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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________________ to _________________
Commission File Number: 000-28871
SWITCHBOARD INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
Delaware 04-3321134
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
120 Flanders Road, 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 April 30, 2004
-------------- ---------------------------------------
Common Stock, par value $0.01 per share 19,203,941
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 website 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 website 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 website, 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 website'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 March 31, 2004 (unaudited) and
December 31, 2003 (audited).............................................. 3
Consolidated Statements of Operations (unaudited) for the Three
Months Ended March 31, 2004 and 2003..................................... 4
Consolidated Statements of Cash Flows (unaudited) for the Three
Months Ended March 31, 2004 and 2003..................................... 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.............................................................. 28
Item 4. -- Controls and Procedures........................................... 28
PART II -- Other Information
Item 1. -- Legal Proceedings................................................. 28
Item 2. -- Changes in Securities and Use of Proceeds......................... 29
Item 6. -- Exhibits and Reports on Form 8-K.................................. 29
Signatures................................................................... 31
2
ITEM 1. - FINANCIAL STATEMENTS
SWITCHBOARD INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
March 31, 2004 December 31, 2003
-------------- -----------------
(unaudited)
Assets:
Cash and cash equivalents $47,993 $47,265
Marketable securities 6,589 6,591
Restricted cash 36 36
Accounts receivable, net of allowance of $139 and $144, respectively 2,083 1,503
Other current assets 1,039 863
------- -------
Total current assets 57,740 56,258
Marketable securities 1,805 1,960
Property and equipment, net 659 794
Deferred offering costs - 511
------- -------
Total assets $60,204 $59,523
======= =======
Liabilities:
Accounts payable $ 1,721 $ 1,398
Accrued expenses 1,285 1,180
Deferred revenue 1,100 603
-------- --------
Total current liabilities 4,106 3,181
Non-current liabilities - -
-------- --------
Total liabilities 4,106 3,181
Commitments and contingencies - -
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 19,590,243 and 19,563,303 shares as of March 31, 2004 and
December 31, 2003, respectively. 196 196
Treasury stock, 386,302 shares at cost (1,255) (1,255)
Additional paid-in capital 164,156 164,053
Unearned compensation - (32)
Accumulated other comprehensive income 25 51
Accumulated deficit (107,024) (106,671)
-------- --------
Total stockholders' equity 56,098 56,342
-------- --------
Total liabilities and stockholders' equity $ 60,204 $ 59,523
======== ========
See accompanying notes.
3
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in thousands, except per share amounts)
Three months ended March 31,
----------------------------
2004 2003
------ ------
Revenue $4,153 $3,341
Cost of revenue 708 707
------ ------
Gross profit 3,445 2,634
------ ------
Operating expenses:
Sales and marketing 1,063 842
Research and development 893 1,114
General and administrative 867 804
Transaction costs 1,127 -
------ ------
Total operating expenses 3,950 2,760
------ ------
Loss from operations (505) (126)
Other income:
Interest income 157 228
Interest expense - (42)
Other expense (3) (4)
------ ------
Total other income 154 182
------ ------
(Loss) income before income taxes (351) 56
Provision for income taxes 2 -
------ ------
Net (loss) income $ (353) $ 56
====== ======
Net (loss) income per share:
Basic $(0.02) $ -
====== ===
Diluted $(0.02) $ -
====== ===
Weighted average number of common shares:
Basic 19,192 18,627
Diluted 19,192 19,055
See accompanying notes.
4
SWITCHBOARD INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Three Months Ended March 31,
----------------------------
2004 2003
------- -------
Cash flows from operating activities:
Net (loss) income $ (353) $ 56
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 224 326
Amortization of unearned compensation 32 36
Non-cash interest income on note receivable - (19)
Changes in operating assets and liabilities:
Accounts receivable (570) (173)
Other current assets (186) 24
Other assets 511 -
Accounts payable 323 (362)
Accrued expenses 108 170
Deferred revenue 497 77
------- -------
Net cash provided by operating activities 586 135
------- -------
Cash flows from investing activities:
Purchases of property and equipment (92) (20)
Decrease (increase) in restricted cash - (4)
Purchase of marketable securities (52) (92)
Proceeds from sales of marketable securities 183 1,920
------- -------
Net cash provided by investing activities 39 1,804
------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 103 52
Payments on notes payable - (275)
------- -------
Net cash (used in) provided by financing activities 103 (223)
------- -------
Net increase in cash and cash equivalents 728 1,716
Cash and cash equivalents at beginning of period 47,265 38,390
------- -------
Cash and cash equivalents at end of period $47,993 $40,106
======= =======
Supplemental statement of non-cash investing and financing activity:
Unrealized loss on investments $26 $16
See accompanying notes.
5
SWITCHBOARD INCORPORATED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A. Nature of Business
Switchboard Incorporated, a Delaware corporation ("Switchboard"), commenced
operations in February 1996. From Switchboard's inception (February 19, 1996)
until its initial public offering on March 7, 2000, Switchboard was a unit and
later a subsidiary of ePresence Inc. ("ePresence"). As of March 31, 2004,
ePresence beneficially owned approximately 51.0% of Switchboard's common stock.
Switchboard is a provider of local online advertising products, enabled by its
consumer-oriented online yellow and white pages directory technology.
Switchboard generates revenue primarily from merchant and national
advertisers that pay to advertise in the Switchboard-powered yellow pages
directories of its licensees, as well as in its own directory website,
www.switchboard.com. Switchboard licenses its yellow pages directory technology
to Internet portals, traditional yellow pages publishers and newspaper
publishers. Switchboard operates in one business segment as a provider of
advertising solutions through its web-hosted directory technologies and
customized yellow pages directory technology, and classifies its revenue into
two categories, namely net merchant network revenue and national banner and site
sponsorship revenue.
Net merchant network revenue includes revenue from various licensing
agreements with Switchboard's directory technology licensees and also includes
engineering and other fees for services provided to support the directories and
programs of Switchboard's licensees. In addition, net merchant network revenue
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. During the three
months ended March 31, 2004 and 2003, net merchant network revenue comprised
85.2% and 88.5% of Switchboard's net revenue, respectively.
Switchboard also continues to generate revenue from the sale of national
banner and site sponsorship advertising on white and yellow pages, as well as
maps pages, across both www.switchboard.com and the websites of several
directory technology licensees. During the three months ended March 31, 2004 and
2003, 14.8% and 11.5% of Switchboard's net revenue, respectively, was derived
from the sale of national banner and site sponsorship advertising.
