sale of national advertising and site
sponsorships, as compared to 14.7% and 12.1% in the three and six months ended
June 30, 2002.
Our cost of revenue consists primarily of expenses paid to third parties
under data licensing and Web site creation and hosting agreements and search
engine placement optimization fees, as well as other direct expenses incurred to
maintain the operations of our Web site as well as the Web-hosted platforms of
our merchant network alliance partners. 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 also
includes an allocation of salaries and benefits for employees, as well as
expenses resulting from external consultants, directly associated with the
delivery of billable engineering and other services. Cost of revenue as a
percentage of revenue has varied in the past, primarily because the amount of
revenue recognized has varied and has been spread over relatively fixed cost of
revenue.
Our sales and marketing expense consists primarily of employee salaries and
benefits, costs associated with channel marketing programs, collateral
production expenses, third-party commission costs, public relations, market
research, provision for bad debts and a pro rata share of occupancy and
information system expenses.
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 hosted directory
platform, 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.
We have experienced substantial net losses. As of June 30, 2003, we had an
accumulated deficit of $108.2 million. These net losses and accumulated deficit
resulted from insufficient revenue to cover the significant costs incurred in
the development of our Web hosted directory platform and the establishment of
our corporate infrastructure and organization.
Adoption of EITF 01-9
We 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") in 2002 and concluded that EITF 01-9 is
applicable to the accounting for our directory and local advertising platform
services agreement with AOL ("Directory Agreement"). Accordingly, we decreased
12
our merchant network revenue by $946,000 and $2.0 million for the three and six
months ended June 30, 2002 and reduced our operating expenses by a corresponding
amount in the same period. There was no offset to revenue for consideration
given to a vendor in the three and six months ended June 30, 2003. 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 (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
------ ------ ------ -------
Gross revenue $3,974 $3,014 $7,315 $ 7,037
Less: Amortization of consideration
given to AOL - (946) - (2,049)
------ ------ ------ -------
Net revenue $3,974 $2,068 $7,315 $ 4,988
====== ====== ====== =======
Operating expenses $2,793 $4,131 $5,553 $ 8,873
Less: Amortization of consideration
given to AOL - (946) - (2,049)
------ ------ ------ -------
Net operating expenses $2,793 $3,185 $5,553 $ 6,824
====== ====== ====== =======
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,
April 2002, August 2002 and November 2002, certain terms of the agreement were
amended. Under the four-year term of the amended Directory Agreement, we share
with AOL specified directory advertisement revenue. In general, we received a
majority of the first $12.0 million of such directory advertisement revenue and
receive a lesser share of any additional directory advertisement revenue
pursuant to the August 2002 amendment. We paid AOL and recorded an asset of
$13.0 million at the signing of the Directory Agreement. Following the
incorporation of the Directory Platform on the AOL.com, AOL Service and Digital
City properties ("AOL Roll-In") in January 2002, we recorded a second asset and
a liability related to future payments of $13.0 million. In April 2002, 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, replacing the $13.0 million originally owed upon the AOL
Roll-In. The August 2002 amendment, among other things, eliminated the $12.0
million in remaining additional payments established in the April 2002
amendment. AOL committed to pay us at least $2.0 million in consulting or
service fees over the term of the Directory Agreement under a payment schedule
which ended in September 2002, of which AOL has paid all $2.0 million and we
have delivered all $2.0 million in services to AOL. In addition, we are required
to provide up to 300 hours of engineering services per month to AOL at no
charge, if requested by AOL for the term of the agreement. These 300 hours are
provided to support the Directory Platform, from which we share in directory
advertising revenue over the term of the amended agreement. Any engineering
services provided by us in excess of 300 hours per month are charged to AOL on a
time and materials basis. AOL typically exceeds these 300 hours each month. In
the three and six months ended June 30, 2003, AOL consulting and service fees
totaled $641,000 and $1.3 million, respectively. In the three and six months
ended June 30, 2002, AOL consulting and service fees totaled $491,000 and
$547,000, respectively.
The August 2002 amended Directory Agreement has an initial term of four
years, expiring in December 2004, and is subject to earlier termination upon the
occurrence of specified events, including, without limitation (1) the Company
being acquired by one of certain third parties, or (2) AOL acquiring one of
certain third parties and AOL pays the Company a termination fee of $25.0
million.
