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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-26371
EASYLINK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Charter)
Delaware 13-3787073
(State or other Jurisdiction of) (I.R.S. Employer
Incorporation or Organization) Identification No.)
399 Thornall Street, Edison, NJ 08837
(Address of Principal Executive Office) (Zip Code)
(732) 906-2000
(Registrant's Telephone Number Including Area Code)
Indicate by check 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 |_|
Common stock outstanding at October 31, 2002: Class A common stock $0.01 par
value 15,935,526 shares, and Class B common stock $0.01 par value 1,000,000
shares.
EASYLINK SERVICES CORPORATION
SEPTEMBER 30, 2002
FORM 10-Q
INDEX
Page
Number
------
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of September 30,
2002 (unaudited) and December 31, 2001.............................3
Unaudited Condensed Consolidated Statements of Operations
for the three months ended September 30, 2002 and 2001.............4
Unaudited Condensed Consolidated Statements of Operations
for the nine months ended September 30, 2002 and 2001..............5
Unaudited Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2002 and 2001..............6
Notes to Unaudited Interim Condensed Consolidated
Financial Statements...............................................8
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................29
Item 3: Qualitative and Quantitative Disclosure about Market Risk.........41
Item 4: Controls and Procedures...........................................52
PART II: OTHER INFORMATION
Item 1: Legal Proceedings.................................................53
Item 2: Changes in Securities and Use of Proceeds.........................53
Item 5: Other Information.................................................53
Item 6: Exhibits and Reports on Form 8-K..................................53
Item 7: Signatures........................................................54
Certifications....................................................55
2
Easylink Services Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
September 30, December 31,
------------- ------------
2002 2001
---- ----
ASSETS (unaudited) Note 1(b)
Current assets:
Cash and cash equivalents............................................................$ 9,325 $ 13,278
Accounts receivable, net of allowance for doubtful accounts
$10,494 and $14,547 as of September 30, 2002 and December 31, 2001, respectively.. 13,956 21,812
Prepaid expenses and other current assets............................................ 3,361 1,810
--------- ----------
Total current assets................................................................. 26,642 36,900
--------- ----------
Property and equipment, net.......................................................... 16,607 21,956
Investments.......................................................................... 1,535 1,535
Goodwill............................................................................. 68,835 65,491
Intangible assets, net............................................................... 32,750 42,446
Other................................................................................ 2,030 1,914
--------- ----------
Total assets.........................................................................$ 148,399 $ 170,242
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.....................................................................$ 13,494 $ 16,182
Accrued expenses..................................................................... 21,982 32,702
Restructuring reserves payable....................................................... 1,104 799
Current portion of capital lease obligations......................................... 459 554
Current portion of notes payable..................................................... 2,770 --
Current portion of capitalized interest on notes payable............................. 3,517 1,410
Deferred revenue..................................................................... 334 759
Other current liabilities............................................................ 621 413
Net liabilities of discontinued operations........................................... 326 1,675
--------- ----------
Total current liabilities............................................................ 44,607 54,494
--------- ----------
Capital lease obligations, less current portion...................................... 275 566
Capitalized interest on notes payable, less current portion.......................... 7,143 12,659
Restructuring reserves payable, less current portion................................. 867 --
Notes payable........................................................................ 72,801 80,923
--------- ----------
Total liabilities.................................................................... 125,693 148,642
--------- ----------
Contingent share issuance on notes payable........................................... 1,025 1,091
Stockholders' equity:
Common stock, $0.01 par value; 510,000,000 shares authorized at September 30,
2002 and December 31, 2001, respectively:
Class A--500,000,000 shares authorized at September 30, 2002 and December 31,
2001; 15,895,688 and 14,580,211 shares issued and
outstanding at September 30, 2002 and December 31, 2001, respectively............. 159 146
Class B--10,000,000 shares authorized at September 30, 2002 and
December 31, 2001, respectively, 1,000,000 issued and outstanding at
September 30, 2002 and December 31, 2001 ......................................... 10 10
Additional paid-in capital........................................................... 537,282 533,878
Deferred compensation................................................................ -- (42)
Accumulated other comprehensive loss................................................. (151) (37)
Accumulated deficit.................................................................. (515,619) (513,446)
--------- ----------
Total stockholders' equity........................................................... 21,681 20,509
--------- ----------
Commitments and contingencies
Total liabilities and stockholders' equity...........................................$ 148,399 $ 170,242
========= ==========
See accompanying notes to unaudited condensed consolidated financial statements.
3
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(unaudited)
Three Months Ended September 30,
--------------------------------
2002 2001
---- ----
Revenues..................................................................... $ 28,017 $36,548
Cost of revenues............................................................. 14,012 18,178
---------- -----------
Gross profit................................................................. 14,005 18,370
---------- -----------
Sales and marketing.......................................................... 5,581 5,388
General and administrative................................................... 7,354 10,593
Product development.......................................................... 1,977 1,787
Amortization of goodwill and other intangible assets......................... 1,687 12,753
Impairment of intangible assets.............................................. -- 50
Restructuring and impairment charges......................................... 1,710 --
Gain on sale of business..................................................... (300) --
---------- -----------
Total operating expenses..................................................... 18,009 30,571
---------- -----------
Loss from operations......................................................... (4,004) (12,201)
---------- -----------
Other income (expense):
Interest income.............................................................. 28 125
Interest expense............................................................. (1,139) (2,353)
Gain (loss) on debt restructuring............................................ 6,558 (1,116)
Other, net................................................................... 315 77
---------- -----------
Total other income (expense), net............................................ 5,762 (3,267)
---------- -----------
Minority interest............................................................ -- 23
---------- -----------
Income (loss) from continuing operations..................................... 1,758 (15,445)
---------- -----------
Loss from discontinued operations............................................ -- (1,140)
---------- -----------
Income (loss) before extraordinary item...................................... 1,758 (16,585)
Extraordinary gain........................................................... -- 782
---------- -----------
Net income (loss) ........................................................... $ 1,758 $(15,803)
========== ==========
Basic and diluted net income (loss) per share:
Income (loss) from continuing operations..................................... $ 0.10 $ (1.66)
Loss from discontinued operations............................................ -- (0.12)
Extraordinary gain........................................................... -- 0.08
---------- -----------
Net income (loss)............................................................ $ 0.10 $ (1.70)
========== ===========
Weighted-average basic shares outstanding.................................... 16,978,437 9,279,410
========== ===========
Weighted-average diluted shares outstanding.................................. 17,231,706 9,279,410
========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
4
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(unaudited)
Nine Months Ended September 30,
----------------------------------
2002 2001
---- ----
Revenues..................................................................... $ 88,351 $90,128
Cost of revenues............................................................. 44,166 58,434
----------- ------------
Gross profit................................................................. 44,185 31,694
----------- ------------
Sales and marketing.......................................................... 16,201 23,545
General and administrative................................................... 21,771 31,820
Product development.......................................................... 5,316 7,522
Amortization of goodwill and other intangible assets......................... 5,063 37,854
Impairment of intangible assets.............................................. -- 2,200
Restructuring and impairment charges......................................... 1,710 25,337
(Gain) loss on sale of businesses............................................ (300) 2,327
----------- ------------
Total operating expenses..................................................... 49,761 130,605
----------- ------------
Loss from operations......................................................... (5,576) (98,911)
----------- ------------
Other income (expense):
Interest income.............................................................. 175 488
Interest expense............................................................. (3,672) (8,002)
Gain on debt restructuring, net.............................................. 6,558 39,312
Impairment of investments.................................................... -- (10,131)
Other, net................................................................... 342 278
----------- ------------
Total other income, net...................................................... 3,403 21,945
----------- ------------
Minority interest............................................................ -- (131)
----------- ------------
Loss from continuing operations.............................................. (2,173) (77,097)
----------- ------------
Loss from discontinued operations............................................ -- (67,164)
----------- ------------
Loss before extraordinary item............................................... (2,173) (144,261)
Extraordinary gain........................................................... -- 782
----------- ------------
Net loss .................................................................... $ (2,173) $ (143,479)
=========== ============
Basic and diluted net loss per share:
Loss from continuing operations.............................................. $ (0.13) $ (9.19)
Loss from discontinued operations............................................ -- (8.01)
Extraordinary gain........................................................... -- 0.09
----------- ------------
Net loss..................................................................... $ (0.13) $ (17.11)
=========== ============
Weighted-average basic and diluted shares outstanding........................ 16,565,016 8,384,085
=========== ============
See accompanying notes to unaudited condensed consolidated financial statements.
5
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended September 30,
-------------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net loss........................................................................ $ (2,173) $(143,479)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Loss from discontinued operations............................................... -- 67,164
Amortization of partner advances................................................ -- 2,304
Non-cash interest............................................................... 1,738 752
Depreciation and amortization................................................... 7,620 13,760
Amortization of goodwill and other intangible assets............................ 6,052 37,854
Provision for doubtful accounts................................................. 2,520 4,510
Provision for restructuring and impairments, net................................ 1,172 25,337
Extraordinary gain.............................................................. -- (782)
Gain on debt restructuring...................................................... (6,558) (39,312)
Amortization of domain assets................................................... -- 233
Amortization of deferred compensation........................................... 42 340
Amortization of debt issuance costs............................................. 124 333
(Gain) loss on sale of businesses............................................... (300) 2,327
Write-off of fixed assets....................................................... 13 (1,500)
Impairment of investments....................................................... -- 10,131
Impairment of intangible assets................................................. -- 2,200
Minority interest............................................................... -- 131
Changes in operating assets and liabilities, net of effect of
acquisitions and discontinued operations:
Accounts receivable, net........................................................ 5,336 (266)
Prepaid expenses and other current assets....................................... (1,551) 1,417
Other assets.................................................................... (34) (175)
Accounts payable, accrued expenses and other current liabilities................ (13,373) 9,169
Deferred revenue................................................................ (425) (274)
----------- ----------
Net cash provided by (used in) operating activities............................. 203 (7,826)
----------- ----------
Cash flows from investing activities:
Proceeds from sales of businesses............................................... 300 4,641
Proceeds from sale of investment................................................ -- 1,950
Proceeds from sales and maturities of marketable securities..................... -- 12,513
Purchases of intangible assets.................................................. -- (913)
Purchases of property and equipment, including capitalized software............. (2,284) (2,384)
Acquisitions, net of cash paid (acquired)....................................... -- (15,308)
----------- ----------
Net cash (used in) provided by investing activities............................. (1,984) 499
----------- ----------
Cash flows from financing activities:
Net proceeds from issuance of Class A common stock.............................. -- 3,010
Issuance of shares to employee benefit plans.................................... 326 346
Proceeds from issuance of convertible notes, net................................ -- 14,110
Proceeds from loan.............................................................. -- 1,065
Payments under capital lease obligations........................................ (460) (4,260)
Interest payments on restructured notes......................................... (897) --
Principal payments of notes payable............................................. (727) (2,149)
----------- ----------
Net cash (used in) provided by financing activities............................. (1,758) 12,122
----------- ----------
Effect of foreign exchange rate changes on cash and cash equivalents............ (114) (50)
Net (decrease) increase in cash and cash equivalents............................ (3,653) 4,745
Cash (used in) provided by discontinued operations.............................. (300) 782
Cash and cash equivalents at beginning of the period............................ 13,278 4,331
----------- ----------
Cash and cash equivalents at the end of the period.............................. $9,325 $9,858
=========== ==========
6
Supplemental disclosure of non-cash information:
During the nine months ended September 30, 2002 and 2001, the Company paid
approximately $3.1 million and $6.7 million, respectively, for interest. In
addition, we issued 777,390 shares of Class A common stock valued at
approximately $1.7 million as payment for interest in lieu of cash during the
nine months ended September 30, 2002 (see Note 6). Through the issuance of
250,740 shares of Class A common stock, the Company paid approximately $743,000
in interest for the nine months ended September 30, 2001.
During the nine months ended September 30, 2002, the Company also issued shares
of Class A common stock as follows:
The Company issued 56,075 shares of Class A common stock valued at
approximately $314,000 in connection with the divestiture of a
subsidiary of the Company's India.com subsidiary (see Note 7).
The Company issued 36,232 shares of Class A common stock valued at
approximately $203,000 in connection with the settlement of an
indemnification obligation arising out of the sale of Asia.com's
eLong.com business. The indemnification obligation arose out of a
contingent payment obligation owed by eLong.com to the sellers of a
business purchased by eLong.com (see Note 7).
The Company issued 11,549 shares of Class A common stock valued at
approximately $73,000 in payment of a bonus to an employee.
The Company issued 21,016 shares of Class A common stock valued at
approximately $78,000 to a consultant in payment of consulting fees.
The Company issued 7,716 shares of Class A common stock valued at
approximately $11,000 in connection with a severance agreement.
The Company issued 106,534 shares of Class A common stock valued at
approximately $100,000 in settlement of a vendor obligation.
During the nine months ended September 30, 2001, the Company also issued shares
of Class A common stock as follows:
The Company issued 100,423 shares of Class A common stock valued at
approximately $585,000 in settlement of a vendor obligation.
The Company issued 31,746 shares of Class A common stock valued at
approximately $200,000 as payment related to the sale of its
advertising network.
The Company issued 162,083 shares of Class A common stock valued at
approximately $1.3 million as payment for a contingent settlement
obligation.
The Company issued 27,500 shares of Class A common stock valued at
$189,000 for a settlement obligation associated with the sale of a
business.
The Company issued 61,475 shares of Class A common stock valued at
approximately $655,000 to certain former employees of Asia.com and
India.com as severance payments.