Switchboard is subject to risks and uncertainties common to growing
technology-based companies, including rapid technological change, 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 customer and vendor relationships and
limited operating history.
Switchboard has experienced substantial net losses since its inception and,
as of March 31, 2004, had an accumulated deficit of $107.0 million. Such losses
and accumulated deficit resulted from Switchboard's lack of substantial revenue
and significantly increased costs incurred in the development of Switchboard's
products and services, in the preliminary establishment of Switchboard's
infrastructure and in the development of Switchboard's brand. Switchboard
expects to continue to incur significant operating expenses in order to execute
its current business plan, particularly sales and marketing and product
development expenses. Switchboard believes that the funds currently available
would be sufficient to fund operations for the foreseeable future.
6
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. The balance
sheet amounts at December 31, 2003 in the accompanying financial statements were
derived from Switchboard's audited 2003 financial statements included in its
Annual Report on Form 10-K for the fiscal year ended December 31, 2003, as
amended. Results of operations for the three-month period ended March 31, 2004
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 Switchboard's Annual Report on Form 10-K for the fiscal year
ended December 31, 2003, as amended, as filed with the Securities and Exchange
Commission on March 29, 2004.
C. Accounting for Stock Based Compensation
Switchboard 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 Switchboard's common stock at the date of
grant. Switchboard 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 March 31, 2004, Switchboard has three stock-based employee compensation
plans as defined by SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123"
("SFAS 148"). Switchboard 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) income if Switchboard 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
years, the below pro-forma effects are not necessarily indicative of the
pro-forma effects on future periods.
7
Three Months Ended March 31,
----------------------------
2004 2003
----- -----
(in thousands, except per share data)
Net (loss) income as reported $(353) $ 56
Add: Stock-based employee compensation
expense included in reported net income
(loss), net of related tax effects 32 36
Add: Adjustment for previously amortized
expense associated with the unvested
portion of options canceled in the period 7 -
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects (546) (579)
----- -----
Pro-forma net loss $(860) $(487)
===== =====
Basic and diluted pro-forma net loss per share $(0.04) $(0.03)
====== ======
Shares used in computing basic and diluted 19,192 18,627
pro-forma net loss per share
D. Net (Loss) Income Per Share
Basic net (loss) income per share is computed using the weighted average
number of shares of common stock outstanding less any restricted shares. Diluted
(loss) income 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.
A reconciliation of basic and diluted weighted average shares outstanding
is as follows (in thousands):
Three Months Ended March 31,
------------------------------
2004 2003
------ ------
Basic weighted average shares outstanding 19,192 18,627
Effect of dilutive common stock equivalents - 428
------ ------
Diluted weighted average shares outstanding 19,192 19,055
====== ======
During the three months ended March 31, 2004 and 2003, options to purchase
3,746,134 and 2,531,190 shares of common stock and shares of restricted common
stock of none and 225,000, respectively, were not included in the computation of
diluted net (loss) income per share since their inclusion would be antidilutive.
8
E. Comprehensive (Loss) Income
Other comprehensive (loss) income is as follows (in thousands):
Three Months Ended March 31,
----------------------------
2004 2003
----- ----
Net (loss) income $(353) $ 56
Other comprehensive loss:
Unrealized loss on investment (26) (16)
---- ----
Comprehensive (loss) income $(379) $ 40
===== ====
F. Revenue Recognition
Switchboard generates its revenue primarily from merchant advertising
placements promoted in the Switchboard-powered directories of its licensees, as
well as in its own directory website. Generally, revenue is recognized as
services are provided, so long as no significant obligations remain and
collection of the resulting receivable is probable. Switchboard believes that it
is able to make reliable judgments regarding the creditworthiness of its
customers based upon historical and current information available to
Switchboard. There can be no assurances that Switchboard's payment experience
with its customers will be consistent with past experience or that the financial
condition of these customers will not decline in future periods, the result of
which could be the failure to collect invoiced amounts. Some of these amounts
could be material, resulting in an increase in Switchboard's provision for bad
debts.
Switchboard licenses its directory technology to its licensees. Licensees
can enter into a development and licensing arrangement with Switchboard whereby
Switchboard creates and/or modifies a private labeled web-hosted directory.
Switchboard recognizes revenue under these agreements when evidence of an
arrangement exists, the related fee is fixed or determinable, and collection of
the fee is reasonably assured, in accordance with Staff Accounting Bulletin No.
101 ("SAB") and No. 104, "Revenue Recognition in Financial Statements" ("SAB
Nos. 101 and 104"). Revenue received by Switchboard for such development and
licensing arrangements is deferred until such time as the customer accepts the
directory. Switchboard considers customer acceptance to occur at the time the
directory is made accessible to the licensee for general use. After acceptance
by the customer, revenue from such development and licensing agreements is
recognized on a straight-line basis over the remaining life of the agreement.
Once the web-hosted directory is operational, Switchboard may earn additional
fees based on the number of merchants promoted within the directory. Per
merchant license fees or additional engineering and other services fees are
recognized as earned. Per merchant fees are considered earned in the period
during which the merchant advertisement is displayed in Switchboard's website
and/or the website of Switchboard's licensees. Additional engineering and other
services fees are considered earned in the period during which the services were
provided.
Switchboard's most significant licensee is America Online, Inc. ("AOL").
Revenues recognized under Switchboard's agreement with AOL are recognized in
accordance with SAB Nos. 101 and 104. Prior to October 2003, Switchboard
received a share of directory advertisement revenue earned by AOL from the sales
of advertisements on the yellow pages directory it provides to AOL, less an
estimate for amounts deemed uncollectable by AOL. Switchboard recorded as
merchant licensing revenue the net amount received from AOL in accordance with
Emerging Issues Task Force ("EITF") Issue No. 99-19, "Reporting Revenue Gross as
a Principal versus Net as an Agent" ("EITF No. 99-19"), as it is earned.