13
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. We also
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 $13.0 million paid and the value of the 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 of $11.7 million were written down to zero as a
result of an impairment analysis as of December 31, 2001. In 2002, we recorded
amortization based upon the remaining net book value of our AOL assets
established upon the AOL Roll-In and April 2002 amendment on a straight-line
basis over the remaining term of the amended agreement. As a result of the
elimination in the August 2002 amendment of the remaining $12.0 million owed to
AOL, an adjustment to amortization of consideration given to a customer of
$482,000 was recorded in August 2002, offsetting amortization recorded in the
period. Amortization of AOL assets totaled $946,000 and $2.0 million in the
three and six months ended June 30, 2002. There was no amortization of AOL
assets in the three and six months ended June 30, 2003. Throughout the remaining
initial term of the amended agreement, we will no longer record amortization of
consideration given to AOL as these assets are now fully amortized and no
further consideration is due AOL. Amortization of assets related to AOL has been
reflected as a reduction of revenue in accordance with EITF 01-9.
Revenue recognized from AOL was $1.8 million, or 45.6% of net revenue, and
$3.4 million, or 47.0% of net revenue, for the three and six months ended June
30, 2003, respectively. Revenue recognized from AOL, including amortization of
consideration given to AOL, was $424,000, or 20.5% of net revenue, and $1.3
million, or 27.0% of net revenue, for the three and six months ended June 30,
2002, respectively. Net amounts due from AOL included in accounts receivable at
June 30, 2003 and December 31, 2002 were $1.1 million and $549,000,
respectively. As of June 30, 2003, AOL beneficially owned 7.9% of our
outstanding common stock.
Results of Operations
Revenue
Net revenue increased 92.2% to $4.0 million for the three months ended June
30, 2003, compared with $2.1 million for the corresponding period in 2002. Net
revenue increased 46.7% to $7.3 million for the six months ended June 30, 2003,
compared with $5.0 million for the corresponding period in 2002. The increases
for both the three and six months ended June 30, 2003 consisted primarily of an
increase in net merchant network revenue, as well as an increase in national
advertising and site sponsorship revenue.
Net merchant network revenue increased 99.3% to $3.5 million for the three
months ended June 30, 2003, compared with $1.8 million for the corresponding
period in 2002. Net merchant network revenue increased 47.6% to $6.5 million for
the six months ended June 30, 2003, compared with $4.4 million for the
corresponding period in 2002.
The increase in net merchant network revenue for both the three and six
months ended June 30, 2003 was primarily due to a reduction in amortization of
consideration given to AOL as a result of the elimination of such amortization
14
in August 2002 upon the amendment to the Directory Agreement with AOL.
Amortization of consideration given to AOL was $946,000 and $2.0 million in the
three and six months ended June 30, 2002, respectively. There was no
amortization of consideration given to AOL in the three and six months ended
June 30, 2003. The increase in net merchant network revenue in the three months
ended June 30, 2003 was also attributable to an increase of $764,000 in
licensing revenue from new and existing merchant network alliance partners,
including AOL, as well as an increase of $130,000 in engineering and other
services revenue. The increase in net merchant network revenue in the six months
ended June 30, 2003 was also attributable to an increase of $676,000 in
engineering and other services revenue, as well as additional licensing revenue
from new merchant network alliance partners. Offsetting these increases in the
six-month period ended June 30, 2003 was a decrease of $690,000 in licensing
revenue from AOL, primarily as a result of significantly reduced nationally
oriented merchant advertising sales by AOL, as well as a reduction in the
percentage by which we share in directory revenue generated by AOL under the
Directory Agreement based upon the achievement of a predetermined cumulative
revenue milestone.
National advertising and site sponsorship revenue increased 50.7% to
$458,000 for the three months ended June 30, 2003, compared with $304,000 for
the corresponding period in 2002. National advertising and site sponsorship
revenue increased 40.0% to $843,000 for the six months ended June 30, 2003,
compared with $602,000 for the corresponding period in 2002. The increase in
national advertising and site sponsorship revenue for both the three and six
months ended June 30, 2003 resulted primarily from the addition of new customers
and an increase in revenue from existing customers due to additional advertising
placements on our site, as well as an increase in traffic to our Web site.
