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 September 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 Identification No.)
of Incorporation or Organization)
120 Flanders Road, Westborough, 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 October 31, 2003
-------------- -----------------------------------------
Common Stock, par value 19,102,147
$0.01 per share
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", "likely", "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 our 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 September 30, 2003 (unaudited) and
December 31, 2002 (audited)............................................................ 3
Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended
September 30, 2003 and 2002............................................................ 4
Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended
September 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......................................................... 12
Item 3. -- Quantitative and Qualitative Disclosures About Market Risk...................... 35
Item 4. -- Controls and Procedures......................................................... 35
PART II -- Other Information
Item 1. - Legal Proceedings................................................................ 35
Item 2. -- Changes in Securities and Use of Proceeds....................................... 36
Item 6. -- Exhibits and Reports on Form 8-K................................................ 37
Signatures................................................................................. 38
2
ITEM 1. - FINANCIAL STATEMENTS
SWITCHBOARD INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
September 30, 2003 December 31, 2002
------------------ -----------------
(unaudited)
Assets:
Cash and cash equivalents $ 42,106 $ 38,390
Short-term marketable securities 8,685 3,589
Restricted cash 36 1,640
Accounts receivable, net of allowance of $242 and $350, respectively 2,543 1,558
Unbilled receivables - 160
Other current assets 775 330
--------- ---------
Total current assets 54,145 45,667
Long-term marketable securities 2,095 10,244
Property and equipment, net 1,007 1,877
--------- ---------
Total assets $ 57,247 $ 57,788
========= =========
Liabilities:
Accounts payable $ 1,013 $ 966
Accrued expenses 1,635 1,437
Deferred revenue 532 475
Payable related to acquisition - 1,600
Note payable, current portion - 1,099
--------- ---------
Total current liabilities 3,180 5,577
Note payable, net of current portion - 1,124
--------- ---------
Total liabilities 3,180 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 19,368,749 and 19,227,230 shares as of September 30, 2003 and
December 31, 2002, respectively. 194 192
Treasury stock, 386,302 shares at cost (1,255) (1,255)
Additional paid-in capital 163,363 162,437
Note and interest receivable for issuance of restricted common stock (848) (1,520)
Unearned compensation (69) (178)
Accumulated other comprehensive income 82 156
Accumulated deficit (107,400) (108,745)
--------- ---------
Total stockholders' equity 54,067 51,087
--------- ---------
Total liabilities and stockholders' equity $ 57,247 $ 57,788
========= =========
See accompanying notes.
3
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in thousands, except per share amounts)
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
------ ------- ------- -------
Revenue $4,108 $ 3,325 $11,423 $10,362
Consideration given to a customer - 49 - (2,000)
------ ------- ------- -------
Net revenue 4,108 3,374 11,423 8,362
Cost of revenue 662 951 2,183 2,981
------ ------- ------- -------
Gross profit 3,446 2,423 9,240 5,381
------ ------- ------- -------
Operating expenses:
Sales and marketing 913 1,127 2,440 3,699
Research and development 1,181 1,378 3,416 4,200
General and administrative 743 1,606 2,569 3,036
Revision of restructuring estimate - - (35) -
------ ------- ------- -------
Total operating expenses 2,837 4,111 8,390 10,935
------ ------- ------- -------
Income (loss) from operations 609 (1,688) 850 (5,554)
Other income:
Interest income 172 322 607 1,560
Interest expense - (31) (74) (60)
Realized gain (loss) on sale of investments - 29 (1) 399
Other expense (3) (14) (9) (124)
------ ------- ------- -------
Total other income 169 306 523 1,775
------ ------- ------- -------
Income (loss) before income taxes 778 (1,382) 1,373 (3,779)
Provision for income taxes 16 - 28 -
------ ------- ------- -------
Net income (loss) $ 762 $(1,382) $ 1,345 $(3,779)
====== ======= ======= =======
Net income (loss) per share:
Basic $0.04 $(0.07) $0.07 $(0.20)
===== ====== ===== ======
Diluted $0.04 $(0.07) $0.07 $(0.20)
===== ====== ===== ======
Weighted average number of common shares:
Basic 18,788 18,525 18,692 18,506
Diluted 20,347 18,525 19,654 18,506
See accompanying notes.
4
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Nine Months Ended September 30,
-------------------------------
2003 2002
------- --------
Cash flows from operating activities:
Net income (loss) $ 1,345 $ (3,779)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 938 1,173
Amortization of unearned compensation 109 120
Non-cash interest income on note receivable (53) (53)
Loss (gain) on sales of marketable securities 1 (431)
Consideration given to a customer - 2,000
Changes in operating assets and liabilities:
Accounts receivable (984) 29
Unbilled receivables 160 508
Other current assets (444) (12)
Other assets - 95
Accounts payable 47 (1,504)
Accrued expenses 337 (161)
Accrued restructuring (39) (927)
Payment on AOL Directory Agreement - (2,000)
Deferred revenue 57 (405)
------- --------
Net cash provided by (used in) operating activities 1,474 (5,347)
------- --------
Cash flows from investing activities:
Purchases of property and equipment (68) (815)
Decrease (increase) in restricted cash 1,602 (1,162)
Purchase of marketable securities (229) (10,789)
Proceeds from sales of marketable securities 3,208 49,274
------- --------
Net cash provided by investing activities 4,513 36,508
------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 1,652 316
Purchase of treasury stock - (1,255)
Proceeds from issuance of note payable - 2,747
Settlement of Envenue litigation (1,700) -
Payments on notes payable (2,223) (1,124)
------- --------
Net cash (used in) provided by financing activities (2,271) 684
------- --------
Net increase in cash and cash equivalents 3,716 31,845
Cash and cash equivalents at beginning of period 38,390 4,212
------- --------
Cash and cash equivalents at end of period $42,106 $ 36,057
======= ========
Supplemental statement of non-cash investing and financing activity:
Repurchase of restricted stock and reduction of note receivable $725,000 $ -
Note receivable from officer for issuance of common stock $ - $1,499
Asset and liability related to AOL Directory Agreement $ - $12,000
Unrealized loss on investments $74 $747
See accompanying notes.
5
SWITCHBOARD INCORPORATED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A. Nature of Business
Switchboard Incorporated, a Delaware corporation (the "Company"), commenced
operations in February 1996. From the Company's inception (February 19, 1996)
until March 7, 2000, the Company was a unit and later a subsidiary of ePresence
Inc. (formerly Banyan Worldwide, "ePresence"). As of September 30, 2003,
ePresence beneficially owned approximately 51.6% of the Company's common stock.
The Company is a provider of local online advertising solutions for local
merchant and national advertisers, enabled by its consumer oriented online
yellow and white pages directory technology. The Company generates revenue
primarily from merchant advertisements that are placed in the
Switchboard-powered yellow pages platforms of its licensees, as well as in its
own directory website, www.switchboard.com. The Company licenses its yellow
pages platform to Internet portals, traditional yellow pages publishers and
newspaper publishers. The Company operates in one business segment as a provider
of advertising solutions through its 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
September 30, 2003, had an accumulated deficit of $107.4 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.
B. 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 nine-month periods ended September 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
C. 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.
At September 30, 2003, the Company had three stock-based employee
compensation plans (as defined within SFAS 123). 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 September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
----- ------- ------- -------
Net income (loss) as reported $ 762 $(1,382) $ 1,345 $(3,779)
Add: Stock-based employee compensation
expense included in reported net loss,
net of related tax effects 36 36 109 120
Add: Adjustment for previously amortized
expense associated with the unvested
portion of options canceled in the period 233 71 293 2,509
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects (366) (870) (1,366) (3,004)
----- ------- ------- -------
Pro-forma net income (loss) $ 665 $(2,145) $ 381 $(4,154)
===== ======= ======= =======
Pro-forma net income (loss) per share
Basic $0.04 $(0.12) $0.02 $(0.22)
===== ======= ===== =======
Diluted $0.03 $(0.12) $0.02 $(0.22)
===== ======= ===== =======
Shares used in computing pro-forma net
income (loss) per share
Basic 18,788 18,525 18,692 18,506
Diluted 20,347 18,525 19,654 18,506
7
D. 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, as well as the effect of unearned compensation resulting
from the unvested portion of stock options issued at an exercise price lower
than the market price on the date of issuance of the stock option.