Switchboard considers this merchant licensing revenue earned during the period
that AOL displays the advertisements sold to its customers in its yellow page
directory. Switchboard also earns revenue from AOL through the provision of
engineering and other services to AOL. Switchboard considers the delivery of
engineering and other services to be a separate earnings process and recognizes
revenue from engineering and other services in the period during which these
services are delivered. Subsequent to October 2003, Switchboard receives an
annual license fee. Switchboard bifurcates this amount between merchant and
9
platform licensing fees and engineering services fees. Switchboard recognizes
revenue from merchant and platform licensing fees as earned. Switchboard
considers revenue from merchant and platform licensing earned as it provides AOL
the yellow pages directory and displays AOL's advertisers in the Switchboard.com
yellow pages. In addition, included as an offset to revenue is consideration
given to AOL, for which the benefits of such consideration are not separately
identifiable from the revenue obtained from AOL.
Switchboard also earns fees from pay-for-performance advertising.
Switchboard recognizes revenue for pay-for-performance advertising in the month
during which it provides the advertising service to its customers. The service
is considered provided when Switchboard delivers the performance element of the
contract - specifically, when Internet users click on Switchboard's customers'
advertisements displayed on Switchboard's website.
Switchboard sells national and local advertisements in Switchboard.com
through its direct sales force, as well as through third-parties. For these
advertisements, Switchboard is generally paid a monthly fee based on the number
of advertisements placed into www.switchboard.com. Switchboard recognizes this
monthly fee as revenue as it is earned. Switchboard considers this fee earned
during the period that Switchboard provides the advertising on
www.switchboard.com.
Deferred revenue is principally comprised of billings relating to
advertising agreements and licensing fees received pursuant to advertising or
services agreements in advance of revenue recognition. Unbilled receivables are
principally comprised of revenues earned and recognized in advance of invoicing
customers, resulting primarily from contractually defined billing schedules.
G. AOL
Revenue recognized from AOL during the three months ended March 31, 2004
was $1.2 million, or 28.9% of revenue, of which $600,000 was from engineering
services. Revenue recognized from AOL during the three months ended March 31,
2003 was $1.6 million, or 48.8% of revenue, of which $633,000 was from
engineering services. Net amounts due from AOL included in accounts receivable
March 31, 2004 were $400,000. There were no amounts due from AOL at December 31,
2003. At March 31, 2004, AOL beneficially owned 7.8% of Switchboard's
outstanding common stock.
H. Related Parties
ePresence provided Switchboard with telephone service and support under a
corporate services agreement during the three months ended March 31, 2003. The
corporate services agreement expired on December 31, 2003. Under the agreement,
Switchboard paid ePresence at a rate of $75,000 per year for these services.
ePresence has agreed to continue to provide these services at a rate of $75,000
per year until such time as Switchboard is able to provide these services
itself. Switchboard recorded $19,000 in expense and paid ePresence $19,000 under
the agreements in both the three months ended March 31, 2004 and 2003.
Switchboard had $6,000 accrued under the agreements as of March 31, 2004 and
December 31, 2003.
Switchboard leases the space it currently occupies from ePresence under a
sublease that expires on September 30, 2005. Under the current sublease
agreement, Switchboard pays rent at a rate of $210,000 per year. Under its
sublease agreements with ePresence, Switchboard recorded rent expense of $52,000
and $57,000 and paid ePresence $54,000 and $81,000 in the three months ended
March 31, 2004 and 2003, respectively. Switchboard had $18,000 and $19,000
accrued under the sublease agreements as of March 31, 2004 and December 31,
2003, respectively. Switchboard believes that the amounts paid to ePresence
under its services agreements and subleases with ePresence are competitive with
amounts Switchboard would have paid to outside third parties for the same or
similar services and leased space.
10
Certain directors of Switchboard hold positions as officers or directors of
ePresence. The Chairman of the Board of Directors of Switchboard is also
Chairman of the Board of Directors, President and Chief Executive Officer of
ePresence. One director of Switchboard is Senior Vice President and Chief
Financial Officer of ePresence. Another director of Switchboard is also a
director of ePresence. In the three months ended March 31, 2004, a total of
$23,000 in compensation was paid to these directors by Switchboard for their
services. In the three months ended March 31, 2003, no compensation was paid to
these directors.
I. Transaction Costs
On March 26, 2004, Switchboard announced a definitive agreement to be
acquired by InfoSpace, Inc. ("InfoSpace"). In connection with the transaction,
each outstanding share of Switchboard will be converted into a right to receive
$7.75 per share in cash, without interest, and Switchboard will become a wholly
owned subsidiary of InfoSpace. The transaction is expected to close during June
2004. The completion of the transaction is subject to several conditions,
including the approval of both Switchboard's and ePresence's stockholders and
regulatory approval. On May 10, 2004, Switchboard filed and on May 12, 2004,
Switchboard mailed to its stockholders a definitive proxy statement regarding
this matter. Investors and security holders are urged to read carefully that
filing because it contains important information in connection with the proposed
acquisition. In the three months ended March 31, 2004, Switchboard recorded
$406,000 in fees associated with the transaction as a component of transaction
costs.
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 were
proposed to be sold by ePresence and certain other selling stockholders, and
100,000 were proposed to be sold by Switchboard. The offering was initiated by
ePresence in order to facilitate an orderly disposition of its Switchboard
holdings in conjunction with ePresence's announced plan of liquidation. In light
of the proposed transaction with InfoSpace Switchboard expects to abandon this
offering.
As of December 31, 2003, Switchboard had incurred $511,000 of costs
associated with the offering. Switchboard classified these deferred offering
costs as a long-term asset on its balance sheet as of December 31, 2003. In the
three months ended March 31, 2004, Switchboard recorded as a component of
non-recurring transaction costs $721,000 in expense associated with the proposed
offering. This amount was comprised of the $511,000 of deferred costs at
December 31, 2003 as well as $210,000 in costs incurred in the three months
ended March 31, 2004.
J. Class Action Lawsuit
Switchboard, its former CEO and director Douglas J. Greenlaw, and its
directors Dean Polnerow, William P. Ferry, Robert M. Wadsworth, Richard
Spaulding and David Strohm have been named as defendants in a purported class
action lawsuit filed by plaintiff David Osher in the Court of Chancery of the
State of Delaware in and for New Castle County on March 26, 2004. The Company
was served notice of this complaint on March 31, 2004. The complaint alleges,
among other things, that the $7.75 per share consideration contemplated by the
merger agreement with InfoSpace Inc. is unfair and grossly inadequate, that the
director defendants failed to inform themselves of Switchboard's market value
and failed to act in the best interest of all of Switchboard's stockholders, as
opposed to the interests of ePresence in liquidating its holdings in
Switchboard, and that the director defendants therefore breached their fiduciary
duties to the public stockholders of Switchboard by approving the merger
agreement and the transactions contemplated thereby. The complaint seeks
injunctive relief and unspecified monetary damages. Switchboard believes that
the litigation is without merit and intends to vigorously defend against such
litigation.