Cost of Revenue
Cost of revenue decreased 26.8% to $814,000, or 20.5% of net revenue, for
the three months ended June 30, 2003, compared with $1.1 million, or 53.8% of
net revenue, for the corresponding period in 2002. Cost of revenue decreased
25.1% to $1.5 million, or 20.8% of net revenue, in the six months ended June 30,
2003, compared with $2.0 million, or 40.7% of net revenue, for the corresponding
period in 2002.
Cost of revenue decreased for the three months ended June 30, 2003
primarily as a result of a decrease of $197,000 in expenses resulting from a
lower margin merchant services project performed for a merchant network alliance
partner in 2002 and decreases in the cost of third-party data, Web site creation
and hosting fees in connection with our merchant services programs and data
communication fees. These decreases were offset in part by increases in search
engine placement optimization fees and employee salaries and benefits associated
with the delivery of engineering services, which are classified as cost of
revenue.
Cost of revenue decreased for the six months ended June 30, 2003 primarily
as a result of a decrease of $201,000 in Web site creation and hosting fees in
connection with our merchant services programs, a decrease of $197,000 in
expenses resulting from a lower margin merchant services project performed for a
merchant network alliance partner in 2002 and decreases in the cost of
third-party data and data communication fees. These decreases were offset in
part by an increase of $150,000 in employee salaries and benefits associated
with the delivery of engineering services, which are classified as cost of
revenue, and an increase in search engine placement optimization fees.
Gross Profit
Gross profit increased 230.5% to $3.2 million, or 79.5% of net revenue, for
the three months ended June 30, 2003, compared with $956,000, or 46.2% of net
revenue, for the corresponding period in 2002. Gross profit increased 95.9% to
$5.8 million, or 79.2% of net revenue, in the six months ended June 30, 2003,
compared with $3.0 million, or 59.3% of net revenue, for the corresponding
period in 2002. The increases in gross profit dollars and percentage for the
three and six months ended June 30, 2003 were primarily due to the reduction in
the amortization of consideration given to AOL discussed above.
15
Sales and Marketing
Sales and marketing expenses decreased 40.2% to $685,000 for the three
months ended June 30, 2003, compared with $1.1 million for the corresponding
period in 2002. Sales and marketing expenses decreased 40.6% to $1.5 million for
the six months ended June 30, 2003, compared with $2.6 million for the
corresponding period in 2002. As a percentage of net revenue, sales and
marketing expenses were 17.2% and 20.9% for the three and six months ended June
30, 2003, as compared with 55.4% and 51.6% for the corresponding periods in
2002.
The decrease for the three months ended June 30, 2003 was primarily related
to a reduction of expense of $200,000 resulting from an amount collected from
AOL related to the final settlement of our prior agreement with AOL, which was
terminated in March 1999. Sales and marketing expenses also decreased in the
three months ended June 30, 2003 as a result of a decrease of $165,000 in
merchant program expenses and decreases in public relations expenses and
provisions for bad debts, offset in part by an increase in employee compensation
and benefits.
The decrease for the six months ended June 30, 2003 was primarily related
to a decrease of $407,000 in merchant program expenses, $200,000 collected from
AOL, a decrease of $131,000 in public relations expenses and a decrease in
employee compensation and benefits.
Research and Development
Research and development expenses decreased 14.9% to $1.1 million for the
three months ended June 30, 2003, compared with $1.3 million for the
corresponding period in 2002. Research and development expenses decreased 20.8%
to $2.2 million for the six months ended June 30, 2003, compared with $2.8
million for the corresponding period in 2002. As a percentage of net revenue,
research and development expenses were 28.2% and 30.6% for the three and six
months ended June 30, 2003, compared with 63.7% and 56.6% for the corresponding
periods in 2002.
The decrease for the three months ended June 30, 2003 was due primarily to
decreases in salaries and benefits associated with the delivery of engineering
services, which are classified as cost of revenue, depreciation, facilities
expense and other employee compensation and benefits.