For the three and nine months ended September 30, 2003, options to purchase
634,878 and 1,464,334 shares of common 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 $7.65 and $4.60 per share for the three
and nine months ended September 30, 2003. For the three and nine months ended of
September 30, 2002, options to purchase 3,578,256 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.
E. Comprehensive Income (Loss)
Other comprehensive income (loss) is as follows (in thousands):
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
---- ------- ------ -------
Net income (loss) $762 $(1,382) $1,345 $(3,779)
Other comprehensive (loss) income:
Unrealized (loss) income on investment (35) 122 (74) (747)
---- ------- ------ -------
Comprehensive income (loss) $727 $(1,260) $1,271 $(4,526)
==== ======= ====== =======
F. 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.
8
G. 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.
H. America Online, Inc. ("AOL")
Amortization of AOL assets totaled $433,000 and $2.0 million in the three
and nine months ended September 30, 2002, respectively. The Company amended its
agreement with AOL in August 2002, which, among other things, eliminated the
Company's requirement to make payments to AOL totaling $12.0 million. As a
result of the elimination of these additional payments 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. There was no
amortization of AOL assets in the three and nine months ended September 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.
Subsequently in October 2003, the Company amended and restated its agreement
with AOL. (See Note N.)
Net revenue recognized from AOL was $1.6 million, or 39.6% of net revenue,
and $5.1 million, or 44.3% of net revenue, for the three and nine months ended
September 30, 2003, respectively. Net revenue recognized from AOL, including
amortization of consideration given to AOL, was $1.7 million, or 51.8% of net
revenue, and $3.1 million, or 37.0% of net revenue, for the three and nine
months ended September 30, 2002, respectively. Net amounts due from AOL included
in accounts receivable at September 30, 2003 and December 31, 2002 were $1.3
million and $549,000, respectively. As of September 30, 2003, AOL beneficially
owned 7.9% of the Company's outstanding common stock.
I. Note Receivable for the Issuance of Restricted Common Stock
In January 2002, the Company recorded a note receivable from its former
Chief Executive Officer and member of its Board of Directors, Mr. Douglas
Greenlaw, 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. 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.
Mr. Greenlaw ceased to be an employee and resigned as a director effective
September 2, 2003. In connection with Mr. Greenlaw's separation of employment,
the Company recorded, as a component of general and administrative expense,
certain separation expenses of $174,000 in the three and nine months ended
September 30, 2003 in accordance with Mr. Greenlaw's employment agreement. At
the time Mr. Greenlaw ceased to be affiliated with the Company, 225,000 of the
original 450,000 shares granted were vested. In September 2003, the Company
exercised its right to repurchase the remaining 225,000 unvested shares for
$725,000, resulting in a corresponding reduction in the outstanding note of
9
$725,000. The interest accrued on the $725,000 of principal repaid in the
transaction remained outstanding at September 30, 2003. At September 30, 2003,
the Company had recorded $848,000 in principal and interest as a note receivable
within stockholders' equity. Per the terms of the note, the note is payable
within 90 days from the date Mr. Greenlaw ceased to be affiliated with the
Company.
During the three and nine months ended September 30, 2003, the Company
recorded $16,000 and $53,000 in interest income resulting from this note
receivable, respectively. During the three and nine months ended September 30,
2002, the Company recorded $18,000 and $53,000 in interest income resulting from
this note receivable, respectively.
J. Related Parties
ePresence provided the Company with telephone service and support under
corporate services agreements during the three and nine month periods ended
September 30, 2003 and 2002. Under the current corporate services agreement,
which expires on December 31, 2003, the Company pays ePresence $75,000 per year
for these services. The Company recorded $19,000 and $56,000 in expense and paid
ePresence $19,000 and $56,000 under the agreements in the three and nine months
ended September 30, 2003, respectively. The Company recorded $19,000 and $56,000
in expense and paid ePresence $19,000 and $113,000 under the agreements in the
three and nine months ended September 30, 2002, respectively. The Company had
$6,000 and $6,000 accrued under the agreements as of September 30, 2003 and
December 31, 2002, respectively.
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 its sublease
agreements with ePresence, the Company recorded rent expense of $57,000 and
$170,000 and paid ePresence $57,000 and $194,000 in the three and nine months
ended September 30, 2003, respectively. Under the sublease agreements, the
Company recorded rent expense and paid $129,000 and $388,000 to ePresence in the
three and nine months ended September 30, 2002, respectively. The Company had
$19,000 and $43,000 accrued under the sublease agreements as of September 30,
2003 and December 31, 2002, respectively. The Company believes that the amounts
paid to ePresence under its services agreements and subleases 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 nine months ended September 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 nine months ended September 30, 2002.
K. Revision of Restructuring Estimate
In the fiscal quarter 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 September 30, 2003, the Company had a remaining liability
of $13,000 for the 2001 special charges related primarily to its remaining net
lease obligations for a closed facility.
10
L. 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. 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.
M. Commitments and Contingencies.
In connection with the November 2001 class action lawsuit was filed in the
United States District Court for the Southern District of New York (the "Court")
that named as defendants Switchboard, the managing underwriters of Switchboard's
initial public offering, Douglas J. Greenlaw, Dean Polnerow, and John P. Jewett,
the Company had established a liability for potential settlement expense. Based
on recent developments, the Company has revised its estimate of potential
settlement expense and accordingly reduced its liability by $107,000 as a
reduction of general and administrative expense in the three and nine months
ended September 30, 2003.
N. Subsequent Events
On October 23, 2003, Switchboard filed a Registration Statement on Form S-1
in connection with a proposed underwritten offering of 8,815,171 shares of its
common stock, plus an over-allotment option of 1,322,250 shares. Of the shares
proposed to be sold, including the over-allotment option, 10,037,421 shares are
proposed to be sold by ePresence, Inc. and certain other selling shareholders,
and 100,000 shares are proposed to be sold by the Company. The offering is being
initiated by ePresence in order to facilitate an orderly disposition of its
Switchboard holdings in conjunction with its recently announced plan of
liquidation. At the completion of the offering, ePresence will continue to own
5.7% of the company's shares. If the over-allotment option is exercised and the
additional 1,322,250 shares are sold, ePresence will no longer own any shares of
the Company. The sale of ePresence's entire holdings of Switchboard stock is
subject to the approval of ePresence's shareholders. However, ePresence may sell
up to approximately 5.4 million of its shares of Switchboard stock without
shareholder approval.
In October 2003, Switchboard amended and restated its Directory and Local
Advertising Platform Services Agreement with AOL. The October 2003 amendment,
among other things, extended the term of the agreement for an additional year
until December 11, 2005, and provides that the Company will receive $4.8 million
annually from AOL, payable in monthly increments of $400,000, in exchange for
providing, maintaining and customizing the AOL yellow pages directory platform
and inclusion of current AOL merchants in our yellow pages platform. In
addition, the amended agreement creates the opportunity for both parties to
share in revenue generated from advertising products that combine both AOL's and
Switchboard's consumer audience. The revenue sharing arrangement, based on a
percentage of AOL merchant subscription revenue, that was previously in effect
has been eliminated. AOL and Switchboard are now able to sell advertising
products offering both local merchant and national advertisers access to the
combined consumer audience of both AOL and Switchboard yellow pages. As part of
the consideration for the $4.8 million annual fee, if requested by AOL, the
11
Company is obligated to provide AOL with up to 3,000 hours of engineering
services per fiscal quarter in order to customize and further AOL's directory
platform. In addition, AOL may carry-over up to 1,000 of its unused engineering
hours into the next quarter. At no time at the end of any fiscal quarter may the
unused hours carried forward exceed 1,000 hours. Revenue attributable to any
unused hours that are carried forward into the following fiscal quarter will be
valued using our standard hourly rates for engineering services and will be
deferred until the hours carried forward are either used or the right to use
them expires. The Company will bill AOL on a time and materials basis for any
hours of engineering services in excess of the 3,000 hours per quarter and
recognize this revenue during the period in which the engineering services are
delivered.