11
Switchboard and its directors Dean Polnerow, William P. Ferry, Robert M.
Wadsworth, Richard Spaulding, David Strohm, Stephen Killeen and Michael Ruffolo
have been named as defendants in a purported class action lawsuit filed by
plaintiff Clifford Peters in the Court of Chancery of the State of Delaware in
and for New Castle County on May 12, 2004. The complaint alleges, among other
things, that the proxy statement disseminated to Switchboard's stockholders in
connection with the merger agreement with InfoSpace Inc. contains material
omissions and is materially misleading in a number of respects, constituting a
breach of the defendants' fiduciary duty of disclosure. The complaint seeks
injunctive relief and unspecified monetary damages. Switchboard believes that
the litigation is without merit and intends to vigorously defend against such
litigation.
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", as well as those otherwise discussed in
this section and elsewhere in this quarterly report. See "Forward-Looking
Statements."
Overview
We are a Delaware corporation that commenced operations in February 1996.
From our inception in February 1996 until our initial public offering in March
2000, we were a unit and later a subsidiary of ePresence. 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 merchant and national
advertisers that pay to advertise in the Switchboard-powered directories of our
licensees, and/or on our own website, www.switchboard.com. We operate in a
single segment, but classify our revenue into two categories, namely merchant
network revenue and national banner and site sponsorship revenue.
Merchant network revenue includes revenue from various licensing agreements
with our directory technology 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
directories or a percentage of revenue generated from those merchant
advertisements. In addition, net merchant network revenue includes engineering
and other fees for services provided to support the directories and programs of
our licensees. 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. During the three months ended March 31, 2004,
merchant network revenue comprised approximately 85.2% of our total revenue, as
compared to 88.5% in the three months ended March 31, 2003.
We also continue to generate revenue from the sale of national banner and
site sponsorship advertising on white and yellow pages, as well as maps pages,
across both www.switchboard.com and the websites of several directory technology
licensees. Such revenue is derived from banner advertisements and sponsorships
that are sold on either a fixed fee, cost per thousand impressions or cost per
action basis. During the three months ended March 31, 2004, approximately 14.8%
12
of our net revenue was derived from the sale of national banner and site
sponsorship advertising, as compared to 11.5% in the three months ended March
31, 2003.
Our cost of revenue consists primarily of expenses paid to third parties
under data licensing and website creation and hosting agreements and search
engine database 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 costs of revenue.
Our sales and marketing expense consists primarily of employee salaries and
benefits, costs associated with channel marketing programs, collateral
production expenses, third-party commission costs, public relations, market
research, provision for bad debts and a pro rata share of occupancy and
information system expenses based on employee headcount.
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,
the enhancement of existing products, quality assurance, product testing and
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, accounting costs and a portion of occupancy and information system
expense based on employee headcount.
Our other income and expense consists primarily of interest income earned
from our investment grade marketable securities and a note receivable during
2003 from a former officer, realized gains and losses from any sales or early
maturities of marketable securities, losses on the disposal of fixed assets,
interest expense associated primarily with equipment financing and bank fees.
We have experienced substantial net losses. As of March 31, 2004, we had an
accumulated deficit of $107.0 million resulting from insufficient revenue to
cover the significant costs incurred in the development of our web-hosted
directory technology and the establishment of our corporate infrastructure and
organization.
On March 26, 2004, we announced a definitive agreement to merge with a
wholly owned subsidiary of InfoSpace, Inc., a diversified technology and
services company that develops Internet and wireless solutions headquartered in
Bellevue, Washington. Upon consummation of the merger, Switchboard will be a
wholly owned subsidiary of InfoSpace. Each share of Switchboard common stock
will be converted into a right to receive $7.75 in cash, without interest, upon
consummation of the merger. The merger is expected to close during June 2004,
and is subject to customary closing conditions, including receipt of Switchboard
and ePresence, Inc. stockholder, as well as regulatory, approvals. On May 10,
2004, we filed and on May 12, 2004, we mailed to our stockholders a definitive
proxy statement regarding this matter. Investors and security holders are urged
to read carefully that filing because it contains important information in
connection with the proposed acquisition. See "Factors Affecting Operating
Results, Business Prospects and Market Price of Stock - Risks Resulting from our
13
Announced Merger Agreement with Infospace" for more information concerning this
announcement.
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 were
proposed to be sold by ePresence, Inc. and certain other selling shareholders,
and 100,000 shares were proposed to be sold by us. The offering was initiated by
ePresence in order to facilitate an orderly disposition of its Switchboard
holdings in conjunction with its announced plan of liquidation. In light of the
proposed transaction with InfoSpace, we expect to abandon this offering.
Significant Relationship
Our largest and most significant directory technology licensee is AOL. 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 over and above the initial $12.0
million.
In October 2003, we amended and restated 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 sell advertising products that combine the consumer audience of
both AOL's and Switchboard's yellow pages. The revenue sharing arrangement,
based on a percentage of AOL merchant subscription revenue that was previously
in effect, has been eliminated.
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 during each fiscal quarter in order to customize and enhance AOL's
directory technology. Accordingly, based on our customary rates we charge for
engineering services, we have bifurcated the $4.8 million annual fee between
licensing and engineering services. We attribute $2.4 million of the $4.8
million annual fee to engineering services, or $600,000 per quarter. Of the
3,000 hours, AOL may carry-over up to 1,000 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 are valued using our
standard hourly rates for engineering services and deferred until the hours
carried forward are either used or the right to use them expires. Accordingly,
revenue attributable to the 3,000 hours we are obligated to provide AOL will
range from $400,000 to $800,000 each quarter depending on how AOL decides to
utilize these minimum 3,000 hours. Regardless of how AOL decides to utilize
these 3,000 hours, AOL is obligated to pay us $400,000 each month under the
October 2003 amendment. We will bill AOL on a time and materials basis for any
hours for engineering services provided in excess of the 3,000 we are required
to provide to AOL, and we will recognize this revenue during the period in which
the engineering services are provided. We expect future cash flows from AOL
under the agreement to be approximately $1.2 million per quarter.