The decrease for the six months ended June 30, 2003 was due primarily to a
decrease of $207,000 in outside consulting fees, a decrease of $158,000 in
salaries and benefits associated with the delivery of engineering services,
which are classified as cost of revenue, a decrease of $112,000 in other
employee compensation and benefits and a decrease in facilities expense.
General and Administrative
General and administrative expenses increased 41.4% to $1.0 million for the
three months ended June 30, 2003, compared with $723,000 for the corresponding
period in 2002. General and administrative expenses increased 27.7% to $1.8
million for the six months ended June 30, 2003, compared with $1.4 million for
the corresponding period in 2002. As a percentage of net revenue, general and
administrative expenses were 25.7% and 25.0% for the three and six months ended
June 30, 2003, compared with 35.0% and 28.7% for the corresponding period in
2002.
The increase for the three months ended June 30, 2003 was primarily due to
an increase in professional services and employee compensation and benefits,
offset in part by a decrease in insurance expense and provisions for excise
taxes.
16
The increase for the six months ended June 30, 2003 was primarily due to
increases in professional services, employee compensation and benefits and an
unallocated occupancy costs, offset in part by a decrease in insurance expense.
Revision of Restructuring Estimate
In the three months ended June 30, 2003, we recorded the reversal of
$35,000 in excess restructuring reserves. This reversal resulted from a revision
of an estimate of the compensation amount for a terminated employee for which we
had reserved as part of our 2001 special charges. It was determined in the three
months ended June 30, 2003 that the reserve for this compensation was no longer
required. As of June 30, 2003, we had a remaining liability of $14,000 for the
2001 special charges related primarily to our remaining net lease obligations
for a closed facility.
Other Income
Other income decreased 80.3% to $172,000 for the three months ended June
30, 2003, compared with $874,000 for the corresponding period in 2002. Other
income decreased 75.9% to $354,000 for the six months ended June 30, 2003,
compared with $1.5 million for the corresponding period in 2002. The decrease in
the three and six months ended June 30, 2003 was due primarily to a decrease in
interest income earned as a result of a decline in interest rates, as well as a
decrease in realized gains on investments.
Income Taxes
In accordance with generally accepted accounting principles, the Company
provides for income taxes on an interim basis using its estimated annual
effective income tax rate. The Company anticipates that it will not have a
significant tax provision in 2003 due to utilization of net operating loss
carryforwards. However, the Company does anticipate that it will be subject to
an alternative minimum tax. Accordingly, the Company has recorded income tax
expense of $12,000 in the three and six months ended June 30, 2002.
Liquidity and Capital Resources
As of June 30, 2003, we had total cash and marketable securities of $50.3
million, consisting of $39.4 million of cash and cash equivalents, $6.6 million
of short-term marketable securities, $4.3 million of long-term marketable
securities and $36,000 of restricted cash. During the six months ended June 30,
2003, cash and cash equivalents increased by $944,000, primarily due to cash
provided by investing activities of $4.4 million and cash provided by operating
activities of $398,000, offset in part by net cash used for financing activities
of $3.8 million.
Net cash provided by operating activities for the six months ended June 30,
2003 was $398,000, primarily due to net income of $583,000 and non-cash income
and expenses of $644,000 of depreciation and amortization, $73,000 of
amortization of unearned compensation and $37,000 of non-cash interest income on
a note receivable. The increase in cash was also due to an increase of $128,000
in accrued expenses and an increase of $58,000 in deferred revenue. These
increases were offset in part primarily by an increase of $566,000 in accounts
receivable and an increase of $519,000 in other current assets.
Net cash provided by investing activities for the six months ended June 30,
2003 was $4.4 million, primarily due to $3.0 million in proceeds from sales of
marketable securities and a decrease of $1.6 million in restricted cash, offset
in part primarily by purchases of marketable securities of $165,000.
17
Net cash used in financing activities for the six months ended June 30,
2003 was $3.8 million, primarily due to payments on notes payable of $2.2
million and a payment of $1.7 million related to the settlement of our
litigation with the former stockholders of Envenue Inc. ("Envenue"), offset in
part by proceeds of $91,000 from the issuance of stock.