Non-cash investing activities:
During the nine months ended September 30, 2001, the Company issued 22,222
shares of its Class A common stock in connection with an investment. These
transactions resulted in non-cash investing activities of $285,000 (see Note 3).
During the nine months ended September 30, 2001, the Company issued 1,896,218
shares of its Class A common stock in connection with certain acquisitions.
These transactions resulted in non-cash investing activities of $31.1 million
(see Note 2).
Non-cash financing activities:
During the nine months ended September 30, 2002, we issued 100,000 shares of
Class A common stock in connection with the March 20, 2001 private placement
(See Note 8).
See accompanying notes to unaudited condensed consolidated financial statements.
7
EasyLink Services Corporation
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Operations and Significant Accounting Policies
(a) Summary of Operations
On April 2, 2001, the Company changed its name to EasyLink Services Corporation.
The Company offers a broad range of information exchange services to businesses
and service providers, including transaction delivery services such as
electronic data interchange or "EDI," telex, desktop fax, broadcast and
production messaging services; managed e-mail and groupware hosting services;
and services that protect corporate e-mail systems such as virus protection,
spam control and content filtering services.
Until March 30, 2001, the Company also offered advertising services and consumer
e-mail services to Web sites, ISP's and direct to consumers through its web site
www.mail.com. On October 26, 2000, the Company announced its intention to sell
its advertising network business and stated that it will focus exclusively on
its established outsourced messaging business. The Company also announced that
as a result of its decision to focus on its outsourced messaging business, it
was streamlining the organization, taking advantage of lower cost areas and
further integrating its technological and operational infrastructures. On March
30, 2001, the Company completed the sale of its advertising network and consumer
e-mail business to Net2Phone. See Note 4 for additional information.
In March 2000, EasyLink formed WORLD.com to develop the Company's extensive
portfolio of domain names into major Web properties, such as Asia.com and
India.com, which served the business-to-business and business-to-consumer
marketplace. Through its subsidiaries, WORLD.com generated revenues primarily
from sales of information technology products, system integration and website
development for other companies, advertising related sales and commissions
earned from booking travel arrangements. On November 2, 2000, the Company
announced that it would sell all assets not related to its core outsourced
messaging business, including its Asia.com Inc., and India.com Inc.
subsidiaries, and its portfolio of category-defining domain names. On May 3,
2001, Asia.com, Inc. sold its business to an investor group. In October 2001,
the Company sold 90% of a subsidiary of India.com, Inc. and the Company has
ceased conducting its portal business. Accordingly, the results of World.com and
its subsidiaries have been restated as discontinued operations in our
consolidated financial statements for all periods presented. See Notes 1(c) and
7 for additional information.
(b) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of
September 30, 2002 and for the three and nine months ended September 30, 2002
and 2001 have been prepared by the Company and are unaudited. In the opinion of
management, the unaudited interim condensed consolidated financial statements
have been prepared on the same basis as the annual consolidated financial
statements and reflect all adjustments, which include only normal recurring
adjustments, necessary to present fairly the consolidated financial position of
EasyLink Services as of September 30, 2002 and the consolidated results of
operations and cash flows for the interim periods ended September 30, 2002 and
2001. The results of operations for any interim period are not necessarily
indicative of the results of operations for any other future interim period or
for a full fiscal year. The condensed consolidated balance sheet at December 31,
2001 has been derived from audited consolidated financial statements at that
date.
For each of the years ended December 31, 2001 and 2000, the Company received a
report from its independent accountants containing an explanatory paragraph
stating that the Company suffered recurring losses from operations since
inception and has a working capital deficiency that raises substantial doubt
about the Company's ability to continue as a going concern. The unaudited
condensed consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. Management believes the
Company's ability to continue as a going concern is dependent upon its ability
to generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, and ultimately to
achieve profitable operations. Management is continuing the process of further
reducing operating costs and increasing its sales efforts. There can be no
assurance that the Company will be successful in these efforts.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations. It is suggested that these unaudited interim
condensed consolidated financial statements be read in conjunction with the
Company's audited consolidated financial statements and notes thereto for the
year ended December 31, 2001 as included in the Company's Form 10-K/A filed with
the Securities and Exchange Commission on April 19, 2002.
8
(c) Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly-owned or majority-owned subsidiaries from the dates of acquisition.
All other investments over which the Company does not have the ability to
control or exercise significant influence are accounted for under the cost
method. The interest of shareholders other than those of EasyLink is recorded as
minority interest in the accompanying consolidated statements of operations and
consolidated balance sheets. When losses applicable to minority interest holders
in a subsidiary exceed the minority interest in the equity capital of the
subsidiary, these losses are included in the Company's results, as the minority
interest holder has no obligation to provide further financing to the
subsidiary. All significant intercompany accounts and transactions have been
eliminated in consolidation.
WORLD.com, Inc., a wholly owned subsidiary, and its majority-owned subsidiaries
have been reflected as discontinued operations and prior year amounts have been
reclassified to reflect such treatment (See Note 7).
Effective January 23, 2002, the Company authorized and implemented a 10-for-1
reverse stock split of all issued and outstanding stock. Accordingly, all issued
and outstanding share and per share amounts in the accompanying consolidated
financial statements that predate the reverse stock split have been
retroactively restated to reflect the reverse stock split.
(d) Use of Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses. These estimates and assumptions
relate to the estimates of collectibility of accounts receivable, the
realization of goodwill and other intangibles, accruals and other factors.
Actual results could differ from those estimates.
(e) Accounting for Impairment of Long-Lived and Intangible Assets
The Company assesses the need to record impairment losses on long-lived assets,
including intangible assets, used in operations when indicators of impairment
are present. On an on-going basis, management reviews the value and period of
amortization or depreciation of long-lived assets, including goodwill and other
intangible assets. During this review, the Company reevaluates the significant
assumptions used in determining the original cost of long-lived assets. Although
the assumptions may vary from transaction to transaction, they generally include
revenue growth, operating results, cash flows and other indicators of value.
Management then determines whether there has been a permanent impairment of the
value of long-lived assets based upon events or circumstances, which have
occurred since acquisition. The impairment policy is consistently applied in
evaluating impairment for each of the Company's wholly owned subsidiaries and
investments. It is reasonably possible that the impairment factors evaluated by
management will change in subsequent periods, given that the Company operates in
a volatile business environment. This could result in material impairment
charges in the future.
(f) Revenue Recognition
The Company's business information exchange services include transaction
delivery services such as electronic data interchange or "EDI;" fax, e-mail and
telex production messaging services; integrated desktop messaging services;
managed e-mail and groupware hosting services including services that help
protect corporate e-mail systems such as virus protection, spam control and
content filtering services, and professional messaging services and support. The
Company derives revenues from monthly per-message and usage-based charges for
its transaction delivery services; from monthly per-user or per-message fees for
managed e-mail and groupware hosting and virus protection, spam control and
content filtering services, and license and consulting fees for our professional
services. Revenue from services is recognized as the services are performed.
Facsimile license revenue is recognized over the average estimated customer life
of 3 years. The Company also licenses software under noncancellable license
agreements. License fee revenues are recognized when a noncancellable license
fee is in force, the product has been delivered and accepted, the license fee is
fixed, vendor specific objective evidence exists for the undelivered element and
collectibility is reasonably assured. Maintenance and support revenues are
deferred and recognized ratably over the term of the related agreements. The
Company also may host the software if requested by the customer. The customer
has the option to decide who hosts the application. If the Company provides the
hosting, revenue from hosting is ratably recognized over the hosting periods.
Pursuant to Emerging Issues Task Force 00-3, "Application of AICPA Statement of
Position 97-2 to Arrangements That Include the Right to Use Software on Another
Entity's Hardware", if the customer has the option of hosting the software
itself or contracting with an unrelated third party to host the software, the
hosting fee is ratably recognized over the hosting period.
9
The Company also enters into supplier arrangements providing bulk services, at a
fixed price and minimum quantity to certain customers for a specified period of
time. Revenues earned under such arrangements are recognized over the term of
the arrangement assuming collection of the resultant receivable is probable.
Prior to the sale of the Advertising Network Business on March 30, 2001 (see
Note 4), advertising revenues were derived principally from the sale of banner
advertisements. Revenue on banner advertisements was recognized ratably as the
advertisements or respective impressions were delivered either on a "cost per
thousand" or "cost per action" basis. Revenue on upfront placement fees and
promotions was deferred and recognized over the term of the corresponding
agreement.
The Company also traded advertisements on its Web properties in exchange for
advertisements on the Internet sites of other companies as part of the ad
network business. Barter revenues and expenses were recorded at the fair market
value of services provided or received; whichever is more determinable in the
circumstances. Revenue from barter transactions were recognized as income when
advertisements were delivered on the Company's Web properties. Barter expense
was recognized when the Company's advertisements are run on other companies' Web
sites, which is typically in the same period when barter revenue was recognized.
If the advertising impressions were received from the customer prior to the
Company delivering the agreed-upon advertising impressions, a liability was
recorded, and if the Company delivered the advertising impressions to the other
companies' Web sites prior to receiving the agreed-upon advertising impressions,
a prepaid expense was recorded. At September 30, 2002 and December 31, 2001, the
Company had no liability for barter advertising to be delivered. Barter
revenues, which are a component of advertising revenue, amounted to $0 and $0.6
million for the nine months ended September 30, 2002 and 2001, respectively. For
the nine months ended September 30, 2002 and 2001, barter expenses, which is a
component of cost of revenues, were approximately $0 and $0.6 million,
respectively.
Deferred revenue represents payments that have been received in advance of the
services being performed.
Other revenues includes revenues from the licensing and sale of domain names,
which are recognized ratably during the licensing period or at the time when the
ownership of the domain name is transferred provided that no significant Company
obligation remains and collection of the resulting receivable is probable. To
date, such revenues have not been material.
(g) Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist of cash, cash equivalents, restricted
investments, marketable securities, accounts receivable, notes payable and
convertible notes payable. At June 30, 2002 and December 31, 2001, the fair
value of cash, cash equivalents, restricted investments, marketable securities
and accounts receivable approximated their financial statement carrying amount
because of the short-term maturity of these instruments. The recorded values of
notes payable and convertible notes payable approximate their fair values, as
interest approximates market rates with the exception of the Convertible
Subordinated Notes payable with a carrying value of $24.1 million, which has an
estimated fair value of $6.1 million and $6.6 million at September 30, 2002 and
December 31, 2001, respectively, based upon quoted market prices (See Note 6).
Credit is extended to customers based on the evaluation of their financial
condition and collateral is not required. The Company performs ongoing credit
assessments of its customers and maintains an allowance for doubtful accounts.
No single customer exceeded 10% of either total revenues or accounts receivable
as of and for the nine months ended September 30, 2002 or 2001. Revenues from
the Company's five largest customers accounted for an aggregate of 6% of the
Company's total revenues for the three months ended September 30, 2002 and 2001.
(h) Basic and Diluted Net Loss Per Share
Income (loss) per share is presented in accordance with the provisions of SFAS
No. 128, "Earnings Per Share", and the Securities and Exchange Commission Staff
Accounting Bulletin No. 98. Under SFAS No. 128, basic Earnings per Share ("EPS")
excludes dilution for common stock equivalents and is computed by dividing
income or loss available to common shareholders by the weighted average number
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock and resulted in the issuance of
common stock. Diluted net income (loss) per share is equal to basic income
(loss) per share since all common stock equivalents are anti-dilutive for each
of the periods presented. Diluted net income (loss) per share for the three
months ended September 30, 2002 and 2001 includes 253,269 and 0 shares,
respectively, issuable upon exercise of employee stock options and warrants and
upon conversion of convertible notes. Diluted net loss per share for the nine
months ended September 30, 2002 and 2001 does not include shares issuable upon
exercise of employee stock options and warrants and upon conversion of
convertible notes.
10
(i) Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations" ("Statement
141"), and Statement No. 142, "Goodwill and Other Intangible Assets" ("Statement
142"). Statement 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001. Statement 141 also
specifies criteria intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. Statement 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 also requires that intangible assets with definite useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with Financial
Accounting Standards Board No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" ("Statement 121").
The Company adopted the provisions of Statement 141 immediately and Statement
142 effective January 1, 2002. Furthermore, any goodwill and any intangible
asset determined to have an indefinite useful life that are acquired in a
purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance with
the appropriate pre-Statement 142 accounting literature. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 were
amortized prior to the adoption of Statement 142.
Statement 141 requires, upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company is required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company is required to test the intangible asset for impairment in
accordance with the provisions of Statement 142 within the first interim period.
Any impairment loss will be measured as of the date of adoption and recognized
as the cumulative effect of a change in accounting principle in the first
interim period.
In connection with the transitional goodwill impairment evaluation, Statement
142 requires the Company to perform an assessment of whether there is an
indication that goodwill is impaired as of the date of adoption. To accomplish
this the Company must identify its reporting units and determine the carrying
value of each reporting unit by assigning the assets and liabilities, including
the existing goodwill and intangible assets, to those reporting units as of the
date of adoption. The Company has up to six months from the date of adoption to
determine the fair value of each reporting unit and compare it to the reporting
unit's carrying amount. To the extent a reporting unit's carrying amount exceeds
its fair value, an indication exists that the reporting unit's goodwill may be
impaired and the Company must perform the second step of the transitional
impairment test. In the second step, the Company must compare the implied fair
value of the reporting unit's goodwill, determined by allocating the reporting
unit's fair value to all of it assets (recognized and unrecognized) and
liabilities in a manner similar to a purchase price allocation in accordance
with Statement 141, to its carrying amount, both of which will be measured as of
the date of adoption. This second step is required to be completed as soon as
possible, but no later than the end of the year of adoption. Any transitional
impairment loss will be recognized as the cumulative effect of a change in
accounting principle in the Company's statement of earnings.