14
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 event that the Directory Agreement is terminated pursuant to the
terms of the Directory Agreement, the parties may 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 will be obligated
to continue to provide AOL with directory technology services, and AOL will be
obligated to pay us a monthly fee of $250,000 (reduced from $400,000 per month)
and will also be obligated to pay us for any engineering hours in excess of 300
hours per month. We will not be obligated to provide AOL with 3,000 hours of
engineering services per quarter during the Wind-Down Period.
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 January 2, 2002. If we renew the Directory Agreement with AOL for
at least an additional four years after the current term, we are required 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.
During the three months ended March 31, 2004, revenue from AOL comprised
$1.2 million, or 28.9%, of our revenue, of which $600,000 was from engineering
services. During the three months ended March 31, 2003, revenue from AOL
comprised $1.6 million, or 48.8%, of our revenue, of which $633,000 was from
engineering services. Net amounts due from AOL included in accounts receivable
at March 31, 2004 were $400,000. There were no amounts due from AOL at December
31, 2003. We anticipate that AOL will continue to represent a significant
percentage of our revenue in 2004 and will be a material component of our
overall business. At March 31, 2004, AOL beneficially owned 7.8% of our
outstanding common stock.
15
Results of Operations
The following table presents certain consolidated statement of operations
information stated as a percentage of total net revenue:
Three Months Ended March 31,
-------------------------------------------
2004 2003
------------------- ------------------- Change in Amount
As a % of As a % of -----------------
Amount Revenue Amount Revenue Amount %
------ --------- ------ --------- ------ -----
Merchant network $3,537 85.2 % $2,956 88.5 % $ 581 19.7 %
National advertising 616 14.8 % 385 11.5 % 231 60.0 %
------ ----- ------ ----- ------ -----
Total revenue 4,153 100.0 % 3,341 100.0 % 812 24.3 %
===== ===== =====
Cost of revenue 708 17.0 % 707 21.2 % 1 0.1 %
------ ----- ------ ----- ------ -----
Gross profit 3,445 83.0 % 2,634 78.8 % 811 30.8 %
Sales and marketing 1,063 25.6 % 842 25.2 % 221 26.2 %
Research and development 893 21.5 % 1,114 33.3 % (221) (19.8)%
General and administrative 867 20.9 % 804 24.1 % 63 7.8 %
Transaction costs 1,127 27.1 % - - % 1,127 n/a
------ ----- ------ ----- ------ -----
Total operating expenses 3,950 95.1 % 2,760 82.3 % 1,190 43.1 %
------ ----- ------ ----- ------ -----
Operating (loss) income (505) (12.2)% (126) (3.8)% (379) (300.8)%
Other income, net 154 3.7 % 182 5.4 % (28) (15.4)%
------ ----- ------ ----- ------ -----
(Loss) income before income
Tax (351) (8.5)% 56 1.7 % (407) (726.8)%
------ ----- ------ ----- ------ -----
Provision for income taxes 2 - % - - % 2 n/a
------ ----- ------ ----- ------ -----
Net (loss) income $ (353) (8.5)% $ 56 1.7 % $ (409) (730.4)%
====== ===== ====== ===== ====== ======
Revenue. The increase in merchant network revenue in the three months ended
March 31, 2004 was due primarily to an increase of $1.1 million in non-AOL
licensing revenue, from additional advertisers in the Switchboard.com directory.
This increase was primarily due to an increase of $861,000 in revenue from
performance-based advertising derived from our LocalClicks products and our
performance-based offerings with Google Inc. and Bell South Corporation.
Offsetting these increases was a decrease in licensing revenue from AOL of
$397,000. The decrease in licensing revenue from AOL was due primarily to the
October 2003 amendment of our Directory Agreement with AOL, which eliminated our
previous revenue sharing arrangement. Under the October 2003 amendment, we now
receive $600,000 per fiscal quarter for licensing services provided to AOL. In
the three months ended March 31, 2004, AOL accounted for 28.9% of revenue and in
the three months ended March 31, 2003, AOL accounted for 48.8% of revenue.
Revenue in the three months ended March 31, 2004 from engineering and other
services, as well as from local merchant website hosting services, remained flat
when compared to the same period in 2003.
The increase in national banner and site sponsorship revenue in the three
months ended March 31, 2004 was due primarily to 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 traffic to our website.
Cost of revenue. Cost of revenue in the three months ended March 31, 2004
was flat when compared to the corresponding period in 2003. We incurred an
increase of $30,000 in search engine database inclusion expense and an increase
of $26,000 in expenses associated with the delivery of billable engineering
16
services. These increases were offset by decreases of $32,000 in data
communications expense and $23,000 in website creation and hosting fees in
connection with our merchant services programs.
Gross profit. The increase in gross profit dollars and percentage in the
three months ended March 31, 2004 was due primarily to an increase in revenue
being spread over relatively fixed costs of revenue.
Sales and marketing. The increase in sales and marketing expense in the
three months ended March 31, 2004 was primarily due to an increase of $161,000
in expense associated with both additional employee and third party sales
representatives and an increase of $72,000 in expenses associated with
promotional activities. In 2004, we began expanding our direct sales channel. We
currently intend to spend an additional $2.5 million during 2004, as compared to
2003, to support direct sales. However, our level of spending in this area may
increase or decrease depending on the success of this initiative, and as we
become more experienced in managing a significant direct sales effort.
Research and development. The decrease in research and development expense
in the three months ended March 31, 2004 was due primarily to decreases of
$134,000 in employee salaries and benefits and a decrease of $63,000 in
depreciation expense. The decrease in employee salaries and benefits was
primarily the result of a decrease in the number of employees performing
research and development activities.
General and administrative. The increase in general and administrative
expense for the three months ended March 31, 2004 was primarily due to increases
of $61,000 in employee salaries and benefits and $45,000 in board of directors
fees, offset in part by a decrease of $27,000 in fees for professional services.
Transaction costs. Non-recurring transaction costs in the three months
ended March 31, 2004 consisted of fees for professional services incurred as a
result of our proposed merger with InfoSpace and proposed secondary stock
offering. Fees associated with the proposed InfoSpace merger were approximately
$406,000, consisting primarily of advisory, legal and accounting services. We
expect to continue to incur significant fees for professional services in the
second quarter of 2004 related to the proposed merger with InfoSpace. In light
of the proposed merger with InfoSpace, we intend to abandon our secondary stock
offering. Accordingly, we have recorded as a component of transaction costs
$511,000 of deferred offering costs which had been recorded as a long-term asset
as of December 31, 2003. Additionally, we incurred $210,000 in fees in the three
months ended March 31, 2004 associated with the proposed secondary offering.