In June 2002, we entered into a loan and security agreement (the "SVB
Financing Agreement") with Silicon Valley Bank ("SVB"), under which we had the
ability to borrow up to $4.0 million for the purchase of equipment. Amounts
borrowed under the facility accrued interest at a rate equal to prime plus
0.25%, and were to have been repaid monthly over a 30-month period. We had
utilized $2.7 million of this facility through borrowings that occurred in June
and September 2002. The SVB Financing Agreement also provided for a $1.0 million
revolving line of credit. We did not borrow any amounts under the revolving line
of credit. Our ability to borrow additional amounts under the SVB Financing
Agreement expired on May 30, 2003. In May 2003, we paid SVB $1.8 million in
satisfaction of our outstanding borrowings under the loan facility. We are no
longer required to maintain minimum amounts in deposit or investment accounts at
SVB, as the SVB Financing Agreement has expired and any outstanding borrowings
have been repaid in full.
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, which we classified as a payable related to
acquisition within current liabilities. We did not pay the $2.0 million on or
before May 24, 2002, as we were involved in a contractual dispute with the
previous owners of Envenue. In June 2002, we placed $2.0 million into an escrow
account, which was to be held until the resolution of this dispute. In October
2002, we paid $410,000 out of the escrowed funds, representing the undisputed
portion of the purchase price plus interest from the original maturity date to
the former stockholders of Envenue. The remaining $1.6 million of the purchase
price was classified separately in the accompanying financial statements as of
December 31, 2002. We recorded $1.6 million as restricted cash at December 31,
2002 related to the cash held in escrow. In June 2003, we paid the former
stockholders of Envenue $1.7 million to settle all claims related to the
acquisition of Envenue. As a result, we no longer have funds in escrow related
to the matter.
We have incurred significant operating expenses since our inception. We
anticipate that our operating expenses and capital expenditures will constitute
a material use of our cash resources into the foreseeable future. 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 internal
research and development activities, 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 several policies 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
18
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. The critical accounting policies we identified
in our most recent Annual Report on Form 10-K are related to revenue
recognition, risks, concentrations and uncertainties, and accounting for
stock-based compensation. It is important that the historical discussion in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations be read in conjunction with our critical accounting policies as
discussed in our Annual Report on Form 10-K for the year ended December 31,
2002.
Critical accounting policies discussed in our Annual Report on Form 10-K
for the year ended December 31, 2002 remain in effect with the exception of our
accounting for bad debts incurred by AOL. In periods prior to April 2003, we
recognized royalty revenue from AOL based upon our percentage of directory
revenue earned by AOL in the period, less our estimate of AOL's bad debt
associated with the revenue for the period. Our estimate of AOL's bad debts was
recorded as a sales allowance, reducing revenue and accounts receivable.
Beginning in April 2003, we began recognizing royalty revenue from AOL based
upon our percentage of directory revenue that was both earned and collected by
AOL. Given that we are recording royalty revenue from AOL based upon revenue
collected by AOL, there is no longer a need for us to estimate and provide for a
sales allowance for AOL.
Recently Issued Accounting Pronouncements
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS No.
150"). SFAS No. 150 affects the issuer's accounting for three types of
freestanding financial instruments. SFAS No. 150 also requires disclosures about
alternative ways of settling the instruments and the capital structure of
entities, all of whose shares are mandatorily redeemable. This statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatorily redeemable financial
instruments of nonpublic entities, for which it is effective for the first
fiscal period beginning after December 31, 2003. It is to be implemented by
reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance date of the statement and
still existing at the beginning of the interim period of adoption. Restatement
is not permitted. We do not expect the adoption of SFAS No. 150 to have a
material impact on our consolidated results of operations, financial position
and cash flows.
19
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 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 SEC.
RISKS RELATED TO OUR BUSINESS
IF THE DIRECTORY AGREEMENT WE ENTERED INTO WITH AMERICA ONLINE, INC., A
SUBSIDIARY OF AOL TIME WARNER INC., IS NOT SUCCESSFUL OR IS NOT RENEWED ON
SUBSTANTIALLY SIMILAR TERMS, IT WOULD HAVE A MATERIALLY NEGATIVE EFFECT ON OUR
RESULTS OF OPERATIONS
The Directory Agreement we entered into with AOL may not generate
anticipated revenues or other benefits. Even though we have amended the
Directory Agreement, the Directory Agreement may still be prematurely terminated
by breach or otherwise fail to be successful. Our revenue from AOL may be lower
than anticipated in future periods, particularly if local merchants do 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 obligations to AOL under the
Directory Agreement.