Subsequent to September 30, 2003, Mr. Greenlaw has made payments totaling
$560,000 to the Company in repayment of the Company's note receivable from Mr.
Greenlaw. These payments were applied first to accrued interest, and the
remaining amount was applied to outstanding principal. As of November 13,
2003, the remaining balance due from Mr. Greenlaw under the note was
approximately $291,000.
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 23, 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 national banner and site sponsorship advertising on
our directory website, www.switchboard.com. We now primarily derive revenue from
advertisements that are placed in the Switchboard-powered directory platforms of
our licensees, as well as merchant advertisers on our own website,
www.switchboard.com.
Net merchant network revenue includes revenue from various licensing
agreements with our directory platform licensees. These agreements involve,
generally, (1) a setup fee for engineering work to develop a web-hosted platform
for our licensees which looks and feels like the licensees' own website and
includes our searching functionality, and (2) a royalty in the form of a fixed
fee per merchant based on the number of merchant advertisements promoted in
their platform, or a percentage of revenue generated from those merchant
advertisements. Net merchant network revenue also includes revenue from running
priority placement, local performance based, and content targeted advertising in
the Switchboard.com yellow pages directory, and building and hosting websites
for local merchant advertisers. 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 the three and nine months ended September
30, 2003, approximately 89.9% and 89.0% of our net revenue was derived from our
local merchant network as compared to 88.4% and 88.1% in the three and nine
months ended September 30, 2002, respectively.
Our largest and most significant directory platform licensee is AOL. We
paid AOL $13.0 million in December 2000 and $2.0 million in April 2002, and
issued 746,260 shares of our common stock to AOL. In October 2003, we amended
12
our agreement with AOL. The October 2003 amendment, among other things, extended
the term of the agreement for an additional year until December 11, 2005, and
provides that we will receive $4.8 million annually from AOL, payable in monthly
increments of $400,000, in exchange for providing, maintaining and customizing
the AOL yellow pages directory platform and inclusion of current AOL merchants
in our yellow pages platform. In addition, the amended agreement creates the
opportunity for both parties to share in revenue generated from advertising
products that combine both AOL's and Switchboard's consumer audience. The
revenue sharing arrangement, based on a percentage of AOL merchant subscription
revenue, that was previously in effect has been eliminated.
AOL and Switchboard are now able to sell advertising products offering both
local merchant and national advertisers access to the combined consumer audience
of both AOL and Switchboard yellow pages. As part of the consideration for the
$4.8 million annual fee, if requested by AOL, we are obligated to provide AOL
with up to 3,000 hours of engineering services per fiscal quarter in order to
customize and further AOL's directory platform. In addition, AOL may carry-over
up to 1,000 of its unused engineering hours into the next quarter. At no time at
the end of any fiscal quarter may the unused hours carried forward exceed 1,000
hours. Revenue attributable to any unused hours that are carried forward into
the following fiscal quarter will be valued using our standard hourly rates for
engineering services and will be deferred until the hours carried forward are
either used or the right to use them expires. We will bill AOL on a time and
materials basis for any hours of engineering services in excess of the 3,000
hours per quarter and recognize this revenue during the period in which the
engineering services are delivered.
In the three and nine months ended September 30, 2003, AOL consulting and
service fees totaled $144,000 and $1.4 million, respectively. In the three and
nine months ended September 30, 2002, AOL consulting and service fees totaled
$538,000 and $1.1 million, respectively. Revenue recognized from AOL, including
consulting and service fees, was $1.6 million, or 39.6% of net revenue, and $5.1
million, or 44.3% of net revenue, for the three and nine months ended September
30, 2003, respectively. Revenue recognized from AOL, net of amortization of
consideration given to AOL and including consulting and services fees, was $1.7
million, or 51.8% of net revenue, and $3.1 million, or 37.0% of net revenue, for
the three and nine months ended September 30, 2002. We anticipate that AOL will
continue to represent a significant percentage of our revenue throughout the
remainder of 2003 and will be a material component of our overall business. Net
amounts due from AOL included in accounts receivable at September 30, 2003 and
December 31, 2002 were $1.3 million and $549,000, respectively. As of September
30, 2003, AOL owned 1,496,260 shares, or approximately 7.9%, of our common
stock.
We also continue to generate revenue from the sale of national advertising
and site sponsorship revenue on white and yellow pages, as well as maps pages,
across both www.switchboard.com and the websites of several directory platform
licensees. 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 the three and nine months ended September 30, 2003,
approximately 10.1% and 11.0% of our net revenue was derived from the sale of
national advertising and site sponsorships, as compared to 11.6% and 11.9% in
the three and nine months ended September 30, 2002, respectively.
Our cost of revenue consists primarily of expenses paid to third parties
under data licensing and website creation and hosting agreements and search
engine inclusion expense, as well as other direct expenses incurred to maintain
the operations of our website as well as the web-hosted platforms of our
licensees. 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.
13
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 expense based on employee headcount.
We have experienced substantial net losses. As of September 30, 2003, we
had an accumulated deficit of $107.4 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.
On October 23, 2003, we filed a Registration Statement on Form S-1 in
connection with a proposed underwritten offering of 8,815,171 shares of our
common stock, plus an over-allotment option of 1,322,250 shares. Of the shares
proposed to be sold, including the over-allotment option, 10,037,421 shares are
proposed to be sold by ePresence, Inc. and certain other selling shareholders,
and 100,000 shares are proposed to be sold by us. The offering is being
initiated by ePresence in order to facilitate an orderly disposition of its
Switchboard holdings in conjunction with its recently announced plan of
liquidation. At the completion of the offering, ePresence will own 5.7% of our
shares. If the over-allotment option is exercised and the additional 1,322,250
shares are sold, ePresence will no longer own any shares of Switchboard. The
sale of ePresence's entire holdings of our stock is subject to the approval of
ePresence's shareholders. However, ePresence may sell up to approximately 5.4
million of its shares of Switchboard stock without the approval of its
shareholders.
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, November 2002 and October 2003, certain terms of the
agreement were amended. Prior to the October 2003 amendment of the Directory
Agreement, we shared with AOL specified directory advertisement revenue. In
general, we received a majority of the first $12.0 million of such directory
advertisement revenue, less approximately $1.0 million of billable engineering
revenue earned from AOL after June 30, 2002, and received a lesser share of any
additional directory advertisement revenue. 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. The November 2002 amendment, among other things, provided for the
14
delivery of administrative services to AOL for the management of merchants who
signed up for advertising in the AOL yellow pages using a self-service tool that
we created for AOL. We no longer provide these administrative services to AOL.
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. Prior to the October 2003 amendment of the
Directory Agreement, we were 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 were provided to support the Directory Platform, from
which we shared in directory advertising revenue over the term of the agreement.
Any engineering services provided by us in excess of 300 hours per month were
charged to AOL on a time and materials basis. AOL typically exceeded these 300
hours each month. In the three and nine months ended September 30, 2003, AOL
consulting and service fees totaled $144,000 and $1.4 million, respectively. In
the three and nine months ended September 30, 2002, AOL consulting and service
fees totaled $538,000 and $1.1 million, respectively.
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. Pursuant to
the April 2002 amendment, the requirement to issue additional shares upon the
two and three-year continuations was eliminated. If we renew the Directory
Agreement with AOL for at least an additional four years after the current 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 31, 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 $2.0 million in the nine months ended
September 30, 2002. There was no amortization of AOL assets in the nine months
ended September 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.