Other income. The decrease in other income in the three months ended March
31, 2004 was due primarily to a decrease of $70,000 in interest income
earned as
a result of a decline in interest rates, offset in part by a decrease of $42,000
in interest expense primarily due to the repayment of all amounts due under our
equipment financing in June 2003.
Income taxes. We did not have a significant tax provision in the three
months ended March 31, 2004. We are subject to federal and state minimum taxes.
Accordingly, we recorded income tax expense of $2,000 in the three months ended
March 31, 2004.
17
Liquidity and Capital Resources
As of March 31, 2004, we had total cash and marketable securities of $56.4
million, consisting of $48.0 million of cash and cash equivalents, $6.6 million
of short-term marketable securities, $1.8 million of long-term marketable
securities and $36,000 of restricted cash. During the three months ended March
31, 2004, cash and cash equivalents increased by $728,000, primarily due to cash
provided by operating activities and cash received from financing activities,
offset in part by cash used for investing activities.
Net cash provided by operating activities in the three months ended March
31, 2004 was $586,000, primarily due to cash receipts from customers of
approximately $3.9 million, offset in part by expenditures of $2.0 million in
employee compensation and benefits, $1.2 million in recurring operating costs,
$81,000 in transaction costs and $43,000 in taxes.
Net cash provided by investing activities in the three months ended March
31, 2004 was $39,000, primarily due to $183,000 in proceeds from marketable
securities, offset in part by purchases of property and equipment of $92,000 and
purchases of marketable securities of $52,000.
Net cash provided by financing activities in the three months ended March
31, 2004 was $103,000 and was comprised of proceeds from the issuance of stock.
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. Based on our
current level of operations, we believe that cash generated from our operations,
available cash and other amounts available will adequately meet the needs of our
capital expenditures and working capital needs for the foreseeable future.
The following table summarizes our long-term contractual obligations as of
March 31, 2004 (in thousands):
Less Than 1
Year 1-3 Years 3-5 Years 5 Years Total
----------- --------- --------- ------- -----
Operating lease obligations $ 723 $343 $- $- $1,066
Other long-term obligations (a) 432 275 9 - 716
------ ---- -- -- ------
Total $1,155 $618 $9 $- $1,782
====== ==== == == ======
(a) 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. 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
dates of our financial statements, and the reported amounts of revenue and
expenses during the reporting periods. 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. Actual results
may differ from those estimates.
18
Critical accounting policies are those policies that are reflective of
significant judgement and uncertainties and potentially result in materially
different results under different assumptions and conditions. The critical
accounting policies we identified in our most recent Annual Report on Form 10-K
are related to revenue recognition, concentration of credit risk, impairment of
long-lived assets 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, 2003.
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 TIME WARNER INC. IS TERMINATED PREMATURELY OR IS NOT RENEWED ON
SUBSTANTIALLY SIMILAR OR FAVORABLE TERMS, IT WOULD CAUSE A MATERIAL REDUCTION IN
OUR REVENUES AND NET INCOME.
Even though we have extended the term of the Directory Agreement we entered
into with AOL, 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 could cause us to
incur losses from operations and drain our capital resources.
IF WE RENEW OUR DIRECTORY AGREEMENT WITH AOL, WE MAY HAVE TO ISSUE WARRANTS
ALLOWING AOL TO PURCHASE SHARES OF OUR COMMON STOCK AT A PRICE BELOW THE CURRENT
MARKET PRICE, WHICH COULD REDUCE OUR REVENUES AND NET INCOME.
If we renew the Directory Agreement with AOL for at least an additional
four years (through at least December 2009) after the initial term, we agreed to
issue to AOL a warrant to purchase up to 721,385 shares of common stock at a per
share purchase price of $4.32. The value of this potential warrant would be
amortized as an offset to revenue over the term of the renewed Directory
Agreement. Therefore, the issuance of such warrants would reduce our net income
and cause dilution of the ownership of our existing stockholders.
19
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, CAUSING THE VALUE OF YOUR INVESTMENT IN OUR COMMON
STOCK TO POTENTIALLY BECOME WORTHLESS.
We have incurred significant net losses in each fiscal quarter previous to
the fiscal quarter ended March 31, 2003, as well as a loss in the fiscal quarter
ended March 31, 2004. From inception to March 31, 2004, we have an accumulated
deficit totaling $107.0 million. Based on recent historical expense levels, we
need to generate revenues in excess of $3.5 million each quarter to remain
profitable. Although we recorded a profit in each of the fiscal quarters in
2003, we may not regain 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. Our quarterly results of operations have
fluctuated significantly in the past and are likely to fluctuate significantly
in the future. We do not believe that period-to-period comparisons of our
results of operations are meaningful and you should not rely upon these
comparisons as indicators of our future performance.
In particular, our quarterly results of operations may fluctuate depending
upon the amount of engineering services we provide to AOL. AOL has the right to
carry forward up to 1,000 unused hours of engineering per quarter into the next
quarter. 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 this 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 our directory
technology licensees. The success of our directory website 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 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 technology licensee could significantly impair our ability to
attract potential local merchant customers.
We have entered into strategic relationships with licensees of our
technology and supplier relationships with third-party information 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
20
lose a significant strategic customer or supplier, we may be unable to replace
that relationship with other strategic relationships with comparable revenue
potential, content or user demographics.
IF WE CANNOT DEMONSTRATE THE VALUE OF OUR ADVERTISING PRODUCTS TO MERCHANTS,
THOSE MERCHANT CUSTOMERS MAY STOP PURCHASING OUR ADVERTISING PRODUCTS, WHICH
COULD REDUCE OUR REVENUE AND MATERIALLY REDUCE NET INCOME.
We may be unable to demonstrate the value of our advertising products to
merchants. Regardless of whether our merchant advertising products effectively
produce leads, merchant and national advertisers may not know the source of the
leads and may cancel their advertising. If local merchants cancel their
advertising, our revenue could decline and we may need to incur additional
expenditures to obtain new merchant and national advertisers, which would reduce
our net income.
WE MAY ATTRACT FEWER ADVERTISERS AND CONSUMERS IF WE ARE NOT ABLE TO LICENSE
ACCURATE DATABASE INFORMATION FROM THIRD-PARTY CONTENT PROVIDERS.
We principally rely upon a single third-party source for our business and
residential listings data, and a single third-party source for our mapping data.