In 2002 and the first six months of 2003, revenue derived from AOL
represented a significant portion of our net revenue. AOL accounted for 41.8% of
total net revenue in 2002 and 45.6% and 47.0% of total net revenue in the three
and six months ended June 30, 2003. We anticipate that AOL will be a material
component of our overall business. The termination of our Directory Agreement
with AOL or the failure of our Directory Agreement with AOL to generate these
anticipated revenues would have a material adverse effect on our results of
operations and financial condition.
The term of our Directory Agreement with AOL expires in December 2004. We
or AOL may elect not to renew the agreement upon its expiration. If the
agreement is renewed, it may be renewed under terms that are materially
different than those in place today. These terms may result in a decrease in our
share of revenue earned by AOL, or require us to pay AOL additional amounts that
could substantially reduce the profitability of the relationship.
WE HAVE A HISTORY OF INCURRING NET LOSSES, WE MAY INCUR NET LOSSES DURING
FUTURE QUARTERS AND WE MAY NEVER ACHIEVE PROFITABILITY AGAIN
We have incurred significant net losses in each fiscal quarter previous to
the fiscal quarter ended March 31, 2003. From inception to June 30, 2003, we
have an accumulated deficit totaling $108.2 million. We need to generate
substantial revenue to fund our operations. Although we recorded a small profit
in each of the fiscal quarters ended March 31 and June 30, 2003, 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 eventually be unable to
continue our operations.
20
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 software;
* 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 MERCHANT NETWORK ALLIANCE PARTNERSHIPS WITH THIRD PARTIES TO GROW
OUR BUSINESS AND OUR BUSINESS MAY NOT GROW IF THE MERCHANT NETWORK 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 merchant network alliance partnerships and to establish additional
merchant network 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
alliance partners to sell Internet yellow pages advertising to local merchants
and to provide billing and other administrative services relating to our
merchant services. The termination of any strategic relationship with a merchant
network alliance 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 merchant network alliance partners on
terms acceptable to us or at all.
In addition to our relationship with AOL, 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 customer and supplier relationships may be terminated by either party
on short notice.
Our strategic customer and supplier relationships are in early stages of
development. These relationships may not provide us benefits that outweigh the
21
costs of the relationships. If any strategic customer or supplier 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.
IF WE CANNOT DEMONSTRATE THE VALUE OF OUR MERCHANT SERVICES TO LOCAL MERCHANTS
ENROLLED TO RECEIVE OUR SERVICES THROUGH OUR MERCHANT NETWORK ALLIANCE PARTNERS,
THOSE LOCAL MERCHANT CUSTOMERS MAY STOP USING THESE SERVICES, WHICH COULD REDUCE
OUR REVENUE
We may be unable to demonstrate the value of our merchant services to local
merchants enrolled to receive our services through our merchant network alliance
partners. 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 data demonstrating the number of leads generated by our
merchant services to merchants who have enrolled to receive our merchant
services on a flat fee per month basis. 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 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
as well as the Web sites of our merchant network alliance partners, and diminish
the attractiveness of our service offerings to those merchant network alliance
partners, advertisers and content providers.
ePRESENCE'S MAJORITY OWNERSHIP INTEREST IN US WILL PERMIT ePRESENCE TO CONTROL
MATTERS SUBMITTED FOR APPROVAL BY OUR STOCKHOLDERS, WHICH COULD DELAY OR PREVENT
A CHANGE IN CONTROL OR DEPRESS OUR STOCK PRICE
As of June 30, 2003, ePresence beneficially owned approximately 51.9% of
our common stock. Because of this majority interest in us, ePresence is
generally able to control all matters submitted to our stockholders for approval
22
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.