In October 2003, we amended our agreement with AOL. The October 2003
amendment, among other things, extended the term of the agreement for an
additional year until December 11, 2005, and provides that we will receive $4.8
million annually from AOL, payable in monthly increments of $400,000, in
exchange for providing, maintaining and customizing the AOL yellow pages
directory platform and inclusion of current AOL merchants in our yellow pages
platform. In addition, the amended agreement creates the opportunity for both
parties to share in revenue generated from advertising products that combine
both AOL's and Switchboard's consumer audience. The revenue sharing arrangement,
based on a percentage of AOL merchant subscription revenue, that was previously
in effect has been eliminated.
AOL and Switchboard are now able to sell advertising products offering both
local merchant and national advertisers access to the combined consumer audience
15
of both AOL and Switchboard yellow pages. As part of the consideration for
the $4.8 million annual fee, if requested by AOL, we are obligated to provide
AOL with up to 3,000 hours of engineering services per fiscal quarter in order
to customize and further AOL's directory platform. In addition, AOL may
carry-over up to 1,000 of its unused engineering hours into the next quarter. At
no time at the end of any fiscal quarter may the unused hours carried forward
exceed 1,000 hours. Revenue attributable to any unused hours that are carried
forward into the following fiscal quarter will be valued using our standard
hourly rates for engineering services and will be deferred until the hours
carried forward are either used or the right to use them expires. We will bill
AOL on a time and materials basis for any hours of engineering services in
excess of the 3,000 hours per quarter and recognize this revenue during the
period in which the engineering services are delivered.
In the event that the Agreement is terminated pursuant to the terms of the
Agreement, the parties will begin a "Wind-Down Period" for a period of time to
be determined by AOL, up to a maximum of three years from the date of
termination. During the Wind-Down Period, we will continue to provide AOL with
directory platform services, and AOL shall pay us a monthly fee of $250,000
(reduced from $400,000 per month) and shall also pay us for any engineering
hours in excess of 300 hours per month. We will not be obligated provide AOL
with 3,000 hours per quarter during the Wind-Down Period.
16
Results of Operations
The following table presents certain consolidated statement of operations
information stated as a percentage of total net revenue:
Change three Change nine
months ended months ended
September September
Three Months Ended September 30, 30, 2003 vs Nine Months Ended September 30, 30, 2003 vs
-------------------------------- September ------------------------------- September
Net revenue: 2003 2002 30, 2002 2003 2002 30, 2002
---- ------ ------------ ---- ----- ------------
Merchant network..................... 89.9 % 88.4 % 23.8 % 89.0 % 88.1 % 38.0 %
National advertising................. 10.1 % 11.6 % 5.9 % 11.0 % 11.9 % 26.6 %
----- ----- ---- ----- ----- ----
Total net revenue.................. 100.0 % 100.0 % 21.8 % 100.0 % 100.0 % 36.6 %
===== ===== ==== ===== ===== ====
Cost of revenue........................ 16.1 % 28.2 % (30.4)% 19.1 % 35.6 % (26.8)%
---- ------ ----- ---- ----- -----
Gross profit....................... 83.9 % 71.8 % 42.2 % 80.9 % 64.4 % 71.7 %
Sales and marketing.................... 22.2 % 33.4 % (19.0)% 21.4 % 44.2 % (34.0)%
Research and development............... 28.7 % 40.8 % (14.3)% 29.9 % 50.2 % (18.7)%
General and administrative............. 18.1 % 47.6 % (53.7)% 22.5 % 36.3 % (15.4)%
Revision of restructuring estimate - % - % - % (0.3)% - % n/a
---- ------ ----- ---- ----- -----
Total operating expenses........... 69.1 % 121.8 % (31.0)% 73.4 % 130.8 % (23.3)%
---- ------ ----- ---- ----- -----
Operating income (loss) ........... 14.8 % (50.0)% 136.1 % 7.4 % (66.4)% 115.3 %
Other income, net.................. 4.1 % 9.1 % (44.8)% 4.6 % 21.2 % (70.5)%
---- ------ ----- ---- ----- -----
Income (loss) before income taxes... 18.9 % (41.0)% 156.3 % 12.0 % (45.2)% 136.3 %
---- ------ ----- ---- ----- -----
Provision for income taxes.......... 0.4 % - % n/a 0.2 % - % n/a
---- ------ ----- ---- ----- -----
Net income (loss) ................. 18.5 % (41.0)% 155.1 % 11.8 % (45.2)% 135.6 %
==== ===== ===== ==== ===== =====
Revenue
Net revenue increased 21.8% to $4.1 million for the three months ended
September 30, 2003, compared with $3.4 million for the corresponding period in
2002. Net revenue increased 36.6% to $11.4 million for the nine months ended
September 30, 2003, compared with $8.4 million for the corresponding period in
2002. The increases for both the three and nine months ended September 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 23.8% to $3.7 million for the three
months ended September 30, 2003, compared with $3.0 million for the
corresponding period in 2002. Net merchant network revenue increased 38.0% to
$10.2 million for the nine months ended September 30, 2003, compared with $7.4
million for the corresponding period in 2002.
17
The increase in net merchant network revenue in the three months ended
September 30, 2003 was attributable primarily to an increase of $1.2 million in
licensing revenue from new and existing directory platform licensees, including
AOL, offset in part by a decrease of $481,000 in engineering and other services
revenue.
The increase in net merchant network revenue for the nine months ended
September 30, 2003 was primarily due to a reduction in amortization of
consideration given to AOL as a result of the elimination of such amortization
in August 2002 upon the amendment to the Directory Agreement with AOL. Net
amortization of consideration given to AOL was $2.0 million in the nine months
ended September 30, 2002. There was no amortization of consideration given to
AOL in the nine months ended September 30, 2003. The increase in net merchant
network revenue in the nine months ended September 30, 2003 was also
attributable to an increase of $782,000 in licensing revenue from new and
existing directory platform licensees, as well as $261,000 in additional revenue
from engineering services.
National advertising and site sponsorship revenue increased 5.9% to
$414,000 for the three months ended September 30, 2003, compared with $391,000
for the corresponding period in 2002. National advertising and site sponsorship
revenue increased 26.6% to $1.3 million for the nine months ended September 30,
2003, compared with $993,000 for the corresponding period in 2002. The increase
in national advertising and site sponsorship revenue for both the three and nine
months ended September 30, 2003 resulted primarily from the addition of new
customers and an increase in revenue from existing customers. The increase in
revenue from existing customers was due primarily to an increase in the rate
charged to those existing customers and additional advertising placements on our
site, as well as an increase in traffic to our Web site.
Cost of Revenue
Cost of revenue decreased 30.4% to $662,000, or 16.1% of net revenue, for
the three months ended September 30, 2003, compared with $951,000, or 28.2% of
net revenue, for the corresponding period in 2002. Cost of revenue decreased
26.8% to $2.2 million, or 19.1% of net revenue, in the nine months ended
September 30, 2003, compared with $3.0 million, or 35.6% of net revenue, for the
corresponding period in 2002.
Cost of revenue decreased for the three months ended September 30, 2003
primarily as a result of a decrease of $101,000 in the cost of third-party data
and decreases in salaries and benefits associated with the delivery of
engineering services, which are classified as cost of revenue. The decrease in
the three months ended September 30, 2003 was also due, to a lesser extent, to
decreases in data communication fees and Web site creation and hosting fees in
connection with our merchant services programs. These decreases in cost of
revenue were offset in part by an increase in search engine inclusion expense.
Cost of revenue decreased for the nine months ended September 30, 2003
primarily as a result of a decrease of $236,000 in Web site creation and hosting
fees in connection with our merchant services programs and a decrease of
$216,000 in the cost of third-party data. The decrease in the nine months ended
September 30, 2003 was also due, to a lesser extent to a decrease in expenses
resulting from a lower margin merchant services project performed for a
directory platform licensee, and completed, in 2002 and a decrease in data
communication fees. These decreases in cost of revenue were offset in part by an
increase in search engine inclusion expense.