As of January 1, 2002, the date of adoption, the Company had unamortized
goodwill in the amount of $68.8 million, which is subject to the transition
provisions of Statement 142. Amortization expense related to goodwill of
continuing operations was $52.1 million for the year ended December 31, 2001.
During the quarter ended June 30,2002, the Company completed its assessment with
the assistance of an independent appraiser in accordance with Statement 142 and
determined that there was no impairment as of January 1, 2002.
11
The following unaudited pro forma disclosure presents the adoption of Statement
142 as if it had occurred at the beginning of all periods presented:
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
------------- -------------
(In thousands, except per share amounts) 2002 2001 2002 2001
---- ---- ---- ----
Income (loss) from continuing operations..................... $1,758 $(15,445) $(2,173) $(77,097)
Add back: Goodwill amortization.............................. -- 10,597 -- 32,258
Adjusted income (loss) from continuing operations............ 1,758 (4,848) (2,173) (44,839)
Loss from discontinued operations............................ -- (1,140) -- (67,164)
Add back: Goodwill amortization.............................. -- 58 -- 3,793
Adjusted loss from discontinued operations................... -- (1,082) -- (63,371)
Extraordinary gain........................................... -- 782 -- 782
Adjusted net income (loss)................................... $1,758 $(5,148) $(2,173) $(107,428)
Basic and diluted net loss per common share:
Income (loss) from continuing operations..................... $0.10 $(1.66) $(0.13) $(9.19)
Goodwill amortization from continuing operations............. -- 1.14 -- 3.85
Adjusted income (loss) from continuing operations............ 0.10 (0.52) (0.13) (5.34)
Loss from discontinued operations............................ -- (0.12) -- (8.01)
Goodwill amortization from discontinued operations........... -- 0.01 -- 0.45
Adjusted loss from discontinued operations................... -- (0.11) -- (7.56)
Extraordinary gain........................................... -- 0.08 -- 0.09
Adjusted net income (loss)................................... $0.10 $(0.55) $(0.13) $(12.81)
Weighted average basic shares outstanding ................... 16,978 9,279 16,565 8,384
Weighted average diluted shares outstanding ................. 17,232 9,279 16,565 8,384
In connection with the adoption of Statement 142 on January 1, 2002, the Company
reclassified $3.6 million in net book value associated with assembled workforce
to goodwill. In addition, during the first quarter of 2002, goodwill was reduced
by $0.3 million as a result of a final reconciliation related to the STI
acquisition (See Note 2).
Included in the Company's balance sheet as of September 30, 2002 are the
following (in thousands):
Accumulated
Gross Cost Amortization Net
---------- ------------ ---
Goodwill..................................................... $152,659 $(83,824) $68,835
Intangibles with finite lives:
Technology................................................ 16,550 (8,372) 8,178
Trademark................................................. 16,000 (2,533) 13,467
Customer lists............................................ 11,000 (1,742) 9,258
Software development and licenses......................... 4,580 (2,733) 1,847
---------- ---------- ----------
$ 48,130 $ (15,380) $ 32,750
========== ========== ==========
Amortization related to intangible assets with finite lives was $2.0 million and
$2.1 million for the three months ended September 30, 2002 and 2001,
respectively. In accordance with Statement 142, the Company reassessed the
useful lives of all other intangible assets. There were no changes to such lives
and there are no expected residual values associated with these intangible
assets. Trademarks and customer lists are being amortized on a straight-line
basis over ten years. Technology and software development and licenses are being
amortized on a straight-line basis over their estimated useful lives from two to
five years.
12
In June 2001, Statement of Financial Accounting Standards No. 143, "Accounting
for Asset Retirement Obligations" ("Statement 143") was issued. Statement 143
addresses financial accounting and reporting for legal obligations associated
with the retirement of tangible long-lived assets and the associated retirement
costs that result from the acquisition, construction, or development and normal
operation of a long-lived asset. Upon initial recognition of a liability for an
asset retirement obligation, Statement 143 requires an increase in the carrying
amount of the related long-lived asset. The asset retirement cost is
subsequently allocated to expense using a systematic and rational method over
the asset's useful life. Statement 143 is effective for fiscal years beginning
after June 15, 2002. The adoption of this statement is not expected to have a
material impact on the Company's financial position or results of operations.
In August 2001, Statement of Financial Accounting Standards 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("Statement 144"), which
supersedes both Statement 121, and the accounting and reporting provisions of
APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" ("Opinion 30"), for the disposal
of a segment of a business (as previously defined in that Opinion). Statement
144 retains the fundamental provisions in Statement 121 for recognizing and
measuring impairment losses on long-lived assets held for use and long-lived
assets to be disposed of by sale, while also resolving significant
implementation issues associated with Statement 121. For example, Statement 144
provides guidance on how a long-lived asset that is used as part of a group
should be evaluated for impairment, establishes criteria for when a long-lived
asset is held for sale, and prescribes the accounting for a long-lived asset
that will be disposed of other than by sale. Statement 144 retains the basic
provisions of Opinion 30 on how to present discontinued operations in the income
statement but broadens that presentation to include a component of an entity
(rather than a segment of a business). Unlike Statement 121, an impairment
assessment under Statement 144 will never result in a write-down of goodwill.
Rather, goodwill is evaluated for impairment under Statement 142, Goodwill and
Other Intangible Assets.
The Company adopted Statement 144 effective January 1, 2002. The adoption of
Statement 144 for long-lived assets held for use did not have an impact on the
Company's financial position and results of operations because the impairment
assessment under Statement 144 is largely unchanged from Statement 121 and the
provisions of the Statement for assets held for sale or other disposals
generally are required to be applied prospectively after the adoption date to
newly initiated disposal activities.
In April 2002, Statement of Financial Accounting Standards No. 145, "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("Statement 145") was issued. FASB Statement No. 4
required all gains and losses from the extinguishment of debt to be reported as
extraordinary items and Statement No. 64 related to the same matter. Statement
145 requires gains and losses from certain debt extinguishment to not be
reported as extraordinary items when the use of debt extinguishment is part of
the risk management strategy. Statement 44 was issued to establish transitional
requirements for motor carriers relative to intangible assets. Those transitions
are completed, therefore Statement 44 is no longer necessary. Statement 145 also
amends Statement No. 13 requiring sale-leaseback accounting for certain lease
modifications. Statement 145 is effective for fiscal years beginning after May
15, 2002. The provisions relating to sale-leaseback are effective for
transactions after May 15, 2002. The Company adopted Statement 145 effective
July 1, 2002. The adoption of this Statement resulted in gains and losses from
debt restructuring and extinguishments of debt that were previously recorded as
extraordinary being reclassified as operating activities. During the quarter
ended Septmeber 30, 2002, the gains from extinguishment of debt were recorded as
part of continuing operations in accordance with Statement 145. The following
sets forth the impact of the reclassifications on the income (loss) from
continuing operations and income (loss) per share from continuing operations:
2002 2001
------------------------------ -------------------------------
Q3 Q2 Q1 Q3 Q2 Q1
Loss from continuing operations - pre FAS 145 $(4,800) $(1,279) $(2,652) $(14,329) $(48,225) $(53,855)
Extraordinary gain (loss) reclassified to:
Gain (loss) on debt restructuring $ 6,558 $ - $ - $ (1,116) $ 1,079 $ 39,349
Income (loss) from continuing operations - post FAS 145 $ 1,758 $(1,279) $(2,652) $(15,445) $(47,146) $(14,506)
Loss per share from continuing operations - pre FAS 145 $ (0.28) $ (0.08) $ (0.16) $ (1.54) $ (5.48) $ (7.64)
Income (loss) per share from continuing
operations - post FAS 145 $ 0.10 $ (0.08) $ (0.16) $ (1.66) $ (5.36) $ (2.06)
Change in income (loss) per share on continuing operations $ 0.38 $ - $ - $ (0.12) $ 0.12 $ 5.58
In July 2002, Statement of Financial Accounting Standards No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities" ("Statement 146") was
issued. This Statement addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue ("EITF") 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The principle difference between Statement
146 and EITF 94-3 relates to the timing of liability recognition. Under
Statement 146, a liability for a cost associated with an exit or disposal
activity is recognized when the liability is incurred. Under EITF 94-3, a
liability for an exit cost was recognized at the date of an entity's commitment
to an exit plan. The provisions of Statement 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The adoption of
this statement is not expected to have a material impact on the Company's
financial position or results of operations.
13
(2) Acquisitions
GN Comtext
During July 2001, the Company acquired the assets of GN Comtext ("GN") for $1.
Additionally, the Company received a $1.1 million unsecured interest free loan
from the former parent company of GN, GN Store Nord A/S, which was paid in the
fourth quarter of 2001, and received approximately $175,000 for transition
services which were recorded as a reimbursement of costs during the third
quarter of 2001 and will collect and retain a percentage of certain accounts
receivable collected on behalf of GN. GN offers value-added messaging services
to over 3,000 customers ranging from small business to multi-national companies
around the world. The excess of fair market value of the assets acquired and the
liabilities assumed over the purchase price resulted in negative goodwill of
$782,000 which was recognized as an extraordinary gain during the quarter ended
September 30, 2001 in accordance with FASB Statement No. 141.
Swift Telecommunications, Inc. And Easylink Services
On January 31, 2001, the Company and Swift Telecommunications, Inc. ("STI"), a
New York Corporation, entered into an Agreement and Plan of Merger ("Merger
Agreement"). On February 23, 2001, the Company completed the acquisition of STI.
On January 31, 2001, and concurrent with the execution and delivery of the
Merger Agreement, STI acquired from AT&T Corp. its EasyLink Services business
("EasyLink Services"). On April 2, 2001, Mail.com changed its name to EasyLink
Services Corporation (formerly Mail.com, Inc., the "Company" or "EasyLink").
STI together with its newly acquired EasyLink Services business is a global
provider of transaction delivery services such as electronic data interchange,
e-mail, fax and telex.
At the closing of the acquisition by STI of the EasyLink Services business from
AT&T, the Company advanced $14 million to STI in the form of a loan, the
proceeds of which were used to fund part of the $15 million cash portion of the
purchase price to AT&T. Upon the closing of the acquisition of STI, the Company
assumed a $35 million note issued by STI to AT&T. The $35 million note was
secured by the assets of STI, including the EasyLink Services business, and the
shares of EasyLink Class A common stock issued to the sole shareholder in the
merger. The AT&T note was payable in equal monthly installments over four years,
bearing interest at the rate of 10% per annum for the first six months of the
note. Thereafter the rate was to be adjusted every six months equal to 1% plus
the prime rate as listed in the Wall Street Journal on such date of adjustment.
AT&T subsequently entered into an agreement with the Company to restructure the
note. On November 27, 2001, the note was converted into a package of securities
consisting of a promissory note in the principal amount of $10 million, 1
million shares of Class A common stock and warrants to purchase 1 million shares
of Class A common stock. The warrants have an exercise price equal to $6.10 per
share, subject to adjustment. See Note 6 Notes Payable for a description of the
restructuring, the promissory note and the warrants.
Upon the closing of the acquisition of STI, the Company paid to the sole
shareholder of STI $835,000 in cash and issued an unsecured note for $9,188,000
and 1,876,618 shares of EasyLink Class A common stock, valued at $30.8 million,
as consideration for the acquisition of STI. The value of the common stock
issued to STI is based on the average market price of EasyLink's common stock,
as quoted on the Nasdaq national market, for the two days immediately prior to,
the day of, and the two days immediately after the announcement of the
transaction on February 8, 2001. The $9,188,000 note was payable in four equal
semi-annual installments over two years and may be prepaid in whole or in part
at any time and from time to time without payment of premium or penalty. The
note was non-interest bearing unless the Company fails to make a required
payment within 30 days after the due date therefor. Thereafter, the note would
bear interest at the rate of 1% per month. The note also contained certain
customary covenants and events of default. The holder of the note subsequently
entered into an agreement with the Company to restructure the note. On November
27, 2001, the note was converted into a package of securities consisting of a
senior convertible note in the principal amount of approximately $2.68 million,
approximately 268,000 shares of Class A common stock and warrants to purchase
approximately 268,000 shares of Class A common stock. The senior convertible
note has an initial conversion price equal to $10.00 per share, subject to
adjustment. The warrants have an exercise price equal to the average of the
closing prices of the Company's Class A common stock over the 30 trading days
ending two days before the closing of the restructuring of $6.10 per share,
subject to adjustment. See Note 6 Notes Payable for a description of the
restructuring, the senior convertible note and the warrants.
14
The cash portion of the merger consideration and the reimbursement of payments
made by the sole shareholder of STI were funded out of EasyLink's available cash
and from the proceeds received by the Company on January 8, 2001 from the
issuance of $10.3 million of 10% Senior Convertible Notes due January 8, 2006.