Conversely, ePresence's control over us could have the effect of enabling a
change of control of Switchboard that other stockholders may believe would
result in a less desirable 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 of
customers. During the three and six months ended June 30, 2003, net revenue
derived from our top ten customers accounted for approximately 73.0% and 72.1%
of our total net revenue, respectively. Additionally, net revenue derived from
AOL alone accounted for 45.6% and 47.0% of our total net revenue in the three
and six months ended June 30, 2003, respectively. 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.
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 products and 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 products and services, develop new 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 products and 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 products and services.
OUR BUSINESS MAY SUFFER AN INTERRUPTION AS A RESULT OF CABLE & WIRELESS'
ANNOUNCEMENT THAT IT INTENDS ON EXITING ITS UNITED STATES OPERATIONS
On June 4, 2003, Cable & Wireless PLC announced that it had decided to
cease its United States operations. We currently use Cable & Wireless' Waltham,
Massachusetts facility for the hosting of our website, as well as the Web-hosted
platforms we provide to our merchant network alliance partners. We believe Cable
& Wireless is attempting to exit its activities at its Waltham, Massachusetts
facility. In the event that Cable & Wireless does exit its activities at this
23
facility, we are unable to predict whether or not Cable & Wireless will be able
to successfully sell or lease this facility. In the event Cable & Wireless is
successful in selling or leasing this facility, we are further unable to predict
whether the purchaser or lessor would provide the same or similar services as
Cable & Wireless presently offers to us. If we are unable to reach an agreement
with an eventual purchaser or lessor of the facility, we will be required to
find a new location from which to host our website as well as the Web-hosted
platforms we provide to our merchant network alliance partners. We may incur
more expense at a new facility than we presently pay to Cable & Wireless.
Further, such a transition to a new location may result in an interruption to
our website or the Web-hosted platforms of our merchant network alliance
partners. Such an interruption could have a material adverse effect on our cash
flows and results of operations.
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 products and 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.
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 products and
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
24
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 alliance 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.
OUR INTERNALLY DEVELOPED SOFTWARE MAY CONTAIN UNDETECTED ERRORS, WHICH COULD
LIMIT OUR ABILITY TO PROVIDE OUR PRODUCTS AND SERVICES AND DIMINISH THE
ATTRACTIVENESS OF OUR SERVICE OFFERINGS
We use internally developed, custom software to provide our products and
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
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.
25
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, advertisers and key personnel.
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.
RISKS RELATED TO THE INTERNET
IF THE ACCEPTANCE AND EFFECTIVENESS OF INTERNET ADVERTISING DOES NOT BECOME
FULLY ESTABLISHED, OUR YELLOW PAGES AND BANNER AND SITE SPONSORSHIP ADVERTISING
REVENUE WILL SUFFER
Our business model is heavily dependent upon increasing our sales,
ultimately through our merchant network alliance partners, 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 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 are less dependent on
revenue from banner and site sponsorship advertisements than we had previously
been in prior years, our future success still depends, in part, on an increase
in the use of the Internet as an advertising medium. We generated 11.5% of our
net revenue from the sale of banner and site sponsorship advertisements during
both the three and six months ended June 30, 2003, respectively. The Internet
advertising market is new and rapidly evolving, and cannot yet be compared with
26
traditional advertising media to gauge its effectiveness. As a result, demand
for and market acceptance of Internet advertising is uncertain.
Many of our merchant network alliance partners' 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 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 banner and site sponsorship advertising customers may
challenge or refuse to accept either our or third-party measurements of
advertisement delivery.
IF WE ARE SUED FOR CONTENT DISTRIBUTED THROUGH, OR LINKED TO BY, OUR WEB SITE
OR THOSE OF OUR MERCHANT NETWORK ALLIANCE PARTNERS, 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 or those of
our merchant network alliance partners. 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.
27
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.
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.
28
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, 2003.
ITEM 4. CONTROLS AND PROCEDURES.
Our management, with the participation of our chief executive officer and
chief financial officer, evaluated the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of June 30, 2003. Based on this evaluation, our chief executive officer
and chief financial officer concluded that, as of June 30, 2003, our disclosure
controls and procedures were (1) designed to ensure that material information
relating to us, including our consolidated subsidiaries, is made known to our
chief executive officer and chief financial officer by others within those
entities, particularly during the period in which this report was being prepared
and (2) effective, in that they provide reasonable assurance that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms.