Gross Profit
Gross profit increased 42.2% to $3.4 million, or 83.9% of net revenue, for
the three months ended September 30, 2003, compared with $2.4 million, or 71.8%
18
of net revenue, for the corresponding period in 2002. Gross profit increased
71.7% to $9.2 million, or 80.9% of net revenue, in the nine months ended
September 30, 2003, compared with $5.4 million, or 64.4% of net revenue, for the
corresponding period in 2002. The increase in gross profit dollars and
percentage for both the three and nine months ended September 30, 2003 was
primarily due to the reduction in the amortization of consideration given to AOL
discussed above, an overall increase in gross revenue and a decrease in cost of
revenue due to lower margin engineering services making up a smaller portion of
gross revenue.
Sales and Marketing
Sales and marketing expenses decreased 19.0% to $913,000 for the three
months ended September 30, 2003, compared with $1.1 million for the
corresponding period in 2002. Sales and marketing expenses decreased 34.0% to
$2.4 million for the nine months ended September 30, 2003, compared with $3.7
million for the corresponding period in 2002.
The decrease for the three months ended September 30, 2003 was primarily
related to a decrease of $131,000 in merchant program expenses. The decrease for
the three months ended September 30, 2003 was also due, to a lesser extent, to
decreases in facilities expenses, depreciation expense and public relations
expense. The decrease for the nine months ended September 30, 2003 was primarily
due to a decrease of $538,000 in merchant program expenses and a reduction of
expense by $200,000 resulting from a payment from AOL for the final settlement
of our prior agreement with AOL, which was terminated in March 1999. The
decrease in sales and marketing expense for the nine months ended September 30,
2003 was also due, to a lesser extent, to decreases in public relations expense,
facilities expenses and depreciation expense.
Research and Development
Research and development expenses decreased 14.3% to $1.2 million for the
three months ended September 30, 2003, compared with $1.4 million for the
corresponding period in 2002. Research and development expenses decreased 18.7%
to $3.4 million for the nine months ended September 30, 2003, compared with $4.2
million for the corresponding period in 2002.
The decrease for the three months ended September 30, 2003 was due
primarily to decreases in facilities expenses, salaries and benefits, and
depreciation. The decrease for the nine months ended September 30, 2003 was due
primarily to decreases in salaries and benefits of $286,000, consulting expense
of $195,000 and facilities expenses of $176,000. The decrease in research and
development expense for the nine months ended September 30, 2003 was also due,
to a lesser extent, to decreases in equipment and software maintenance contract
expenses and depreciation expense.
General and Administrative
General and administrative expenses decreased 53.7% to $743,000 for the
three months ended September 30, 2003, compared with $1.6 million for the
corresponding period in 2002. General and administrative expenses decreased
15.4% to $2.6 million for the nine months ended September 30, 2003, compared
with $3.0 million for the corresponding period in 2002.
The decrease for the three months ended September 30, 2003 was primarily
due to a decrease in expenses of $633,000 we incurred in the 2002 period for
professional services related to the amending of our Annual Report on Form 10-K
for the year ended December 31, 2001 and our Quarterly Report on Form 10-Q for
the three months ended March 31, 2002 and the restatement of the financial
statements included therein. The decrease in general and administrative expense
in the three months ended September 30, 2003 was also due, to a lesser extent,
to a reduction in expense due to our revision of our estimate of the liability
required for potential damages resulting from a class action lawsuit filed
19
against the Company and certain of its current and former officers, as well as
decreases in other professional services, insurance expense and employee
compensation and benefits. These decreases were offset in part by an increase in
separation benefit expenses resulting from Mr. Greenlaw's resignation as
Switchboard's CEO.
The decrease for the nine months ended September 30, 2003 was primarily due
to the $633,000 we incurred in the 2002 period for professional services
resulting from the aforementioned restatements. The decrease in general and
administrative expense in the nine months ended September 30, 2003 was also due,
to a lesser extent, to a decrease in insurance expense and the reduction of
expense resulting from the revision of our estimate of our liability for damages
resulting from the class action lawsuit described above. These decreases were
offset in part by separation benefit expenses resulting from Mr. Greenlaw's
resignation.
Revision of Restructuring Estimate
In the fiscal quarter 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 September 30, 2003, we had a remaining liability of $13,000 for
the 2001 special charges related primarily to our remaining net lease
obligations for a closed facility.
Other Income
Other income decreased 44.7% to $169,000 for the three months ended
September 30, 2003, compared with $306,000 for the corresponding period in 2002.
Other income decreased 70.5% to $523,000 for the nine months ended September 30,
2003, compared with $1.8 million for the corresponding period in 2002. The
decreases in the three and nine months ended September 30, 2003 were 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, offset
in part by a decrease in bank fees and interest expense.
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 the 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 $16,000 and $28,000 in the three and nine months ended September 30,
2003, respectively.
Net Income (Loss)
Net income increased to $762,000 in the three months ended September 30,
2003 from a net loss of $1.4 million in the three months ended September 30,
2002. Net income increased to $1.3 million in the nine months ended September
30, 2003 from a net loss of $3.8 million in the nine months ended September 30,
2003. As of September 30, 2003, our accumulated deficit totaled $107.4 million.
20
Liquidity and Capital Resources
As of September 30, 2003, we had total cash and marketable securities of
$52.9 million, consisting of $42.1 million of cash and cash equivalents, $8.7
million of short-term marketable securities, $2.1 million of long-term
marketable securities and $36,000 of restricted cash. During the nine months
ended September 30, 2003, cash and cash equivalents increased by $3.7 million,
primarily due to cash provided by investing activities of $4.5 million and cash
provided by operating activities of $1.5 million, offset in part by net cash
used for financing activities of $2.3 million.
Net cash provided by operating activities for the nine months ended
September 30, 2003 was $1.5 million, primarily due to net income of $1.3 million
and non-cash income and expenses of depreciation and amortization of $938,000,
amortization of unearned compensation of $109,000 and non-cash interest income
on a note receivable of $53,000. The increase in cash was also due to an
increase of $337,000 in accrued expenses and a decrease of $160,000 in unbilled
receivables. These increases were offset in part by an increase of $984,000 in
accounts receivable and $444,000 in other current assets.
Net cash provided by investing activities for the nine months ended
September 30, 2003 was $4.5 million, primarily due to $3.2 million in proceeds
from sales of marketable securities and a decrease of $1.6 million in restricted
cash, offset in part by purchases of marketable securities of $229,000.
Net cash used in financing activities for the nine months ended September
30, 2003 was $2.3 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 $1.7 million from the issuance of stock. Of the $1.7 million
in proceeds from the issuance of stock, $1.6 million was received in the three
months ended September 30, 2003 resulting primarily from employee stock option
exercises.
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, after we chose not to extend the agreement.
In May 2003, we paid SVB $1.8 million in satisfaction of our outstanding
borrowings under the loan facility.
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.
21
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.
The following table summarizes our long-term contractual obligations as of
September 30, 2003 (in thousands):
Less Than 1 Year 1-3 Years Total
---------------- --------- ------
Operating lease obligations (a) $156 $105 $ 261
Other long-term obligations (b) 419 456 875
---- ---- ------
Total $575 $561 $1,136
==== ==== ======
(a) Excludes our operating lease for our principal administrative, sales and
marketing, and research and development facility located in Westborough,
Massachusetts, which expires on December 31, 2003. We are currently
negotiating with ePresence to extend our operating lease through
September 30, 2005.
(b) Consists of scheduled payments under various third-party data licensing
agreements.