The Company allocated a portion of the purchase price to the fair market value
of the acquired assets and liabilities assumed of STI and the EasyLink Services
business. The excess of the purchase price over the fair market value of the
acquired assets and liabilities assumed of STI and the EasyLink Services
business has been allocated to goodwill ($24 million), assembled workforce ($3
million), technology ($11 million), trademarks ($16 million) and customer lists
($11 million). During 2001, prior to the adoption of Statement 142, goodwill,
trademarks and customer lists were being amortized over a period of 10 years,
the expected estimated period of benefit, and assembled workforce and technology
were being amortized over 5 years, the estimated period of benefit. The purchase
price that was allocated was based upon the final outcome of the valuation and
appraisals of the fair value of the acquired assets and assumed liabilities at
the date of acquisition, as well as the identification and valuation of certain
intangible assets such as customer lists, in-place workforce, technology and
trademarks, etc. The fair value of the technology, assembled workforce,
trademarks, customer lists and goodwill was determined by management using the
excess earnings method, a risk-adjusted cost approach and the residual method,
respectively. During the first quarter of 2002, goodwill was reduced by $0.3
million as a result of a final reconciliation related to the acquisition.
Additionally, upon the closing of the STI acquisition, the President and sole
shareholder of STI entered into an employment agreement with the Company and
became President of International Operations as well as a member of the
Company's Board of Directors.
The consideration paid by EasyLink was determined as a result of negotiations
between EasyLink and STI.
During January 2001, STI purchased the real time fax business from Xpedite
Systems, Inc. located in Singapore and Malaysia (these two subsidiaries conduct
business under the name "Xtreme") for approximately $500,000 in cash.
In connection with the acquisition of STI, the Company entered into a
conditional commitment to acquire Telecom International, Inc. ("TII"), which
immediately prior to the acquisition of STI was an affiliate of the sole
shareholder of STI. The purchase price for TII was originally negotiated at
$117,646 in cash, a promissory note in the aggregate principal amount of
approximately $1,294,000 and 267,059 shares of the Company's Class A common
stock. In order to facilitate the Company's proposed debt restructuring and to
reduce the Company's debt obligations and cash commitments, the former sole
shareholder of STI and the Company agreed to modify the Company's commitments in
respect of TII. In lieu of acquiring TII, the Company purchased certain assets
owned by TII and assumed certain liabilities. As consideration, the Company
issued 300,000 shares of Class A common stock valued at $1.9 million as the sole
purchase price. As a result of this transaction, the Company recorded an
extraordinary loss on the extinguishment of this commitment of $2.4 million
during the fourth quarter of 2001.
As part of the transaction with STI, we also entered into a conditional
commitment to acquire the 25% minority interests in two STI subsidiaries for
$47,059 in cash, promissory notes in the aggregate principal amount of
approximately $517,647 and 106,826 shares of Class A Common Stock. This
transaction is subject to certain conditions, including satisfactory completion
of due diligence, receipt of regulatory approvals and other customary
conditions.
The following unaudited pro-forma consolidated amounts give effect to the 2001
acquisitions as if they had occurred on January 1, 2001, by consolidating their
results of operations with the results of the Company for the three and nine
months ended September30, 2001. The unaudited pro-forma consolidated results are
not necessarily indicative of the operating results that would have been
achieved had the transactions been in effect as of the beginning of the periods
presented and should not be construed as being representative of future
operating results. The pro forma basic and diluted net loss per common share is
computed by dividing the net loss attributable to common stockholders by the
weighted-average number of common shares outstanding. Diluted net loss per share
equals basic net loss per share, as common stock equivalents are anti-dilutive
for all pro forma periods presented.
15
Three Months Ended Nine Months Ended
------------------ -----------------
In thousands, except per share amounts) September 30, 2001 September 30, 2001
------------------ ------------------
Revenues...................................................................... $ 36,548 $ 116,664
Loss from continuing operations............................................... $(15,445) $ (81,257)
Loss from discontinued operations............................................. $ (1,140) $ (67,164)
Extraordinary gain............................................................ $ 782 $ 782
Net loss ..................................................................... $(15,803) $(147,639)
Basic and diluted net loss per common share:
Loss from continuing operations............................................... $ (1.66) $ (9.28)
Loss from discontinued operations............................................. (0.12) (7.67)
Extraordinary gain............................................................ 0.08 0.09
Net loss...................................................................... $ (1.70) $ (16.86)
Weighted average shares used in net loss
per share calculation (1)..................................................... 9,279 8,757
(1) The Company computes net loss per share in accordance with provisions of
SFAS No. 128, "Earnings per Share." Basic net loss per share is computed by
dividing the net loss for the period by the weighted-average number of common
shares outstanding during the period. The calculation of the weighted average
number of shares outstanding assumes that 1,896,218 shares of EasyLink's common
stock issued in connection with its acquisitions were outstanding for the entire
period or date of inception, if later. The weighted average common shares used
to compute pro forma basic net loss per share includes the actual weighted
average common shares outstanding for the periods presented, respectively, plus
the common shares issued in connection with the 2001 acquisitions from January
1, 2001 or date of inception if later. Diluted net loss per share is equal to
basic net loss per share as common stock issuable upon exercise of the Company's
employee stock options and upon exercise of outstanding warrants are not
included because they are antidilutive. In future periods, the weighted-average
shares used to compute diluted earnings per share will include the incremental
shares of common stock relating to outstanding options and warrants to the
extent such incremental shares are dilutive.
(3) Other Acquisition Related Events
TCOM
On October 18, 1999, the Company acquired TCOM, Inc. ("TCOM"), a software
technology development firm, specializing in the design of carrier class
applications for the telecommunications and computer telephony industries. The
Company was not continuing the business operations of TCOM but made the
acquisition in order to obtain technology and development resources. The
acquisition had been accounted for an acquisition of assets. The Company paid $2
million in cash and issued 43,983 shares of Class A common stock valued at
approximately $6.1 million. In addition, the Company paid to the former
employees of TCOM bonuses totaling $400,000, payable in six-month installments
after the closing date in the amounts of $74,000, $88,000, $116,000 and
$122,000, provided such employees continue their employment through the
applicable payment dates. As of December 31, 2001, the amount was fully repaid.
The excess of the purchase price over the net book value of the assets acquired
and assumed liabilities of TCOM of approximately $8.1 million has been allocated
to other intangible assets. Such amounts will be ratably amortized over a period
of three years, the expected period of benefit.
The Company was obligated to pay additional consideration to the sellers of TCOM
based upon the achievement of certain objectives over an 18-month period. The
additional consideration was to consist of up to $1.0 million payable in cash
and up to $2.75 million payable in shares of Class A common stock based on the
market value of such stock at the time of payment, although the market value
would be deemed to be not less than $40.00 per share. On November 1, 2000, the
Company settled its contingent consideration obligation with TCOM. The Company
agreed to pay the former shareholders of TCOM a total of $3.75 million,
comprised of a cash payment of $1 million and $2.75 million in Class A common
stock, on April 18, 2001, determined based on the market price at that time, but
not less than $40.00 per share. The Company adjusted the purchase price for the
$1 million payment and is amortizing such costs over the remaining life of the
other intangible assets.
During the first quarter of 2001, management determined that a portion of the
carrying value of the other intangible assets associated with TCOM had become
impaired due to the restructuring of the workforce that had generated those
intangible assets upon acquisition in October 1999. As a result, an impairment
charge of $4.3 million was recorded as part of the restructuring charge.
16
(4) Sale of Businesses
On September 20, 2002, the Company sold its customer contracts related to its
email hosting service ("NIMS") line to Call Sciences, Inc. Call Sciences paid
$300,000 in cash upon closing. The consideration paid to EasyLink was determined
as a result of negotiations between Call Sciences, Inc. and EasyLink. In
connection with the sale, the parties entered into a transition services
agreement whereby the Company would receive payments for services rendered
during the 2 month period following the close. As a result of the sale, the
Company transferred the customer contracts and recorded a gain on the sale of
NIMS of $300,000.
On March 30, 2001, the Company sold its advertising network to Net2Phone, Inc.
Net2Phone paid the Company $3 million in cash upon the closing. The Company
received an additional $500,000 in April 2001 based upon the achievement of
certain milestones by the Company. The consideration paid to EasyLink was
determined as a result of negotiations between Net2Phone, Inc. and EasyLink. In
connection with the sale, the parties entered into a hosting agreement whereby
the Company would receive payments for hosting the consumer mailboxes for a
minimum of one year. As a result of the sale, the Company transferred net
assets, including certain domain names and partner agreements, and liabilities
related to the advertising network to Net2Phone, and recorded a loss on the sale
of the advertising network of $2.3 million. The loss was subsequently adjusted
to $1.8 million during the fourth quarter of 2001.
During the second quarter of 2001, the Company completed the migration of the
hosting of these consumer mailboxes to a third party provider who is paid for
this service. The hosting agreement was terminated as of September 30, 2001.
(5) Investments
The Company assesses the need to record impairment losses on investments and
records such losses when the impairment of an investment is determined to be
other-than-temporary.
On July 25, 2000, EasyLink entered into a strategic relationship with
BulletN.net, Inc. The investment has been accounted for under the cost method of
accounting, as EasyLink owns less than 20% of the outstanding stock of
BulletN.net. As part of this agreement BulletN.net issued 666,667 shares of its
common stock and a warrant to purchase up to 666,667 shares of BulletN.net
common stock at $3.75 per share to EasyLink in exchange for 36,443 shares of
EasyLink Class A common stock valued at approximately $3.1 million. The Company
concluded that the carrying value of this cost-based investment was permanently
impaired based on the achievement of business plan objectives and milestones and
the fair value of the investment relative to its carrying value. During the
first quarter of 2001, the Company recorded an impairment charge of $2.6 million
due to an other-than-temporary decline in the value of this investment. This
amount is included in impairment of investments within other income (expense) in
the 2001 statement of operations. On March 1, 2001, in consideration of the
exchange and cancellation of the 666,667 warrants and the waiver of certain
anti-dilution rights, the Company received a new warrant to purchase 266,667
shares of BulletN.net common stock at $1 per share. As of September 30, 2002,
the carrying value of this investment was $0.5 million.
During 1999, the Company acquired an equity interest in 3Cube, Inc. ("3Cube"),
which was accounted for under the cost method. Under the agreement, the Company
paid $1.0 million in cash and issued 8,008 of its Class A common stock, valued
at approximately $2.0 million, in exchange for 307,444 shares of 3Cube
convertible preferred stock which represents an equity interest of less than 20%
of 3Cube. On June 30, 2000, the Company made an additional investment in 3Cube,
Inc. by issuing 25,505 shares of Class A common stock valued at approximately
$1.5 million in exchange for 50,411 shares of 3Cube Series C Preferred Stock. At
December 31, 2000, EasyLink owned preferred stock of 3Cube, representing an
ownership interest of 21% of the combined common and preferred stock outstanding
of 3Cube, Inc. Accordingly, the Company accounted for this investment under the
equity method of accounting. The change from the cost method to the equity
method of accounting resulted in a decrease of the carrying value of the
investment by $2.1 million in 2000. In addition, as a result of sequential
declines in operating results of 3Cube, management made an assessment of the
carrying value of its equity investment and determined that it was in excess of
its estimated fair value. Accordingly, in December 2000, EasyLink wrote down the
value of its investment in 3Cube by $200,000 as it determined that the decline
in its value was other-than-temporary. During the first quarter of 2001, the
Company further reduced its investment in 3Cube by $59,000 to $2 million,
representing the value the Company received in August 2001 upon the liquidation
of its investment.
17
On April 17, 2000, in exchange for $500,000 in cash, the Company acquired
certain source code technologies, trademarks and related contracts relating to
the InTandem collaboration product ("InTandem") from IntraACTIVE, Inc., a
Delaware corporation (now named Bantu, Inc., "Bantu"). On the same date, the
Company also paid Bantu an upfront fee of $500,000 for further development and
support of the InTandem product. On the same date, pursuant to a Common Stock
Purchase Agreement, the Company acquired shares of common stock of Bantu
representing approximately 4.6% of Bantu's outstanding capital stock in exchange
for $1 million in cash and 46,296 shares of its Class A common stock, valued at
approximately $3.6 million. Pursuant to the Common Stock Purchase Agreement, the
Company also agreed to invest up to an additional $8 million in the form of
shares of its Class A Common stock in Bantu in three separate increments of $4
million, $2 million and $2 million, respectively, based upon the achievement of
certain milestones in exchange for additional shares of Bantu common stock
representing 3.7%, 1.85% and 1.85%, respectively, of the outstanding common
stock of Bantu as of April 17, 2000. The number of shares of the Company's Class
A common stock issuable at each closing will be based on the greater of $90 per
share and the average of the closing prices of the Company's Class A common
stock over the five trading days prior to such closing date. In July 2000, the
Company issued an additional 9,259 shares of its Class A common stock valued at
approximately $590,000 to Bantu in accordance with a true-up provision in the
Common Stock Purchase Agreement. In September 2000, the Company issued an
additional 44,444 shares of its Class A common stock valued at approximately
$2.9 million as payment for the achievement of a milestone indicated above. In
January 2001, the Company issued an additional 22,222 shares of its Class A
common stock valued at approximately $285,000 as payment for the achieved
milestone indicated above. The Company accounts for this investment under the
cost method. During the second quarter of 2001, management made an assessment of
the carrying value of its investment, based upon an incremental investment made
by a third party, and determined that the carrying value of this cost-based
investment was permanently impaired as it was in excess of its estimated fair
value. Accordingly, EasyLink wrote down the value of its investment in Bantu by
$7.3 million as it determined that the decline in its value was
other-than-temporary. As of September 30, 2002, the carrying value of this
investment was $1.0 million.
On July 25, 2000, the Company issued 10,222 shares of its Class A common stock
valued at approximately $872,000 as an investment in Madison Avenue Technology
Group, Inc. (CheetahMail). The investment has been accounted for under the cost
method of accounting as the Company owns less than 20% of the outstanding stock
of CheetahMail. In consideration thereof, the Company received 750,000 shares of
Series B convertible preferred stock and a warrant to purchase 75,000 shares of
common stock of CheetahMail. The Company transferred these shares of preferred
stock and warrants to Net2Phone pursuant to the sale of the Company's
Advertising Network.