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended June 30, 2003 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On May 31, 2002 the Company was sued by the former stockholders of Envenue,
Inc., from whom the Company purchased all of the stock of Envenue in November
2000. The suit alleged that the Company breached its agreement with the
plaintiffs by failing to pay the purchase price of the Envenue stock when it
became due on May 24, 2002. The Company paid $400,000, plus interest,
representing a portion of the purchase price, to the plaintiffs. The suit sought
payment of $1.6 million, representing the balance of the purchase price, plus
additional unquantified damages including treble damages. In June 2003 the
former stockholders of Envenue and the Company agreed to settle this suit and in
connection therewith, the Company paid $1.7 million to the former stockholders
of $1.7 million. The parties have exchanged releases and a stipulation of
dismissal of this suit was filed with the court on June 16, 2003.
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,
29
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. In July 2002, the Company, Douglas J. Greenlaw, Dean Polnerow and
John P. Jewett joined in an omnibus motion to dismiss which challenges the legal
sufficiency of plaintiffs' claims. The motion was filed on behalf of hundreds of
issuer and individual defendants named in similar lawsuits. The plaintiffs
opposed the motion. On September 30, 2002, the lawsuit against Messrs. Greenlaw,
Polnerow and Jewett was dismissed without prejudice. The Court heard oral
argument on the motion in November 2002. On February 19, 2003, the court issued
its decision on the defendants' motion to dismiss, granting in part and denying
in part the motion as to Switchboard. In doing so, the court dismissed the
plaintiffs' claims against certain defendants, including Switchboard.
In June 2003, the plaintiffs, the issuer defendants and their insurers
agreed on the terms and conditions of a proposed settlement of this case. The
terms and conditions of the proposed settlement have been widely reported in the
press. Switchboard's special committee of the board of directors met twice
during June 2003 to evaluate the proposed settlement. The committee was advised
by outside counsel on the merits of the proposed settlement. The committee
determined that the settlement was in the best interest of Switchboard and that
Switchboard should accept the proposed settlement. There is no guarantee that
the settlement will become final, as it is subject to a number of conditions,
including court approval; however, based on this proposed settlement,
Switchboard does not believe it will suffer material future losses related to
this lawsuit.
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, 2003, we used approximately $22.9
million of the proceeds from the offering for working capital purposes, of which
approximately $4.8 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
(the "Directory Agreement") entered into with America Online on that date. 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. In April 2002, we
paid America Online $2.0 million upon the execution of the Second Amendment to
the Directory Agreement. In October 2002, we paid the former stockholders of
Envenue Incorporated approximately $410,000, and in June 2003 we paid the former
stockholders of Envenue an additional $1.7 million. As of June 30, 2003, we have
invested the remaining net proceeds in interest-bearing, investment-grade
securities and money market funds.
30
Item 4. Submission of Matters to a Vote of Security Holders.
On May 15, 2003, the Company held its 2003 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 Class III directors to serve for the ensuing three years and
until their respective successors are elected and qualified.
For Withheld
---------- --------
(i) Douglas J. Greenlaw 17,918,290 202,024
(ii) Dean Polnerow 18,021,141 99,173
2. Ratification of the appointment of Ernst & Young LLP as the Company's
independent auditors for the current year.
For: 18,104,668
Against: 11,591
Abstain: 4,055
Broker non-votes none
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits
The Exhibits filed as part of this report 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 SEC. Switchboard's file
number under the Securities Exchange Act of 1934 is 000-28871.
b. Reports on Form 8-K.
On April 29, 2003, the Company furnished a Current Report on Form 8-K dated
April 29, 2003 under Item 9 containing a copy of the Company's earnings release
for the period ended March 31, 2003 pursuant to Item 12 (Results of Operations
and Financial Condition).
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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: August 8, 2003 By:/s/ Robert P. Orlando
---------------------
Robert P. Orlando
Vice President and Chief Financial
Officer (principal financial
officer and chief accounting
officer)
32
EXHIBIT INDEX
Exhibit No. Description
- ----------- -------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C,
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C,
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
33