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
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
22
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 addition to bad debts arising from
the failure to collect monies due from our customers for products and services
delivered, under the Directory Agreement we previously shared a portion of bad
debts incurred by AOL. Prior to the October 2003 amendment of the Directory
Agreement, the royalty we received from AOL was primarily based upon revenue
recognized by AOL in the period, less any commissions paid on such revenue and
any amounts written off by AOL as bad debt. For periods prior to the fiscal
quarter ended June 30, 2003, we established and maintained a sales allowance to
reserve for our estimate of our portion of AOL's future bad debts associated
with revenue recognized during the period based upon AOL's historical bad debt
experience. We had previously identified our estimation of our portion of AOL's
bad debts as a critical accounting policy. Beginning in April 2003 and until the
October 2003 amendment of the Directory Agreement, we recognized royalty revenue
from AOL based upon our percentage of directory revenue that was both earned and
collected by AOL. Given that we recorded royalty revenue during this period from
AOL based upon revenue collected by AOL, there was no longer a need for us to
estimate and provide for a sales allowance for AOL. Further, the October 2003
amendment eliminates the sharing of revenue based upon collected revenue. Future
calculation of revenue sharing from sales of advertising products that combine
the consumer audience of both AOL and Switchboard yellow pages will not
contemplate uncollectable amounts. Therefore, we no longer consider our
estimation of our portion of AOL's bad debts to be a critical accounting policy.
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.
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 Securities and Exchange
Commission.
RISKS RELATED TO OUR BUSINESS
If the directory agreement we entered into with America Online, Inc., a
subsidiary of AOL Time Warner Inc. ("AOL") (the "Directory Agreement"), is not
successful, is terminated prematurely or is not renewed on substantially similar
or favorable terms, it would have a materially negative effect on our results of
operations.
Prior to the October 2003 amendment of the Directory Agreement, we shared
with AOL specified directory advertisement revenue. The October 2003 amendment
extends the initial term of the Directory Agreement through December 2005. Among
23
other things, the October 2003 amendment provides that we will receive $4.8
million annually from AOL in exchange for providing, maintaining and customizing
the AOL yellow pages directory platform and including existing AOL yellow pages
local advertisers in our Switchboard.com directory. In addition, the amendment
creates the opportunity for both parties to share in revenue generated from
advertising products that combine the consumer audience of both AOL and
Switchboard. The revenue sharing arrangement based on a percentage of AOL
merchant subscription revenue that was previously in effect has been eliminated.
The exact nature and terms of the combined advertising products have yet to
be fully defined. Any future growth in revenue under the Directory Agreement is
dependent upon the acceptance of these combined products by advertisers and our
ability to sell these products, for which we have no prior experience. There can
be no assurances that we will be successful in selling these advertisements.
Even though we have amended the Directory Agreement, the Directory
Agreement may still be prematurely terminated due to a breach by either party.
Further, 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. The termination or expiration of our
Directory Agreement with AOL would have a material adverse effect on our results
of operations and financial condition.
If we renew the Directory Agreement with AOL for at least an additional
four years after the initial term (through at least December, 2009), 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 issuance of such warrants may have a
material adverse effect on our operating results and dilute the ownership of
existing shareholders.
AOL accounted for $1.6 million, or 39.6% of total net revenue, and $5.1
million, or 44.3% of total net revenue, in the three and nine months ended
September 30, 2003, and accounted for $4.9 million, or 41.8% of net revenue,
during 2002. Under the amended Directory Agreement, AOL will be obligated to pay
us $4.8 million per year and there is no assurance that any additional revenue
will be recognized from the Directory Agreement. The new arrangement by which
both Switchboard and AOL will share in the revenues associated with the sale of
combined advertising products may not be successful and may not generate any
additional revenue for us.
We have a history of incurring net losses, we may incur net losses during future
quarters and we may not sustain or improve our current financial performance or
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 September 30, 2003,
we have an accumulated deficit totaling $107.4 million. We need to generate
substantial revenue to fund our operations. Although we recorded a profit in
each of the fiscal quarters ended March 31, 2003, June 30, 2003 and September
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.
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 due to the concentration of revenue generated
from our relationship with AOL. 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.
24
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;
* a decline in Internet traffic at our website and the websites of our
licensees;
* 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.
Additionally, our results of operations may fluctuate due to the
significant contribution of our relationship with AOL to our revenue. Although
we have recently amended the Directory Agreement to provide for an annual
license fee of $4.8 million, our quarterly results of operations may fluctuate
depending upon the amount of engineering services we provide to AOL and the
amount of revenue generated by advertising products that combine the consumer
audience of AOL and Switchboard. AOL has the right to carry forward up to 1,000
unused hours of engineering per quarter into the next quarter. At no time at the
end of any fiscal quarter may the unused hours carried forward exceed 1,000
hours. Revenue associated with any such hours of engineering services carried
forward would also be deferred until such time as the engineering services are
delivered to AOL, or AOL's right to use those hours expires. As a result, our
revenue, results of operations and cash flows from operating activities could
fluctuate on a quarterly basis.
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 strategic customer and supplier relationships to grow our business
and our business may not grow if the relationships 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 customer relationships, particularly those with directory platform
licensees. The success of our directory platform depends in substantial part
upon our ability to access a broad base of local merchants. The target merchant
base is highly fragmented and local merchants are difficult to contact
efficiently and cost-effectively. Consequently, we depend on relationships with
licensees who license our directory platform technology to sell Internet yellow
pages advertising to local merchants and provide them billing and other
administrative services. The termination of any strategic relationship with a
directory platform licensee could significantly impair our ability to attract
potential local merchant customers.
In addition to our relationship with AOL, we have entered into strategic
relationships with additional licensees of our technology and supplier
relationships with 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 the early stages
of development. These relationships may not provide us benefits that outweigh
the 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
website, 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 customer or supplier, we may be unable to replace
25
that relationship with other strategic relationships with comparable revenue
potential, content or user demographics.
If we cannot demonstrate the value of our advertising products to merchants,
those merchant customers may stop purchasing our advertising products, which
could reduce our revenue and have a material adverse effect on our results of
operations.
We may be unable to demonstrate the value of our advertising products to
merchants. If local merchants cancel their advertising, our revenue could
decline and we may need to incur additional expenditures to obtain new local
merchant advertisers. We do not presently provide data demonstrating the number
of leads generated by the advertising that merchants have purchased. Regardless
of whether our merchant advertising products effectively produce leads, merchant
advertisers may not know the source of the leads and may cancel their
advertising.
The attractiveness of our advertising products 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 a significant disruption to 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 products.
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 website
as well as the websites of our directory platform licensees and our merchant
advertisers, and diminish the attractiveness of our service offerings to those
licensees, merchant advertisers and content providers.
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 who license our technology and sell our products. During the three and
nine months ended September 30, 2003, net revenue derived from our top ten
customers accounted for approximately 69.4% and 69.7% of our total net revenue,
respectively. Additionally, net revenue derived from AOL alone accounted for
39.6% and 44.3% of our total net revenue in the three and nine months ended
September 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.
26
Our pay for performance based advertising is a new business offering, and we may
be unable to successfully market this service to new and existing customers and
we may be unable to develop reliable administrative tools required to support
the new business offering, which could adversely affect our revenue.
We recently introduced our LocalClicks(SM) pay for performance advertising
service. This is a new aspect of our business, and we do not have any
significant prior experience in marketing or providing this type of advertising
product. Our failure to successfully attract merchant advertisers to the
LocalClicks product could adversely effect our ability to generate revenue.
We use internally developed software to administer and support our pay for
performance based advertising. This software is still being refined, and may
contain undetected errors, defects or bugs. We may discover significant errors
or defects in the future that we may not be able to fix. Our inability to detect
or fix any such errors or defects could limit our ability to provide our
services and collect payments, and it may impair the reputation of our brand and
our services and our ability to accurately monitor performance based
advertising, and generally diminish the attractiveness of our service offerings
to our customers.
Our sales strategy for LocalClicks and our other advertising products may
include broad direct sales initiatives to local and national merchants.
Historically, we have primarily relied on third parties to sell our advertising
products. Expanding our direct channel would be a new aspect of our business.
Our failure to successfully attract merchant advertisers and the increased
expenses associated with direct sales could adversely affect our results of
operations.
If we do not introduce new or enhanced offerings to our directory platform
licensees and our advertisers, we may be unable to attract and retain those
customers, which would significantly impede our ability to generate revenue.
We need to introduce new or enhanced products to attract and retain
directory platform licensees and advertisers, 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 website 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 directory platform licensees, which would significantly impede our
revenue growth. In addition, if any new product or service introduction, such as
our LocalClicks pay for performance advertising product, 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.