(6) Notes Payable
7% Convertible Subordinated Notes
On January 26, 2000, the Company issued $100 million of 7% Convertible
Subordinated Notes ("the Notes"). Interest on the Notes is payable on February 1
and August 1 of each year, beginning on August 1, 2000. The Notes are
convertible by holders into shares of EasyLink Class A common stock at a
conversion price of $189.50 per share (subject to adjustment in certain events)
beginning 90 days following the issuance of the Notes.
The notes will mature on February 1, 2005. Prior to February 5, 2003 the Notes
may be redeemed at the Company's option ("the Provisional Redemption"), in whole
or in part, at any time or from time to time, at certain redemption prices, plus
accrued and unpaid interest to the date of redemption if the closing price of
the Class A common stock shall have equaled or exceeded specified percentages of
the conversion price then in effect for at least 20 out of 30 consecutive days
on which the NASDAQ national market is open for the transaction of business
prior to the date of mailing the notice of Provisional Redemption. Upon any
Provisional Redemption, the Company will be obligated to make an additional
payment in an amount equal to the present value of the aggregate value of the
interest payments that would thereafter have been payable on the notes from the
Provisional Redemption Date to, but not including, February 5, 2003. The present
value will be calculated using the bond equivalent yield on U.S. Treasury notes
or bills having a term nearest the length to that of the additional period as of
the day immediately preceding the date on which a notice of Provisional
Redemption is mailed.
On or after February 5, 2003, the Notes may be redeemed at the Company's option,
in whole or in part, in cash at the specified redemption prices, plus accrued
interest to the date of redemption.
In connection with the issuance of these Notes, the Company incurred
approximately $3.8 million of debt issuance costs. Such costs have been
capitalized and are being amortized ratably over the original term of the Notes.
As a result of the exchange note agreements entered into in 2001 and discussed
below, the Company recorded a charge of $2.2 million to reduce debt issuance
costs relating to that portion of the notes that were exchanged. This charge has
been netted against the extraordinary gain on exchange of convertible notes,
included in the 2001 statements of operations.
Senior Convertible Notes issued in Exchange for 7% Convertible Subordinated
Notes
On February 1, 2001, the Company entered into a note exchange agreement (the
"Note Exchange Agreement"). Under the terms of the agreement, EasyLink issued
$11,694,000 principal amount of a new series of 10% Senior Convertible Notes due
January 8, 2006 in exchange for the cancellation of $38,980,000 principal amount
of its 7% Convertible Subordinated Notes due February 1, 2005.
18
On February 8, 2001, the Company entered into an additional note exchange
agreement. Under the terms of the agreement, EasyLink issued $4,665,000
principal amount of a new series of 10% Senior Convertible Notes due January 8,
2006 in exchange for the cancellation of $15,550,000 principal amount of its 7%
Convertible Subordinated Notes due February 1, 2005.
On February 14, 2001, the Company entered into an additional note exchange
agreement. Under the terms of the agreement, EasyLink issued $7,481,250
principal amount of a new series of 10% Senior Convertible Notes due January 8,
2006 in exchange for the cancellation of $21,375,000 principal amount of its 7%
Convertible Subordinated Notes due February 1, 2005 (the "Subordinated Notes").
Pursuant to this note exchange agreement, on or about May 23, 2001, $2,531,250
in principal amount of these Senior Convertible Notes were exchanged for 142,071
shares of Class A common stock (the "Exchange Shares") leaving $4,950,000 in
principal amount of this series of Senior Convertible Notes outstanding.
The Senior Convertible Notes issuable under the February 1, February 8 and
February 14 note exchange agreements (the "Exchange Notes") are unsecured, joint
and several obligations of EasyLink and its subsidiary EasyLink Services USA,
Inc. (collectively, the "Companies").
The Exchange Notes bear interest semi-annually at the rate of 10% per annum. One
half of each interest payment is payable in cash and one half is payable in
shares of EasyLink Class A common stock, par value $.01 per share ("Class A
common stock"), until 18 months after the closing date of the financing.
Thereafter, one half of each interest payment may be paid in shares of Class A
common stock at the option of the Companies. For purposes of determining the
number of shares issuable upon payment of interest in shares of Class A common
stock, such shares will be deemed to have a value equal to the applicable
conversion price at the time of payment.
$11,694,000 of the Exchange Notes is convertible at any time at the option of
the holder into Class A common stock at an initial conversion price equal to
$13.00 per share. The conversion price is subject to anti-dilution adjustments.
$4,665,000 of the Exchange Notes is convertible at any time at the option of the
holder into Class A common stock at an initial conversion price equal to $17.50
per share. The conversion price is subject to anti-dilution adjustments.
$7,481,250 of the Exchange Notes is convertible at any time at the option of the
holder into Class A common stock at an initial conversion price equal to $15.00
per share. Also, $2,531,250 of the Exchange Notes was cancelled in exchange for
the issuance of Exchange Shares as described above. The conversion price is
subject to anti-dilution adjustments.
The Companies may, at their option, prepay the Exchange Notes, in whole or in
part, at any time (i) on or after the third anniversary of the closing date of
the financing, (ii) if the closing price of the Class A common stock on the
NASDAQ stock market, or other securities market on which the Class A common
stock is then traded, is at or above $50.00 per share (such amount to be
appropriately adjusted in the event of a stock split, stock dividend, stock
combination or recapitalization or similar event having a similar effect) for 30
consecutive trading days or (iii) EasyLink desires to effect a merger,
consolidation or sale of all or substantially all of its assets in a manner that
is prohibited by the Note Purchase Agreement between EasyLink and the initial
purchasers of the Exchange Notes (the "Note Purchase Agreement") and the holders
of the Exchange Notes fail to consent to a waiver of such prohibition to permit
such merger, consolidation or sale.
All of the above exchange transactions (other than the exchange of $2,531,250 of
the Senior Convertible Notes described above, which closed on or about May 23,
2001) under the Exchange Note Agreements closed on March 28, 2001.
The above exchange transactions have been accounted for in accordance with
Financial Accounting Standards Board Statement No. 15 ("FASB No.15"),
"Accounting by Debtors and Creditors for Troubled Debt Restructurings." As a
result of these exchanges, the Company recorded a $40.4 million gain on the
exchange of convertible notes during the nine months ended September 30, 2001.
Because the total future cash payments specified by the new terms of the
Exchange Notes, including both payments designated as interest and those
designated as face amount, are less than the carrying amount of the Notes, the
Company was required to reduce the carrying amount of the Notes, to an amount
equal to the total future cash payments specified by the new terms and
recognized a gain on exchange of payables equal to the amount of the reduction,
less the applicable deferred financing costs associated with the original $100
million 7% Convertible Subordinated Notes of $2.2 million and new financing
costs of $40,000.
In future periods, all payments under the terms of the Exchange Notes shall be
accounted for as reductions of the carrying amount of the Exchange Notes, and no
interest expense shall be recognized on the Exchange Notes for any period
between the exchange dates and maturity dates of the Exchange Notes.
19
Other Senior Convertible Notes
On January 8, 2001, the Company issued $10 million (subsequently increased to
$10.26 million) of 10% Senior Convertible Notes due January 8, 2006 to an
investor group. On March 19, 2001, the Company completed the issuance of $3.9
million principal amount of 10% Senior Convertible Notes due January 8, 2006
(together with the notes issued pursuant to the January 8, 2001 agreement, (the
"Notes") to certain private investors. The Notes are unsecured, joint and
several obligations of EasyLink and its subsidiary EasyLink Services USA, Inc.
(collectively, the "Companies").
The Notes bear interest, payable semi-annually, at the rate of 10% per annum.
One half of each interest payment is payable in cash and one half is payable in
shares of EasyLink Class A common stock ("Class A common stock"), until 18
months after the closing date of the financing. Thereafter, one half of each
interest payment may be paid in shares of Class A common stock at the option of
the Companies. For purposes of determining the number of shares issuable upon
payment of interest in shares of Class A common stock, such shares will be
deemed to have a value equal to the applicable conversion price at the time of
payment.
The Companies may, at their option, prepay the Notes, in whole or in part, at
any time (i) on or after the third anniversary of the closing date of the
financing, (ii) if the closing price of the Class A common stock on the NASDAQ
stock market, or other securities market on which the Class A common stock is
then traded, is at or above $50.00 per share (such amount to be appropriately
adjusted in the event of a stock split, stock dividend, stock combination or
recapitalization or similar event having a similar effect) for 30 consecutive
trading days or (iii) EasyLink desires to effect a merger, consolidation or sale
of all or substantially all of its assets in a manner that is prohibited by the
Note Purchase Agreement dated as of March 13, 2001 between EasyLink and the
initial purchasers of the Notes and the holders of the Notes fail to consent to
a waiver of such prohibition to permit such merger, consolidation or sale.
Each of the Notes is convertible at any time at the option of the holder into
Class A common stock at an initial conversion price equal to $10.00 per share.
The conversion price is subject to anti-dilution adjustments.
The $10.26 million principal amount of Notes issued pursuant to the January 8,
2001 agreement are secured by a pledge of the Company's and its wholly-owned
subsidiary WORLD.com, Inc.'s share interest in its majority owned subsidiary
India.com, Inc. The security interest will be released, among other
circumstances, (i) upon repayment of the Notes and accrued interest thereon,
(ii) upon a sale, transfer or other disposition of the shares as permitted under
the Note Purchase Agreement and the prepayment of Notes as become subject to
prepayment in accordance with the Note Purchase Agreement, or (iii) if EasyLink
raises at least $35 million in cash proceeds from the sale of assets (including
the pledged shares) or from the issuance of certain additional debt or equity
financings on or before April 30, 2001.
The net proceeds of the issuance of the $10.26 million principal amount of Notes
issued pursuant to the January 8, 2001 agreement were used to fund a portion of
the purchase price payable by Swift Telecommunications, Inc. for the acquisition
of the AT&T EasyLink Services business and for working capital and other general
corporate purposes.
In connection with the issuance of the Notes, the Company granted to the
investor group the right to designate one director to the Board of Directors for
so long as the investor group and certain other parties associated with it own a
specified number of shares of Class A common stock on a fully diluted basis (the
"Designation Agreement"). Pursuant to the Designation Agreement, the Board of
Directors appointed a director to the Board of EasyLink effective upon the
closing of the financing.
During the second quarter of 2001, the Company issued an aggregate of $550,000
principal amount of 10% Senior Convertible Notes Due January 8, 2006 to certain
vendors in exchange for settlement of its obligations to those vendors. Terms of
the notes are similar to those notes that were issued on January 8, 2001.
Notes issued in STI/EasyLink Acquisition
In connection with the acquisition of STI, the Company assumed a $35 million
note from STI and issued a $9.2 million unsecured note to the former shareholder
of STI as partial payment (see Note 2 for additional information). These notes
were subsequently restructured (see Restructuring of Certain Debt and Lease
Obligations below).
Zones, Inc. Promissory Note
On July 13, 2001, EasyLink entered into an agreement with Zones, Inc. (formerly
Multiple Zones, Inc.) regarding payment of a $1 million promissory note.
Pursuant to the agreement, EasyLink paid Zones $200,000 in cash on July 16,
2001. Additionally, Zones agreed to convert $400,000 of the original promissory
note into a number of shares of EasyLink Class A common stock based upon the
average sales price of the Class A Common Stock over the ten (10) trading days
immediately preceding the earlier of (a) the filing of a registration statement
for the resale of the shares, and (b) the date on which EasyLink enables
Multiple Zones to resell the shares or receive the economic benefit of such
resale, but in any event not more than 125,000 shares. EasyLink also undertook
to file an S-3 registration statement with the United States Securities and
Exchange Commission ("SEC"), or such other registration statement as necessary
to register the Settlement Shares with the SEC to permit public resale of those
shares by Multiple Zones as soon as practicable after execution of the
Settlement Agreement, but in no event later than September 30, 2001. EasyLink
also agreed to pay to Multiple Zones an additional $430,000 upon the earlier of
(i) the closing of the sale of Multiple Zones Mauritius, Ltd. or Multiple Zones
Pvt., Ltd. or their respective successors; or (ii) October 31, 2001.
20
Under an Amended and Restated Settlement Agreement and Release between the
Company and Zones, Inc. dated October 8, 2001, the Company and Zones amended
their original July 13, 2001 settlement agreement. Under the October 8, 2001
agreement, the Company paid Zones the remaining $430,000 cash payment owed to
Zones, and the parties also fixed the number of shares of Class A common stock
issuable by the Company to Zones at 103,359. The shares were issued in the
fourth quarter of 2001.
GN Store Nord A/S
During July 2001, the Company received a $1.1 million loan from the parent of GN
Comtext, GN Store Nord A/S, in connection with assets acquired. During the
quarter ended September 30, 2001, receivables due from GN Comtext of
approximately $200,000 were netted against the principal amounts due to them.
The loan was paid December 2001.
Restructuring of Certain Debt and Lease Obligations
During the third quarter of 2001, pending the completion of the subsequent
restructuring, the Company issued $16.3 million of interim notes, bearing
interest at a rate of 12% per annum, in exchange for present and future lease
obligations in the amount of $15.1 million. These notes were cancelled upon
completion of the fourth quarter debt restructuring. This interim transaction
resulted in a loss of $1.1 million in accordance with FASB No. 15.
On November 27, 2001, the Company completed the restructuring of approximately
$63 million of debt and lease obligations and a related financing in the amount
of approximately $10 million.