The loss of either of these sources or the inability of either 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 technology licensees and our merchant
and national advertisers, and diminish the attractiveness of our service
offerings to those licensees, merchant and national 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
months ended March 31, 2004, revenue derived from our top ten customers
accounted for approximately 63.7% of our total revenue. Additionally, revenue
derived from AOL alone accounted for 28.9% of our total revenue in the three
months ended March 31, 2004. 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.
21
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
WHICH COULD IMPAIR OUR ABILITY TO MAINTAIN AND GROW OUR BUSINESS.
In 2003, we introduced our LocalClicks 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 and national advertisers
to the LocalClicks product could impair our ability to maintain and grow our
business.
WE INTEND TO EXPAND OUR DIRECT SALES INITIATIVES, WHICH IS A NEW MARKETING
CHANNEL FOR US AND WILL REQUIRE INCREMENTAL INVESTMENT WHICH COULD INCREASE OUR
COSTS.
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 sales channel would be a new aspect of our
business. Increased expenses associated with direct sales could reduce our net
income. We currently intend to spend an additional $2.5 million during 2004, as
compared to 2003, to support direct sales. However, our level of spending in
this area may increase or decrease depending on the success of this initiative,
and as we become more experienced in managing a significant direct sales effort.
IF WE DO NOT INTRODUCE NEW OR ENHANCED OFFERINGS TO OUR DIRECTORY TECHNOLOGY
LICENSEES AND OUR ADVERTISERS, WE MAY BE UNABLE TO ATTRACT AND RETAIN THOSE
CUSTOMERS, WHICH COULD SIGNIFICANTLY IMPEDE OUR ABILITY TO GENERATE REVENUE.
We need to introduce new or enhanced products to attract and retain
directory technology 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 technology licensees and our advertisers, 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
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
22
stronger position to respond quickly to new or emerging technologies and changes
in customer requirements. 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.
IF WE LOSE THE SERVICES OF OUR CHIEF EXECUTIVE OFFICER AND FOUNDER, OR ARE NOT
ABLE TO ATTRACT AND RETAIN HIGHLY SKILLED MANAGERIAL AND TECHNICAL PERSONNEL
WITH INTERNET EXPERIENCE, WE MAY NOT BE ABLE TO IMPLEMENT OUR BISINESS MODEL
SUCCESSFULLY, WHICH COULD HARM OUR ABILITY TO REMAIN COMPETITIVE IN THE MARKET
OF INTERNET ADVERTISING.
Our future success depends to a significant extent on the continued service
of and effective working relationship with Dean Polnerow, our Chief Executive
Officer and founder. Our business may suffer if we lose the services of Mr.
Polnerow. Additionally, 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. We also 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.
If we are not able to hire or retain the necessary personnel to implement our
business strategy, our competitiveness in the Internet search market will
suffer.
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 technology 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. Some of our software, including the software used to administer our
new pay for performance based advertising, is still being refined, and our
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 and collect payments, 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.
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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, courts may not 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 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 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.
Although acquisitions are not a central element of our current business
strategy, we do, from time to time, pursue acquisitions. 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. As was the case with our Envenue acquisition, future acquisitions
may have negative effects on our business. The Envenue acquisition failed to
provide us with all of the financial and business-related benefits that we
anticipated and, as a result, we suffered substantial financial expense and the
diversion of our management team's time and attention. 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.
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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 of local
online advertising products 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 technology 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.
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.
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 ability to expand our customer base and increase
revenue will suffer.
IF WE CANNOT MAINTAIN OR GROW THE NUMBER OF CONSUMERS WHO USE OUR WEBSITE AND
THE WEBSITES OF OUR LICENSEES, OUR REVNEUE WILL DECLINE.
In the three months ended March 31, 2004, approximately 39% of our revenue
was directly dependent on the number of users of our website, including revenue
from content-targeted advertising, performance based advertising and national
banner and site sponsorship advertising. If the number of users of our website
falls, our revenue will decline and could cause us to incur losses.
If our directory technology licensees are unable to maintain or grow the
number of consumers using their websites, it is likely that their ability to
attract merchant and national advertisers will be impaired. This could result in
us losing licensees or reducing our revenue from licensees, which would reduce
our revenue and net income.
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IF WE ARE SUED FOR CONTENT DISTRIBUTED THROUGH, OR LINKED TO BY, OUR WEBSITE OR
THOSE OF OUR DIRECTORY TECHNOLOGY 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 technology 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 AGAISNT ONLINE SECURITY
RISKS THAT COULD RESULT IN MISAPPROPRIATION OF OUR PROPRIETARY INFORMATION OR
CAUSE INTERRUPTION IN OUR OPERATIONS.
Our networks may be vulnerable to unauthorized access, computer viruses and
other disruptive problems. Someone who is able to circumvent security measures
could misappropriate our proprietary information or cause interruptions in our
operations. Internet and online service providers have experienced, and may in
the future experience, interruptions in service as a result of the accidental or
intentional actions of Internet users, current and former employees or others.
We may need to expend significant resources protecting against the threat of
security breaches or alleviating problems caused by breaches. Eliminating
computer viruses and alleviating other security problems may require
interruptions, delays or cessation of service.
WE MAY BE SUED FOR DISCLOSING TO THIRD PARTIES PERSONAL IDENTIFYING INFORMATION
WITHOUT CONSENT, WHICH COULD HARM OUR RELATIONSHIP WIHT BOTH OUR CUSTOMER
ADVERTISERS AND OUR WEBSITE USERS AND MAY REQUIRE US TO PAY MONETARY DAMAGES.
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, we may face potential liability for invasion of privacy,
which may require us to pay monetary damages. In addition to the financial harm
any liability could cause, such circumstances may negatively impact our
relationships with our customers and website users.
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATION AND LEGAL
UNCERTAINTIES, WHICH COULD FORCE US TO MODIFY OUR TECHNOLOGY OR BUSINESS
PRACTICES AND INCREASE OUR COSTS.
There are currently relatively few laws or regulations directly applicable
to the Internet and even in areas where legislation has been enacted, laws
governing the Internet remain largely unsettled. 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.
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Laws and regulations directly applicable to Internet communications,
commerce and advertising are however, becoming more prevalent. The Digital
Millennium Copyright Act is intended, in part, to limit the liability of
eligible online service providers for listing or linking to third-party websites
that include materials that infringe copyrights or rights of others. Any failure
by us to comply with FTC requirements or other privacy-related laws and
regulations could result in proceedings by the FTC or others which could
potentially decrease our revenues and negatively impact our business.