The markets for Internet content 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
27
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 websites
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 or
technology that is superior to ours or that achieves greater market acceptance
than ours, we may not be able to develop alternative content or technology in a
timely, cost-effective manner, or at all, and we may lose market share.
We may have to relocate our operations, and our business may suffer as a result.
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 directory platform licensees. 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
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 licensees. 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 directory platform licensees. Such an interruption could have a
material adverse effect on our cash flows and results of operations.
Our lease with ePresence for our headquarters located in Westborough,
Massachusetts expires in December 2003. Although we are negotiating with
ePresence to extend the term of our lease, in the event we are unsuccessful in
extending the term, we will be required to find a new location for our corporate
headquarters. We may incur greater expense at a new location, and such a
transition could result in an interruption of our daily business operations.
Our business may suffer if we lose the services of our Chief Executive Officer
and 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 Dean Polnerow, our Chief Executive
Officer and founder. Our business may suffer if we lose the services of 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
28
strategy. In addition, we may need to pay higher compensation to employees than
we currently expect.
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 website or
our directory platform licensees' websites 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 website, 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 website 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.
Our success depends both on our internally developed technology and our
third party technology. We rely on a variety of trademarks, service marks and
designs to promote brand name development and recognition. We also rely on a
combination of contractual provisions, confidentiality procedures and patent,
trademark, copyright, trade secrecy, unfair competition, and other intellectual
property laws to protect the proprietary aspects of our products and services.
These legal measures afford limited protection and may not prevent our
competitors from gaining access to our intellectual property and proprietary
information. In addition, there can be no assurance that courts will always
uphold our intellectual property rights, or enforce the contractual arrangements
that we have entered into to protect our proprietary technology. Any of our
patents may be challenged, invalidated, circumvented or rendered unenforceable.
Furthermore, we cannot assure you that any pending patent application held by us
will result in an issued patent, or that if patents are issued to us, such
patents will provide meaningful protection against competitors or competitive
technologies.
Litigation may be necessary to enforce our intellectual property rights, to
protect our trade secrets and to determine the validity and scope of our
proprietary rights. Any litigation could result in substantial expense, may
reduce our profits and may not adequately protect our intellectual property
rights. In addition, we may be exposed to future litigation by third parties
based on claims that our products or services infringe their intellectual
property rights. Any litigation or claim against us, whether or not successful,
could result in substantial costs and harm our reputation. In addition,
intellectual property litigation could force us to do one or more of the
29
following: cease selling or using any of our products that incorporate the
challenged intellectual property, which would adversely affect our revenue;
obtain a license from the holder of the intellectual property right alleged to
have been infringed, which license may not be available on reasonable terms, if
at all; and redesign or, in the case of trademark claims, rename our products to
avoid infringing the intellectual property rights of third parties, which may
not be possible and nonetheless could be costly and time-consuming.
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.
Recent legislative actions and proposed amendments to the Nasdaq listing
standards will require changes in our board of directors and the implementation
of other corporate governance initiatives, which may be difficult and expensive
to achieve.
To satisfy the director independence requirements of the provisions of the
Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), recently adopted
accounting rules, and proposed amendments to the Nasdaq listing standards, we
will be required to substantially reconfigure the composition of our board of
directors, audit committee, nominating committee, and compensation committee
such that a majority of our board of directors and all of the members of our
audit, nominating and compensation committees are considered to be independent
under applicable regulatory standards. We will also be required to form a
corporate governance committee. We currently have a strategy to reconfigure our
board and board committees, and we do not anticipate any problems implementing
this strategy, however we may not be successful in identifying qualified
individuals who are deemed to be independent under applicable standards and
willing to serve on our board of directors or board committees. Any failure to
reconfigure our board of directors and board committees with qualified
independent directors could cause us to be in violation of the Sarbanes-Oxley
Act and Nasdaq listing requirements, which could have an adverse effect on our
results of operations and the trading market for our common stock.
To implement other required corporate governance initiatives mandated by
the Sarbanes-Oxley Act, the Securities and Exchange Commission ("SEC") and the
proposed amendments to the Nasdaq rules, we may be required to enhance our
internal controls, hire additional personnel and utilize additional outside
legal, accounting and advisory services, all of which would cause our general
and administrative expenses to substantially increase. In order to attract and
retain independent directors, we expect to pay directors' fees estimated to
total at least $170,000 per year. We also expect that the premiums we pay for
directors' and officers' insurance policies will increase in the future as a
result of higher claim rates incurred by insurers on other insured companies in
recent years. These increased costs may adversely affect our operating results
in the absence of increased revenue.
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RISKS RELATED TO THE INTERNET
If the acceptance and effectiveness of Internet advertising does not become
fully established, our advertising revenue will suffer.
Our business model is heavily dependent upon increasing our sales,
primarily through the Switchboard-powered yellow pages platforms of our
licensees, of local online advertising solutions to local merchants and national
advertisers. The Internet advertising market is new and rapidly evolving, and
cannot yet be compared with traditional advertising media to gauge its
effectiveness. As a result, demand for and market acceptance of Internet
advertising is uncertain. If Internet advertising fails to gain wide acceptance
and to grow from year to year, our overall revenue will be affected. Similarly,
if use of Internet yellow pages by consumers does not increase, Internet yellow
pages advertising will not become more attractive to local merchant and national
advertisers, and our yellow pages advertising revenue will suffer.
Many of our directory platform licensees' current and potential local
merchant and national advertisers 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 merchant 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 website or
those of our directory platform licensees, 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 and other content over the
Internet. In addition, third-party websites are accessible through our website
or those of our directory platform licensees. 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 or through our website or websites of our
directory licensees. Other claims may be based on links to sexually explicit
websites 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
31
could misappropriate our proprietary information or cause interruptions in our
operations. Internet and online service providers have experienced, and may in
the future experience, interruptions in service as a result of the accidental or
intentional actions of Internet users, current and former employees or others.
We may need to expend significant resources protecting against the threat of
security breaches or alleviating problems caused by breaches. Eliminating
computer viruses and alleviating other security problems may require
interruptions, delays or cessation of service.
We may be sued for disclosing to third parties personal identifying information
without consent.
Individuals whose names, addresses and telephone numbers appear in our
yellow pages and white pages directories have occasionally contacted us because
their phone numbers and addresses were unlisted with the telephone company.
While we have not received any formal legal claims from these individuals, we
may receive claims in the future for which we may be liable. In addition, if we
begin disclosing to third parties personal identifying information about our
users without consent or in violation of our privacy policy, we may face
potential liability for invasion of privacy.
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 Internet 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
the extent to which 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.
32
RISKS RESULTING FROM OUR SECONDARY OFFERING
Our net operating loss carry-forwards for federal and state tax purposes may be
limited as a result of our secondary offering.
If our secondary offering is completed, it may have the effect of limiting
the usage of our existing net operating losses ("NOL's") to reduce taxes on our
future income. As of December 31, 2002, our NOL carry-forwards for federal and
state tax purposes were approximately $86.9 million and $86.8 million,
respectively. The change in ownership of Switchboard over the past several
years, as well as the consummation of our secondary offering, may cause a change
in control in our company as defined by the federal income tax codes. In
general, the annual usage of NOL carry-forwards following a change in control is
limited to our market value on the date of the change in control, multiplied by
the federal long-term tax exempt rate. As a result, our NOL usage in future
periods may be limited if our market value is inadequate to support our present
NOL's. The limitation of the usage of NOL's may result in additional income tax
liability in future periods, which additional taxes may negatively impact future
results of operations and cash flows from operating activities.
Our major shareholder is selling all or substantially all of its shares of our
common stock and if it completes that sale, it will no longer have the same
influence over our business or ability to enable, delay, deter or prevent a
change of control or other business combination.