Under the terms of the debt restructuring, the Company exchanged an aggregate of
approximately $63 million of debt and equipment lease obligations for an
aggregate of approximately $20 million of restructure notes and obligations due
in installments commencing June 2003 through June 2006, 1.97 million shares of
Class A Common Stock and warrants to purchase 1.8 million shares of Class A
Common Stock. In addition, the Company purchased certain leased equipment for an
aggregate purchase price of $3.5 million. The Company also recorded net gains of
$7.8 million upon the completion of the restructuring in accordance with FASB
No. 15 during the fourth quarter of 2001.
The restructure notes bear interest at a rate of 12% per annum and mature five
years from the date of the debt restructuring. The Company may elect to defer
payment of accrued interest on a portion of the restructure notes until various
dates commencing June 2003 and may elect to pay accrued interest on other
restructure notes in shares of Class A common stock having a market value at the
time of payment equal to 120% of the interest payment due. $9.1 million in
principal amount of the restructure notes are convertible, at the option of the
holder, into shares of Class A Common Stock of the Company at a conversion price
of $10.00 per share, subject to adjustment in certain events. The Company will
not be required to make scheduled principal payments on any of the notes until
June 2003. All of the notes are callable at any time for cash. The warrants
allow the holders to purchase shares of Class A Common Stock of the Company at
an exercise price equal to $6.10 per share. The number of shares issuable upon
exercise and the exercise price of the warrants are subject to adjustment in
certain events. The warrants are exercisable for ten years after the date of the
grant.
The restructure notes issued to AT&T Corp. and the former shareholder of STI
have been accounted for in accordance with Financial Accounting Standards Board
Statement No. 15, "Accounting by Debtors and Creditors for Troubled Debt
Restructurings." Because the total future cash or share payments specified by
the terms of these restructure notes, including both payments designated as
interest and those designated as principal, are less than the carrying amount of
these restructure notes, the Company was required to reduce the carrying amount
of the original notes exchanged for the restructure notes issued to AT&T and
such former STI shareholder to an amount equal to the total future cash payments
specified by the new terms. In future periods, all payments under the terms of
the restructure notes for which future interest was included in the carrying
amounts of such notes shall be accounted for as reductions of such carrying
amounts, and no interest expense shall be recognized on such notes for any
period between the respective dates of commencement of the accrual of interest
on such notes and the maturity dates of such notes.
The Company recognized a gain on the debt restructuring in the amount of $7.8
million during the fourth quarter of 2001. This gain was calculated based on the
amount of the total reduction in carrying values of the original restructure
obligations as compared to the carrying values of the restructure notes minus
the amount of the contingent share issuance obligation of $1.1 million recorded
by the Company due to the assumed payment of interest on a portion of the
restructure notes in shares of Class A common stock as described above. The gain
also reflects the impact of the settlement of certain trade payables.
21
$5.875 million of the financing was represented by the investment of cash in
exchange for 1,468,750 shares of Class A common stock. Approximately $1.3
million of this financing was represented by the investment of cash in exchange
for senior convertible notes that are convertible into approximately 520,000
shares of Class A common stock, subject to adjustment in certain events. These
notes are convertible at $2.50 per share. The beneficial conversion feature of
$1.1 million is being amortized over a period of 5 years. Approximately $3.0
million of this financing was represented by the exchange of $1.4 million of
cash equipment purchase obligations held by lessors and $1.6 million of other
cash obligations held by AT&T for an aggregate of 820,000 shares of Class A
common stock.
On July 15, 2002, the Company entered into a transfer and assignment agreement
to repurchase a 12% Senior Restructure Note and a restructuring balloon payment
in the amount of $0.5 million for $90,000 in cash and 5,415 shares in Class A
common stock, valued at approximately $6,000. This transaction was accounted for
in accordance with Financial Accounting Standards Board Statement No. 15 ("FASB
No.15"), "Accounting by Debtors and Creditors for Troubled Debt Restructurings."
As a result of this transaction, the Company recorded a $0.4 million gain during
the three months ended September 30, 2002.
On September 27, 2002, the Company entered into a transaction agreement to
repurchase 10% Senior Convertible Notes in the amount of $4.95 million for
$495,000. This transaction was accounted for in accordance with Financial
Accounting Standards Board Statement No. 15 ("FASB No.15"), "Accounting by
Debtors and Creditors for Troubled Debt Restructurings." As a result of this
transaction, the Company recorded a $6.2 million gain during the three months
ended September 30, 2002 which includes the impact of a $1.7 million reversal of
capitalized interest previously recognized in connection with the February 14,
2001 exchange agreement related to such notes.
Notes payable include the following, in thousands
September 30, 2002 December 31, 2001
------------------ -----------------
Capitalized Capitalized
Interest Principal Interest Principal
------------- ------------- ------------ ------------
2000 7% Convertible Subordinated Notes due February 2005 $ -- $ 24,095 $ -- $ 24,095
2001 10% Senior Convertible Notes due January 2006 5,528 31,059 8,615 36,009
2001 12% AT&T restructure note 13 quarterly payments
beginning June 2003 4,300 10,000 4,300 10,000
2001 12% note payable to former shareholder of STI 13 quarterly
payments beginning June 2003 832 2,683 1,154 2,683
2001 12% Restructure notes 13 quarterly payments
beginning June 2003 -- 6,132 -- 6,435
2001 10% Note payable due October 2006 -- 380 -- 525
2001 Restructuring balloon payments due October 2004 -- 774 -- 846
Other -- 448 -- 330
---------- ---------- ---------- ----------
Total notes payable and capitalized interest 10,660 75,571 14,069 80,923
Less current portion 3,517 2,770 1,410 --
---------- ---------- ---------- ----------
Non current portion $ 7,143 $ 72,801 $ 12,659 $ 80,923
========== ========== ========== ==========
(7) Discontinued Operations
In March 2000, the Company formed World.com, Inc. in order to develop the
Company's portfolio of domain names into independent web properties and
subsequently acquired or formed its subsidiaries Asia.com, Inc. and India.com,
Inc., in which World.com was the majority owner. On November 2, 2000, the
Company announced its intention to sell all assets not related to its core
outsourced messaging business including Asia.com, Inc., India.com, Inc. and its
portfolio of domain names. Accordingly, World.com has been reflected as a
discontinued operation.
The Consolidated Financial Statements of the Company have been restated to
reflect World.com as a discontinued operation in accordance with APB Opinion No.
30. Accordingly, revenues, costs and expenses, assets, liabilities and cash
flows of World.com have been excluded from the respective captions in the
Consolidated Statement of Operations, Consolidated Balance Sheets and
Consolidated Statements of Cash Flows and have been reported as "Loss from
discontinued operations," "Net liabilities of discontinued operations," and "Net
cash (used in) provided by discontinued operations," for all periods presented.
During the nine months ended September 30, 2001, the Company recorded a loss of
$67.1 million to recognize the loss on discontinued operations. This loss
includes a write-down of $52.6 million of assets, primarily goodwill, to net
realizable value, operating losses of $12.4 million, severance and related
benefits of $1.3 million, and other related cost and expenses including the
closure of facilities of $0.8 million.
22
Summarized financial information for the discontinued operation is as follows:
Statements of Operations Data
Nine Months Ended September 30,
(In Thousands)
--------------
2002 2001
---- ----
Revenues.......................................................... $ -- $ 5,834
========= ========
Loss from discontinued operations................................. $ -- $ 67,164
========= ========
Balance Sheet Data
(In Thousands)
--------------
September 30, December 31,
2002 2001
---- ----
Current assets.................................................... $ 57 $ 74
Total assets...................................................... 444 423
Current liabilities............................................... 545 1,873
Long-term liabilities and minority interest....................... 225 225
Net liabilities of discontinued operations........................ $ (326) $(1,675)
The information below pertains to certain events and activities associated with
the operations of World.com and include: financings in connection with
India.com, domain names included in discontinued operations, the acquisition and
subsequent disposition of eLong.com, which was renamed to Asia.com, Inc., and
other acquisitions made by World.com.
India.com Financing
During the third quarter of 2000, India.com, Inc., a wholly-owned subsidiary,
issued 1,365,769 shares of Series A convertible preferred stock to private
investors valued at $14.2 million. These shares were convertible into India.com
Class A common stock at the initial purchase price of the preferred shares,
subject to certain anti-dilution adjustments. In addition, the preferred share
conversion price was also subject to reduction if the effective sales price in
India.com's next significant equity financing did not represent a 33% premium to
the current conversion price. The Company would measure the contingent
beneficial conversion feature at the commitment date and treat this feature as a
preferred dividend but would not recognize this preferred dividend in earnings
until the contingency was resolved, if ever. The holders of the Series A
convertible exchangeable preferred stock were entitled to a one time right
exercisable during the 60 days after September 13, 2001 to exchange these shares
for the number of shares of EasyLink Class A common stock equal to the original
purchase price of such shares divided by the lesser of the market price of
EasyLink's Class A common stock on September 13, 2001 (but not less than $45.00)
and $60.00. This exchange right has since been modified as described below.
The Company entered into a Bridge Funding and Amendment Agreement with
India.com, Inc. (the "Bridge Funding Agreement"). Under the Bridge Funding
Agreement, the Company borrowed approximately $5 million from its majority-owned
subsidiary India.com and issued to India.com bridge notes evidencing these
borrowings (the "Bridge Notes"). Under the Bridge Funding Agreement, the Company
issued to India.com warrants to purchase 20,000 shares of EasyLink's Class A
common stock at an exercise price of $13.00 per share in consideration of the
commitment under the Bridge Funding Agreement. In addition, India.com received
warrants to purchase an additional 16,000 shares of EasyLink Class A common
stock for each $1 million drawn down by the Company under the Bridge Funding
Agreement. As a result of the drawings under the Bridge Funding Agreement, the
Company issued an additional 80,000 warrants at exercise prices ranging from
$6.20 to $14.00 per warrant.
In consideration of the commitments under the Bridge Funding Agreement, the
period during which the one-time exchange right of the holders of India.com
preferred stock was changed from the 60-day period immediately after September
13, 2001 to the 60-day period immediately after December 31, 2001. In addition,
the floor price at which shares of EasyLink Class A common stock were issuable
upon the exchange was reduced from $45.00 per share to $30.00 per share
immediately upon execution and delivery of the Bridge Funding Agreement and was
subject to further reduction to $12.50 per share for a percentage of the total
number of shares of India Preferred Stock that is equal to the percentage of the
Bridge Note drawn down. As of March 31, 2001, $4.0 million of the Bridge Note
had been drawn down.
23
Pursuant to an Exchange Agreement Amendment entered into on July 17, 2001 (the
"Exchange Agreement Amendment") between the Company and the holders of India.com
preferred stock, all of the holders of the outstanding shares of India.com
preferred stock exercised their right to exchange their shares of India.com
preferred stock for shares of the Company's Class A common stock based on the
average of the closing market prices of the Company's stock over the five
trading days ending on September 13, 2001, subject to a floor on the exchange
price of $10.00 and a cap of $30.00 and subject to adjustment in certain
circumstances. Based on the average of the closing prices of the Company's
stock, the exchange price was $10.00 per share and 1,420,400 became issuable
upon consummation of the exchange. As of September 30, 2001, the closing of the
exchange transaction was subject to compliance with the requirements of the
NASDAQ stock market. The Company entered into the Exchange Agreement Amendment
in connection with the elimination of its obligations under the $5 million
aggregate principal amount of bridge notes and the warrants to purchase an
aggregate of 100,000 shares of the Company's Class A common stock issued to
India.com.
On October 17, 2001, the Company and the holders of India.com preferred stock
completed the exchange of India.com preferred stock for 1,420,400 shares of the
Company's Class A common stock.
eLong.com, Inc.
On March 14, 2000, the Company acquired eLong.com, Inc., a Delaware corporation
("eLong.com") for approximately $62 million including acquisition costs of
$365,000. eLong.com, through its wholly owned subsidiary in the People's
Republic of China ("PRC"), operates the Web Site www.eLong.com, which is a
provider of local content and other internet services. Concurrently with the
merger, eLong.com changed its name to Asia.com, Inc. ("Asia.com"). In the
merger, the Company issued to the former stockholders of eLong.com an aggregate
of 359,949 shares of EasyLink Class A common stock valued at approximately $57.2
million, based upon the Company's average trading price at the date of
acquisition. All outstanding options to purchase eLong.com common stock were
converted into options to purchase an aggregate of 27,929 shares of EasyLink
Class A common stock. The value of the options was approximately $4.4 million
based on the Black-Scholes pricing model with a 110% volatility factor, a term
of 10 years, a weighted average exercise price of $12.40 per share and a
weighted average fair value of $156.90 per share.
The acquisition was accounted for as a purchase business combination. The excess
of the purchase price over the fair market value of the acquired assets and
assumed liabilities of Asia.com has been allocated to goodwill ($62 million).
Goodwill is being amortized over a period of 3 years, the expected estimated
period of benefit. During the fourth quarter of 2000, approximately $7.8 million
of goodwill was written off as it was determined that the carrying value had
become permanently impaired as a result of the November 2, 2000 decision, as
approved by the Board of Directors, to sell all assets not related to its core
outsourcing business, including its Asia-based businesses. After giving effect
to the write off, the net goodwill balance at December 31, 2000 was $38.2
million.