Additionally, new 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. While we
are not aware of any specific efforts to do so, various U.S. and foreign
governments might attempt to regulate our transmissions or levy sales or other
taxes relating to our activities.
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 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,
which could impair our ability to generate revenue. 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.
RISKS RESULTING FROM OUR ANNOUNCED MERGER AGREEMENT WITH INFOSPACE
IF OUR ANNOUNCED ACQUISITION BY INFOSPACE IS NOT COMPLETED, OUR BUSINESS,
REPUTATION AND STOCK PRICE MAY SUFFER.
On March 26, 2004 we announced a definitive agreement to be acquired by
InfoSpace. The agreement contains customary conditions to closing, including the
absence of material adverse changes to our business and the receipt of
Switchboard and ePresence stockholder, as well as regulatory, approvals. If the
transaction is not consummated as a result of a failure of one of these
conditions to be met, our customers, prospective customers and investors in
general may view this failure as a poor reflection on our business or prospects.
As a result, if the transaction is not consummated as anticipated, we may
experience adverse results in our business and the market price for our common
stock may fall. On May 10, 2004, we filed and on May 12, 2004, we mailed to
our stockholders a definitive proxy statement in connection with the proposed
acquisition of Switchboard by InfoSpace. Investors and security holders are
urged to read this filing carefully as it contains important information and
additional risk factors in connection with the proposed acquisition.
27
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 March 31, 2004.
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 March 31, 2004. Based on this evaluation, our chief executive officer
and chief financial officer concluded that, as of March 31, 2004, 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 March 31, 2004 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.
Switchboard, its former CEO and director Douglas J. Greenlaw, and its
directors Dean Polnerow, William P. Ferry, Robert M. Wadsworth, Richard
Spaulding and David Strohm have been named as defendants in a purported class
action lawsuit filed by plaintiff David Osher in the Court of Chancery of the
State of Delaware in and for New Castle County on March 26, 2004. The Company
was served notice of this complaint on March 31, 2004. The complaint alleges,
among other things, that the $7.75 per share consideration contemplated by the
merger agreement with InfoSpace Inc. is unfair and grossly inadequate, that the
director defendants failed to inform themselves of Switchboard's market value
and failed to act in the best interest of all of Switchboard's stockholders, as
opposed to the interests of ePresence in liquidating its holdings in
Switchboard, and that the director defendants therefore breached their fiduciary
duties to the public stockholders of Switchboard by approving the merger
agreement and the transactions contemplated thereby. The complaint seeks
injunctive relief and unspecified monetary damages. Switchboard believes that
the litigation is without merit and intends to vigorously defend against such
litigation.
28
Switchboard and its directors Dean Polnerow, William P. Ferry, Robert M.
Wadsworth, Richard Spaulding, David Strohm, Stephen Killeen and Michael Ruffolo
have been named as defendants in a purported class action lawsuit filed by
plaintiff Clifford Peters in the Court of Chancery of the State of Delaware in
and for New Castle County on May 12, 2004. The complaint alleges, among other
things, that the proxy statement disseminated to Switchboard's stockholders in
connection with the merger agreement with InfoSpace Inc. contains material
omissions and is materially misleading in a number of respects, constituting a
breach of the defendants' fiduciary duty of disclosure. The complaint seeks
injunctive relief and unspecified monetary damages. Switchboard believes that
the litigation is without merit and intends to vigorously defend against such
litigation.
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 March 31, 2004, we used approximately $16.8
million of the proceeds from the offering for working capital purposes, of which
approximately $5.0 million was for the purchase of fixed assets. In December
2000 we paid $13.0 million of the proceeds to AOL pursuant to the terms of our
Directory Agreement entered into with AOL 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 AOL $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 March 31, 2004, we have invested the remaining
net proceeds in interest-bearing, money market funds and investment-grade
securities.
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.
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b. Reports on Form 8-K.
On February 5, 2004, Switchboard furnished a Current Report on Form 8-K
dated February 4, 2004, reporting under Item 12 (Results of Operations and
Financial Condition), containing a copy of its earnings release for the quarter
and year ended December 31, 2003.
On March 15, 2004, Switchboard filed Amendment No. 1 to its Current Report
on Form 8-K dated October 15, 2003 reporting under Item 5 (Other Events and
Regulation FD Disclosure) disclosing the amendment and restatement of its
Directory and Local Advertising Platform Services Agreement with AOL and its
entry into a Services Agreement with Monstermoving, Inc. This Amendment No. 1 to
Current Report on Form 8-K was filed to amend the exhibit index and the exhibit
attached thereto.
On March 29, 2004, Switchboard filed a Current Report on Form 8-K dated
March 25, 2004, reporting under Item 5 (Other Events and Regulation FD
Disclosure) disclosing that it had entered into an Agreement and Plan of Merger
with InfoSpace, Inc.
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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: May 13, 2004 By: /s/Robert P. Orlando
--------------------
Robert P. Orlando
Vice President and Chief Financial
Officer (principal financial officer
and chief accounting officer)
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EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
10.1+ Incentive Stock Option Agreement between Switchboard Incorporated
and Dean Polnerow, dated March 3, 2004.
10.2+ Incentive Stock Option Agreement between Switchboard Incorporated
and James M. Canon, dated March 3, 2004.
10.3+ Incentive Stock Option Agreement between Switchboard Incorporated
and Robert P. Orlando, dated March 3, 2004.
10.4 Employment Agreement between Switchboard Incorporated and Dean
Polnerow dated March 19, 2004.
10.5 Employment Agreement between Switchboard Incorporated and James M.
Canon dated March 19, 2004.
10.6 Employment Agreement between Switchboard Incorporated and Robert P.
Orlando dated March 19, 2004.
10.7(1) Agreement and Plan of Merger dated March 25, 2004.
10.8 Form of Switchboard Stockholder Voting Agreement entered into by
directors and officers of Switchboard Incorporated dated March 25,
2004.
10.9 Form of ePresence Stockholder Voting Agreement entered into by
directors and officers of ePresence Incorporated dated March 25,
2004.
10.10 Majority Stockholder Voting Agreement between Switchboard
Incorporated, ePresence Incorporated and InfoSpace, Inc. dated
March 25, 2004.
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.
+ 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.
(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
March 29, 2004.
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