On October 23, 2003, ePresence announced that it had signed a definitive
agreement to sell the assets of its services business to Unisys Corporation and
that its Board of Directors had approved a plan of liquidation of ePresence. As
of October 31, 2003 ePresence beneficially owned 9,802,421 shares, or 51.3%, of
our common stock. ePresence further announced its intention to sell these shares
in an underwritten public offering to facilitate an orderly distribution of its
shares held in Switchboard. A registration statement for this offering was filed
by Switchboard with the SEC on October 23, 2003. The sale of ePresence's assets,
sale of its entire holdings of Switchboard stock and the liquidation of
ePresence are subject to the approval of ePresence's shareholders.
If the public offering of ePresence's shares of Switchboard is completed,
ePresence will beneficially own approximately 5.7% of our common stock based
upon shares outstanding as of September 4, 2003 or, if the over-allotment option
is exercised in full, none of our common stock. In addition, three of our five
current directors are employees or directors of ePresence. There can be no
assurance that all of these directors will choose to remain directors after the
offering. Without a significant shareholder holding a majority of our common
stock it may be more difficult for the Company to effect a desirable business
combination or fend off a hostile bidder for control of the Company.
A large number of shares may be sold into the market following our secondary
offering, which may cause the price of our common stock to decline.
If the secondary offering of ePresence's shares of Switchboard is
completed, 19,000,173 shares of our common stock will be outstanding based upon
shares outstanding as of September 4, 2003. The 8,815,171 shares we and certain
stockholders are selling in the secondary offering, and the 1,322,250 shares
being offered by the selling stockholders if the underwriters exercise their
over-allotment option in full, will be freely tradable, without restriction or
further registration, under the federal securities laws unless purchased by our
affiliates. Previously, the shares offered were subject to restrictions
regarding sale without registration with the SEC. This represents a significant
increase in the number of shares eligible for sale without registration, which
could cause downward pressure on the trading price of our common stock. In
addition, our largest stockholder, ePresence, has announced its intention to
33
distribute to its stockholders or sell, in a public offering or otherwise, up to
all of its shares of our common stock not sold by ePresence in the offering.
If our secondary offering is not consummated or if ePresence sells less than all
of its shares in the secondary offering, ePresence may distribute its
Switchboard stock to its stockholders or sell it in open market or negotiated
transactions, which could cause the number of shares of Switchboard stock sold
into the market to increase significantly and cause the price of our common
stock to decline.
As a result of ePresence's announced plan of liquidation, if the secondary
offering is not consummated or if ePresence sells less than all of its shares in
the secondary offering, ePresence may distribute some or all of its Switchboard
stock to its stockholders or sell it in open market or negotiated transactions.
Shares distributed to ePresence stockholders who are not themselves affiliates
of Switchboard would be freely tradeable without volume or other restrictions.
This would represent a significant increase in the number of shares eligible for
sale without registration with the SEC, which could cause downward pressure on
the trading price of our common stock. If ePresence sells less than all of its
shares in the secondary offering, we intend to enter into arrangements whereby
ePresence and each of the selling stockholders involved in the offering will
agree that for a period of 90 days after the date of the prospectus related to
the secondary offering, they will not, without the prior written consent of the
lead underwriter of the secondary offering, offer, sell, or otherwise dispose of
any shares of our common stock or any securities convertible into or
exchangeable for shares of our common stock except for the shares of our common
stock offered in the offering, the shares of our common stock issuable upon
exercise of outstanding options on the date of the prospectus and the shares of
our common stock that are issued under the option plans. However, there can be
no assurance that ePresence or any other selling stockholder will agree to enter
into these arrangements.
Our stock price could be volatile, which could result in substantial losses for
stockholders and expose us to costly securities class action litigation.
The trading price of our common stock is likely to be volatile. The stock
market in general, and the market for technology and Internet-related companies
in particular, has experienced extreme volatility in recent years. This
volatility has often been unrelated to the operating performance of particular
companies. In the past, securities class action litigation has often been
brought against a company following periods of volatility in the market price of
its securities. Due to the potential volatility of our stock price, we may be
the target of securities litigation, which could result in substantial costs and
divert management's attention and resources.
Anti-takeover provisions in our charter documents and Delaware law could prevent
a potential acquiror from buying our stock.
Our certificate of incorporation and bylaws contain provisions that could
delay or prevent a change in control of our company, including provisions that:
* authorize the issuance of preferred stock that can be created and issued
by the board of directors without prior stockholder approval, commonly
referred to as "blank check" preferred stock, with rights senior to those
of common stock;
* prohibit stockholder actions by written consent; and
* provide for a classified board of directors.
In addition, we are governed by the provisions of Section 203 of Delaware
General Corporation Law. These provisions may prohibit stockholders owning 15%
or more of our outstanding voting stock from merging or combining with us. These
and other provisions in our certificate of incorporation and bylaws, and under
Delaware law, could discourage potential acquisition proposals, delay or prevent
a change in control or management or reduce the price that investors might be
willing to pay for shares of our common stock in the future.
34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our cash and cash equivalents are generally invested in investment grade
securities with maturities within two years. Consequently, we are exposed to
some financial market risks, including changes in interest rates. We invest in
securities solely for non-trading purposes. We typically do not attempt to
reduce or eliminate our market exposures on our investment securities and have
not entered into any hedges. 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 September 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 September 30, 2003. Based on this evaluation, our chief executive
officer and chief financial officer concluded that, as of September 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 September 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 November 21, 2001, a class action lawsuit was filed in the United States
District Court for the Southern District of New York naming as defendants
Switchboard, the managing underwriters of Switchboard's initial public offering,
Douglas J. Greenlaw, Dean Polnerow, and John P. Jewett. Mr. Polnerow is an
officer of Switchboard, and Mr. Greenlaw and Mr. Jewett are former officers 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.
35
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.
In the third quarter of 2003, Switchboard was informed by outside counsel
that all but two of the non-bankrupt issuers decided to accept the terms and
conditions of a proposed settlement of this case. The two issuers who did not
accept the proposal were in unique circumstances that do not apply to other
issuers. In addition, Switchboard was notified that the final settlement
agreements are currently being drafted, and that they are expected to be
available for distribution sometime in the fourth quarter of this year.
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 September 30, 2003, we used approximately
$20.3 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, Inc. approximately $410,000, and in June 2003 we paid
the former stockholders of Envenue an additional $1.7 million. As of September
30, 2003, we have invested the remaining net proceeds in interest-bearing, money
market funds and investment-grade securities.
36
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 July 29, 2003, the Company furnished a Current Report on Form 8-K dated
July 29, 2003 under Item 12 (Results of Operations and Financial Condition)
containing a copy of the Company's earnings release for the period ended June
30, 2003.
On August 21, 2003, the Company filed a Current Report on Form 8-K dated
August 21, 2003 under Item 5 (Other Events and Regulation FD Disclosure) and
Item 7 (Financial Statements and Exhibits) reporting the resignation of Douglas
J. Greenlaw as the Registrant's Chief Executive Officer and director and the
appointment of Dean Polnerow as Chief Executive Officer.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SWITCHBOARD INCORPORATED
Date: November 14, 2003 By:/s/Robert P. Orlando
--------------------
Robert P. Orlando
Vice President and Chief Financial Officer
(principal financial officer and chief
accounting officer)
38
EXHIBIT INDEX
Exhibit No. Description
- ----------- ------------------------------------------------------------------
10.1 Separation Agreement and General Release by and between
Switchboard Incorporated and Douglas Greenlaw dated August 21,
2003.
10.2 (1)+ Amended and Restated Directory and Local Advertising Platform
Services Agreement by and between Switchboard Incorporated and
America Online, Inc., dated October 15, 2003.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1 Section 1350 Certification of Chief Executive Officer.
32.2 Section 1350 Certification of Chief Financial Officer.
(1) Incorporated by reference to the Registrant's Current Report on Form 8-K
(File No. 000-28871) filed with the Securities and Exchange Commission on
October 16, 2003.
+ Confidential treatment requested as to certain portions, which portions
have been omitted and filed separately with the Securities and Exchange
Commission pursuant to a Confidential Treatment Request.
39