In addition, the Company was obligated to issue up to an additional 71,990
shares of the Company's Class A common stock in the aggregate to the former
stockholders of eLong.com if EasyLink or Asia.com acquired less than $50.0
million in value of businesses engaged in developing, marketing or providing
consumer or business internet portals and related services focused on the Asian
market or a portion thereof, or businesses in furtherance of such a business,
prior to March 14, 2001. In May 2001, the Company issued 7,500 shares of Class A
common stock in settlement of this contingency.
In the merger, certain former stockholders of eLong.com retained shares of Class
A common stock of Asia.com, representing approximately 4.0% of the outstanding
common stock of Asia.com. Under a Contribution Agreement with Asia.com, these
stockholders contributed an aggregate of $2.0 million in cash to Asia.com in
exchange for additional shares of Class A common stock of Asia.com, representing
approximately 1.9% of the outstanding common stock of Asia.com. Pursuant to the
Contribution Agreement, EasyLink (1) contributed to Asia.com the domain names
Asia.com and Singapore.com and $10.0 million in cash and (2) agreed to
contribute to Asia.com up to an additional $10.0 million in cash over the next
12 months and to issue, at the request of Asia.com, up to an aggregate of 24,242
shares of EasyLink Class A common stock for future acquisitions. In connection
with the subsequent sale of eLong.com, Inc., the Contribution Agreement was
terminated. See also "Asia.com Acquisitions" and "Sale of eLong.com Inc.,"
below. As a result of the transactions effected pursuant to the Merger Agreement
and the Contribution Agreement, EasyLink initially owned shares of Class B
common stock of Asia.com representing approximately 94.1% of the outstanding
common stock of Asia.com. The company's ownership percentage decreased to 92% as
of December 31, 2000. Asia.com granted to management employees of Asia.com
options to purchase Class A common stock of Asia.com representing, as of
December 31, 2000, 9% of the outstanding shares of common stock after giving
effect to the exercise of such options.
24
Sale of eLong.com Inc.
On May 3, 2001, the Company's majority owned subsidiary Asia.com, Inc. sold its
business to an investor group. Under the terms of the sale, the buyer paid
Asia.com $1.5 million and assumed eLong.com liabilities of approximately $1.5
million. The consideration paid was determined as a result of negotiations
between the buyer and EasyLink. In addition, the Company issued 20,000 shares of
its Class A common stock valued at $138,000 in exchange for the cancellation of
certain options granted to the former owners of eLong.com. The Company accounted
for this transaction as part of the sale of the business of Asia.com. As a
result of the sale, the Company recorded a loss on the sale of eLong.com, Inc.
of $264,000. After the closing of the sale, the Company issued 36,232 shares in
January 2002 to eLong.com, Inc. in full satisfaction of an indemnity obligation.
The indemnity obligation arose out of eLong.com's settlement of a claim brought
by former Lohoo shareholders for a contingent payment. Lohoo was previously
acquired by eLong.com, Inc.
Mauritius Entity
On March 31, 2000, the Company acquired 100% of a Mauritius entity, which in
turn owned 80% of an Indian subsidiary. The terms were $400,000 in cash and a $1
million 7% note payable one year from closing. The acquisition was accounted for
as a purchase business combination. The excess of the purchase price over the
fair market value of the assets acquired and assumed liabilities of the
Mauritius entity has been allocated to goodwill ($2.1 million). Goodwill is
being amortized over a period of five years, the expected estimated period of
benefit.
In June 2000, the Company acquired, through the Mauritius entity, the remaining
20% of the Indian subsidiary for $2.2 million. The acquisition was accounted for
as a purchase business combination. The excess of the purchase price over the
fair market value of the assets acquired has been allocated to goodwill ($2.2
million), and is being amortized over a period of five years, the expected
estimated period of benefit.
In connection with the Mauritius acquisition, the Company incurred a $1.8
million charge related to the issuance of 10,435 shares of Class A common stock,
as compensation for services performed, $200,000 cash and an additional $200,000
payable in EasyLink Class A common stock as compensation for employees.
On October 31, 2001, the Company's India.com, Inc. subsidiary sold 90% of the
share of its Multiple Zones Prvt. Ltd. Subsidiary. The Company recorded a
nominal gain on the transaction.
India Acquisition and Divestiture
During the first quarter of 2001, the Company acquired a US and India based
company for approximately $600,000, including acquisition costs. The terms were
$300,000 in cash and 19,600 shares of EasyLink Class A common stock valued at
approximately $272,000 based upon the average trading price of EasyLink Class A
common stock surrounding the date of acquisition. The acquisition was accounted
for as a purchase business combination. The excess of the purchase price over
the fair market value of the assets acquired and assumed liabilities had been
allocated to goodwill ($831,000), which was being amortized over a period of
three years, the expected estimated period of benefit.
The Company subsequently transferred this acquired business to the former
management of its India.com subsidiary. As part of the transaction, the
transferred business assumed all of the liabilities of the transferred business
and certain liabilities of India.com. In consideration for the assumption of
these liabilities, the Company contributed to the transferred business
immediately prior to the sale in January 2002 56,075 shares of Class A common
stock valued at approximately $314,000 and $300,000 in cash.
(8) Related Party Transactions
Federal Partners, L.P. Financings
On January 8, 2001, the Company issued $5,000,000 principal amount of 10% Senior
Convertible Notes due January 8, 2006 to Federal Partners, L.P. The Clark
Estates, Inc. provides management and administrative services to Federal
Partners. Federal Partners and accounts for which The Clark Estates, Inc.
provides management and administrative services are beneficial holders of
approximately 9.9% of the Company's common stock, including shares issuable upon
conversion of senior convertible notes held by Federal Partners but excluding
shares issuable upon the conversion or exercise of other notes, warrants or
options. On March 20, 2001, the Company issued to Federal Partners, L.P. 300,000
shares of our Class A Common Stock for a purchase price of $3,000,000, and
committed to issue to Federal Partners an additional 100,000 shares of Class A
Common Stock if the closing price of our Class A Common Stock on the principal
securities exchange on which they are traded was not at or above $100 per share
for 5 consecutive days. These additional shares were issued in January 2002. As
part of the financing completed on November 27, 2001 in connection with our debt
restructuring, the Company issued to Federal Partners an aggregate of 250,369
shares of Class A common stock for a purchase price of $1,700,000, and committed
to issue to Federal Partners an additional 173,632 shares of Class A Common
Stock if the average of the closing prices of our Class A Common Stock on Nasdaq
was not at or above $16.00 per share for the 10 consecutive trading days through
year end 2001.
25
In connection with the issuance of the senior convertible notes on January 8,
2001, the Company granted to Federal Partners, L.P. the right to designate one
director to our Board of Directors so long as Federal Partners, L.P. and other
persons associated with it owns at least 300,000 shares of Class A Common Stock,
including shares issuable upon conversion of or in payment of interest on the
senior convertible notes. Federal Partners, L.P. designated Stephen Duff and he
was appointed to our Board on January 8, 2001. Mr. Duff is a Senior Investment
Manager for The Clark Estates, Inc. and is Treasurer and a limited partner of
Federal Partners, L.P. The Clark Estates, Inc. provides management and
administrative services for Federal Partners, L.P. Through his limited
partnership interest in Federal Partners, L.P., Mr. Duff has an indirect
interest in $10,000 principal amount of the senior convertible notes issued on
January 8, 2001, in 600 of the shares of Class A Common Stock issued to Federal
Partners, L.P. on March 20, 2001 and in 850 of the shares of Class A Common
Stock issued to Federal Partners, L.P. in connection with the November 27, 2001
financing.
Acquisition of Swift Telecommunications, Inc.
The Company acquired Swift Telecommunications, Inc. on February 23, 2001. George
Abi Zeid was the sole shareholder of Swift Telecommunications, Inc ("STI"). In
connection with the acquisition, Mr. Abi Zeid was elected to the Board of
Directors of the Company and was appointed President - International Operations.
EasyLink Services paid $835,294 in cash, issued 1,876,618 shares of Class A
Common Stock and issued a promissory note in the original principal amount of
approximately $9.2 million to Mr. Abi Zeid in payment of the purchase price for
the acquisition payable at the closing. Under the merger agreement, EasyLink
Services also agreed to pay additional contingent consideration to Mr. Abi Zeid
equal to the amount of the net proceeds, after satisfaction of certain
liabilities of STI and its subsidiaries, from the sale or liquidation of the
assets of one of STI's subsidiaries. The $9.2 million note was payable in four
equal semi-annual installments over two years. The note was non-interest bearing
except in certain circumstances. Pursuant to the debt restructuring completed on
November 27, 2001, EasyLink issued $2,682,964 principal amount of restructure
notes, 268,296 shares of Class A common stock and warrants to purchase 268,296
shares of Class A common stock in exchange for Mr. Abi Zeid's $9.2 million note.
See Note 6 Notes Payable.
In connection with the acquisition by STI on January 31, 2001 of the EasyLink
services business from AT&T Corp., Mr. Abi Zeid pledged to AT&T Corp. under a
Pledge Agreement dated January 31, 2001 all of the shares of EasyLink Services
Class A Common Stock that he was entitled to receive pursuant to the acquisition
to secure a $35 million note issued to AT&T Corp. by STI and assumed by EasyLink
Services as part of the purchase price for the EasyLink Services business. As a
result of the debt restructuring completed on November 27, 2001, these shares
now secure the $10 million principal amount of restructure notes issued to AT&T
Corp. in exchange for the $35 million note held by it.
In connection with the acquisition of STI on February 23, 2001, the Company also
entered into a conditional commitment to acquire Telecom International, Inc.
("TII"). TII was an affiliate of STI prior to the acquisition of STI by the
Company. George Abi Zeid is a principal beneficial shareholder of TII. The
purchase price for TII was originally agreed to be US$117,646 in cash, a
promissory note in the aggregate principal amount of approximately $1,294,118
and 267,059 shares of the Company's Class A common stock. In order to facilitate
the debt restructuring and to reduce the Company's debt obligations and cash
commitments, the parties agreed to modify the Company's commitments in respect
of TII. In lieu of acquiring TII, the Company purchased certain assets owned by
TII for six monthly payments of $10,000 commencing May 27, 2002 and one payment
of $190,000 on November 27, 2002. The Company also agreed to reimburse TII for
up to 50% of TII's payments on certain accounts payable up to a maximum
reimbursement of $200,000, to cancel a $236,490 payable owed by STI to the
Company and to issue up to 20,000 shares of Class A common stock to TII. In
addition, the Company issued 300,000 shares of Class A common stock to TII.
As part of the transaction with STI, EasyLink Services also entered into a
conditional commitment to acquire the 25% minority interests in two STI
subsidiaries for $47,059 in cash, promissory notes in the aggregate principal
amount of approximately $517,647 and 106,826 shares of Class A Common Stock.
This transaction is subject to certain conditions, including satisfactory
completion of due diligence, receipt of regulatory approvals and other customary
conditions.
Mr. Abi Zeid also agreed to contribute up to approximately 1.2 million shares of
Class A common stock issuable to him in connection with the debt restructuring
in order to permit the grant of shares or options to employees. The shares,
which were valued at $0.5 million, were accounted for as compensation expense in
the fourth quarter of 2001.
26
(9) Capital Stock
Reverse Stock Split
Effective January 23, 2002, the Company authorized and implemented a 1 for 10
reverse stock split. Accordingly, all share and per share amounts in the
accompanying consolidated financial statements have been retroactively restated
to affect the reverse stock split.
Authorized Shares
In 2001, the Company amended its amended and restated certificate of
incorporation, as amended, in order to increase the number of authorized shares
up to 570,000,000 consisting of 500,000,000 and 10,000,000 shares of Class A and
Class B common stock, respectively; and 60,000,000 undesignated shares of
preferred stock, all classes with a par value of $0.01 per share. These amounts
continue to represent the respective numbers of authorized shares of the Company
as of the date hereof.
Private Placements of Common Stock
On March 20, 2001, the Company completed a private placement of 300,000 shares
of Class A common stock (the "Common Shares") with a private investor for an
aggregate price of $3,000,000. Pursuant to the Common Stock Purchase Agreement
dated as of March 13, 2001 between the Company and the private investor and
subject to the effectiveness of a registration statement covering shares of
Class A common stock issuable upon conversion of certain convertible notes,
EasyLink was obligated to issue an additional 100,000 shares of Class A common
stock to the private investor if the closing price of the Company's Class A
common stock was not at or above $100 per share for at least five consecutive
trading days during 2001. These shares were issued in January 2002.
Common Stock and Warrants issued in Debt Restructuring and Related Financing
Under the terms of the Company's debt restructuring completed on November 27,
2001, the Company exchanged an aggregate of approximately $63 million of debt
and equipment lease obligations for an aggregate of approximately $20 million of
restructure notes and obligations due in installments commencing June 2003
through June 2006, 1.97 million shares of Class A Common Stock valued at $12.0
million and warrants to purchase 1.8 million shares of Class A Common Stock
valued at $0.5 million. $9.1 million in principal amount of the restructure
notes are convertible into shares of Class A common stock at a conversion price
of $10.00 per share, subject to adjustment.
As a condition to the debt restructuring, the Company completed a financing.
$5.875 million of this financing was represented by the investment of cash in
exchange for 1,468,750 shares of Class A common stock. Approximately $3.0
million of this financing was represented by the exchange of $1.4 million of
cash equipment purchase obligations held by lessors and $1.6 million of other
cash obligations held by AT&T for an aggregate of 820,000 shares of Class A
common stock.
Additional Common Stock Issued
The Company issued 777,390 shares of Class A common stock valued at
approximately $1.7 million as payment for interest in lieu of cash during the
nine months ended September 30, 2002.
During the nine months ended September 30, 2002, the Company also issued shares
of Class A common stock as follows:
The Company issued 56,075 shares of Class A common stock valued at approximately
$314,000 in connection with the divestiture of a subsidiary of the Company's
India.com subsidiary (see Note 7).
The Company issued 36,232 shares of Class A common stock valued at approximately
$203,000 in connection with the settlement of an indemnification obligation
arising out of the sale of Asia.com's eLong.com business. The indemnification
obligation arose out of a contingent payment obligation owed by eLong.com to the
sellers of a business purchased by eLong.com (see Note 7).
The Company issued 11,549 shares of Class A common stock valued at approximately
$73,000 in payment of a bonus to an employee.
The Company issued 21,016 shares of Class A common stock valued at approximately
$78,000 to a consultant in payment of consulting fees.
The Company issued 7,716 shares of Class A common stock valued at approximately
$11,000 in connection with a severance agreement.
27
The Company issued 106,534 shares of Class A common stock valued at
approximately $100,000 in settlement of a vendor obligation.
The Company issued 198,966 shares of Class A common stock valued at
approximately $326,000 to the trustee of the Company's 401(k) plan in
satisfaction of the Company match feature of the plan.
(10) Restructuring Charges
During the nine months ended September 30, 2002 and 2001, restructuring charges
of $1.7 million and $25.3 million, respectively, were recorded by the Company in
accordance with the provisions of EITF 94-3, and Staff Accounting Bulletin 100.
During 2002, the Company's restructuring initiatives are related to the
relocation and consolidation of its New Jersey-based office facilities into one
location. The relocation process will begin in the first quarter of 2003. The
restructuring charges are comprised of abandonment costs with respect to leases,
including the write-off of leasehold improvements. During 2001, the Company's
restructuring initiatives were related to our strategic decisions to exit the
consumer messaging business and to focus on the Company's outsourced messaging
business. The Company's restructuring program included an incremental reduction
in the workforce of approximately 150 employees. Employees affected by the
restructuring were notified by direct personal contact and by written
notification. The remaining employee benefit termination amounts are being paid
out in 2002. The lease abandonments represent the cost to exit the facility
leases. The remaining amounts are to be paid out over the next 3 years, which
corresponds to the terms of the lease.
The following sets forth the activity in the Company's restructuring reserve (in
thousands):
Beginning Current year- Current year- Ending
balance provision utilization balance
------- --------- ----------- -------
Employee termination benefits.................. $228 $ -- $ 88 $ 140
Lease abandonments............................. 539 1,710 450 1,799
Other exit costs............................... 32 -- -- 32
---- ------ ---- ------
$799 $1,710 $538 $1,971
==== ====== ==== ======
(11) Commitments and Contingencies
Master Carrier Agreement
In connection with the acquisition of the EasyLink Services business from AT&T
Corp., the Company entered into a Master Carrier Agreement with AT&T. Under this
agreement, AT&T will provide the Company with a variety of telecommunications
services that are required in connection with the provision of the Company's
services. The term of the agreement for network connection services is 36 months
commencing after an initial ramp-up period of 6 months (that is, until May 1,
2005) and the term of the agreement for private line and satellite services is
36 months commencing with the first full month in which any of these services
are provided (that is, until March 1, 2004). Under the agreement, the Company
has a minimum revenue commitment for network connection services equal to $3
million for each of the three years of the contract. In addition, the Company
has a minimum revenue commitment for private line and satellite services equal
to $375,000 per month during the three-year term. If the Company terminates the
network connection services or the private line and satellite services prior to
the term or AT&T terminates the services for our breach, the Company must pay to
AT&T a termination charge equal to 50% of the unsatisfied minimum revenue
commitment for these services for the period in which termination occurs plus
50% of the minimum revenue commitment for each remaining commitment period in
the term.
Other Telecommunications Services
The Company has committed to purchase from MCI Worldcom a minimum of $500,000
per month in telecommunications services through December 31, 2002 and $75,000
per month in other telecommunications services through January 2005.
Legal Proceedings
From time to time the Company has been, and expects to continue to be, subject
to legal proceedings and claims in the ordinary course of business. These
include claims of alleged infringement of third-party patents, trademarks,
copyrights, domain names and other similar proprietary rights; employment
claims; and contract claims. These claims include pending claims that some of
our services employ technology covered by third party patents. These claims,
even if not meritorious, could require the Company to expend significant
financial and managerial resources. No assurance can be given as to the outcome
of one or more claims of this nature. If an infringement claim were determined
in a manner adverse to the Company, the Company may be required to discontinue
use of any infringing technology, to pay damages and/or to pay ongoing license
fees which would increase the Company's costs of providing the service.
28
The Company has also received notices or claims from certain third parties for
disputed and unpaid accounts payable. The Company believes that it has
appropriately reserved for the amount of any liability that may arise out of
these matters, and management believes that these matters will be resolved
without a material effect on the Company's financial position or results of
operations.
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
We make forward-looking statements within the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 throughout this report. These
statements relate to our future plans, objectives, expectations and intentions.
These statements may be identified by the use of words such as "expects,"
"anticipates," "intends," "believes," "estimates," "plans" and similar
expressions. Our actual results could differ materially from those discussed in
these statements. Factors that could contribute to such differences include, but
are not limited to, those discussed in the "Risk Factors" section of this
report. EasyLink Services Corporation undertakes no obligation to update
publicly any forward-looking statements for any reason even if new information
becomes available or other events occur in the future.
Unless otherwise indicated or the context otherwise requires, all references to
"we," "us," "our" and similar terms refer to EasyLink Services Corporation and
its direct and indirect subsidiaries.
Overview
On April 2, 2001, we changed our name to EasyLink Services Corporation. We
believe that the name change will help create a corporate identity tied to our
focus on outsourced electronic information exchange services. We are a leading
provider of services that power the electronic exchange of information between
enterprises, their trading communities and their customers. Every business day,
we handle over 800,000 transactions that are integral to the movement of money,
materials, products and people in the global economy such as insurance claims,
trade and travel confirmations, purchase orders, invoices, shipping notices and
funds transfers, among many others. We offer a broad range of information
exchange services to businesses and service providers, including electronic data
interchange services or "EDI;" production messaging services; integrated desktop
messaging services; boundary and managed email services; and other services
largely consisting of legacy real time fax services.
Until March 30, 2001, we also offered advertising services and consumer e-mail
services to Web sites, ISP's and direct to consumers. In this market, we
provided Web-based e-mail services or WebMail to Internet Service Providers
(ISPs) including several of the world's top ISPs, and we partnered with top
branded Web sites to provide WebMail services to their users. In addition, we
served the market directly through our flagship web site www.mail.com. On
October 26, 2000, the Company announced its intention to sell its advertising
network business and stated that it will focus exclusively on its established
outsourced messaging business. The Company also announced that as a result of
its decision to focus on its outsourced messaging business, it is streamlining
the organization, taking advantage of lower cost areas and further integrating
its technological and operational infrastructures. On March 30, 2001, we
completed the sale of our advertising network and consumer e-mail business to
Net2Phone. In connection with the sale, we entered into a hosting agreement
under which we would host or arrange for a third party to host the consumer
e-mailboxes for Net2Phone for a minimum of one year. In November 2001, we
finalized an agreement with Net2Phone terminating the hosting agreement as of
September 30, 2001.
In March 2000, EasyLink formed WORLD.com to develop the Company's extensive
portfolio of domain names into major Web properties, such as Asia.com and
India.com, which served the business-to-business and business-to-consumer
marketplace. Through its subsidiaries, WORLD.com generated revenues primarily
from sales of information technology products, system integration and website
development for other companies, advertising related sales and commissions
earned from booking travel arrangements. On November 2, 2000, the Company
announced that it would sell all assets not related to its core outsourced
messaging business, including its Asia.com Inc., and India.com Inc.
subsidiaries, and its portfolio of category-defining domain names. On May 3,
2001, Asia.com, Inc. sold its business to an investor group. In October 2001, we
sold 90% of a subsidiary of India.com, Inc. and we have ceased conducting its
portal business. Accordingly, the results of World.com and its subsidiaries have
been restated as discontinued operations in our financial statements for all
periods presented. See Notes 1(c) and 7 to our consolidated financial statements
for additional information.
For the nine months ended September 30, 2002, total revenues were $88.4 million
compared to $90.1 million for the nine months ended September 30, 2001. Net loss
was $2.2 million for the nine months ended September 30, 2002 as compared to
$143.5 million for the nine months ended September 30, 2001.
29
For the nine months ended September 30, 2002 and 2001, approximately $88.4
million and $88.5 million, respectively, of our revenues were generated from
companies we acquired since January 1, 2001.
We derive revenues primarily from monthly per-message and usage-based charges
for our EDI, production messaging and integrated desktop messaging services; and
monthly per-user or per-message fees for managed e-mail and groupware hosting
services and virus protection, spam control and content filtering services. Our
services generate revenue in a number of different ways. We charge our EDI
customers per message. Customers of our production messaging services pay
consulting fees based upon the level of integration work and set-up requirements
plus per-page or per-minute usage charges, depending on the delivery method, for
all messages successfully delivered by our network. Customers who purchase our
integrated desktop messaging services pay initial site license fees based on the
number of user seats being deployed plus per page usage charges for all faxes
successfully delivered by our network. For our e-mail and groupware hosting
services, customers are billed monthly based upon the number of mailboxes set up
and for additional features that they may purchase. For our virus protection,
spam and content filtering services, we charge customers either a monthly fee
per user or per message charges. Revenue from services is recognized as the
services are performed. Facsimile software license revenue is recognized over
the average estimated customer life of 3 years.
Historically, our basic advertising network e-mail services were free to our
members. Prior to our acquisition of NetMoves in February 2000, we generated the
majority of our revenues from our advertising network e-mail services, primarily
from advertising related sales, including direct marketing and e-commerce
promotion. We also engaged in barter transactions as part of the advertising
network business. Under these arrangements, we delivered advertisements
promoting a third party's goods and services in exchange for their agreement to
run advertisements promoting our Webmail service. We recorded barter revenues
and expenses at the fair market value of either the services we provided or of
those we received, whichever was more readily determinable under the
circumstances. Barter revenues were $0.6 million for the nine months ended
September 30, 2001 as the date of sale of this business was March 30, 2001.
In light of the evolving nature of our business and our limited operating
history, we believe that period-to-period comparisons of our revenues and
operating results are not meaningful and should not be relied upon as
indications of future performance. However, we do believe that the our revenues
and operating results in future periods will be more comparable to the results
for the nine months ended September 30, 2002.
Notwithstanding the inclusion of revenues from our acquisition of the EasyLink
Services business from AT&T Corp., we have experienced declines in revenues for
the three months and nine months periods ended September 30, 2002 as compared to
the comparable periods ended September 30, 2001. See "Results Of Operations
Three And Nine Months Ended September 30, 2002 and 2001 - Three Months Ended
September 30, 2002 and 2001" and "- Nine Months Ended September 30, 2002 and
2001." The decrease primarily occurred in production messaging services,
boundary and hosted email services and legacy fax services. The decline in
production messaging services, which include fax, email and telex, resulted from
reduced volumes and negotiated price reductions at the time of customer contract
renewals for certain of our larger customers and a reduction in revenues from
smaller customers. The decrease in hosted email services includes the loss of
$0.6 million and $1.2 million for the three and nine month periods ended
September 30, 2001, respectively, of hosting revenues from Net2Phone (an
arrangement related to the sale of our advertising network to Net2Phone in March
2001). We expect that the declines in revenues from production messaging
services and legacy fax services may continue in the future. Our strategy to
grow revenues and to mitigate the effects of this decline includes the sale of
existing and new services to our large base of existing customers, as well as
offering our services to new customers. Among the new services that we intend to
offer are our recently introduced trading community enablement services such as
Web EDI.
Our prospects should be considered in light of risks described in the section of
this report entitled "Risk Factors That May Affect Future Results."
Critical Accounting Policies
In response to the Securities & Exchange Commission's (SEC) Release No. 33-8040,
"Cautionary Advice Regarding Disclosure About Critical Accounting Policies," we
have identified the most critical accounting principles upon which our financial
status depends. Critical principles were determined by considering accounting
policies that involve the most complex or subjective decisions or assessments.
The most critical accounting policies were identified to be those related to
revenue recognition, valuation of intangible assets, valuation of accounts
receivable and purchase commitments. Our revenue recognition, intangible asset
and commitments and contingencies policies are stated in the notes to the
consolidated financial statements and at relevant sections in this discussion
and analysis.
30
Acquisitions, Investments and Divestitures
Continuing Operations
Swift Telecommunications, Inc. and EasyLink Services
On February 23, 2001, we acquired Swift Telecommunications, Inc., ("STI"). Just
prior to the acquisition in January 2001, STI acquired the EasyLink Services
business ("EasyLink Services") from AT&T Corp. At the closing of the acquisition
by STI of the EasyLink Services business from AT&T, we advanced $14 million to
STI in the form of a loan, the proceeds of which were used to fund part of the
cash portion of the purchase price to AT&T. Upon the closing of the acquisition
of STI, we assumed a $35 million note issued by STI to AT&T. The $35 million
note was secured by the assets of STI, including the EasyLink Services business,
and the shares of our Class A common stock issued to the sole shareholder in the
Merger. The note was payable in equal monthly installments over four years with
interest at the rate of 10% per annum. In November 2001, the note, and accrued
interest thereon, was exchanged for a new note in the principal amount of $10
million, 1 million shares of the Company's Class A common stock and warrants to
purchase an additional 1 million shares of stock. See Note 6 for a description
of the Restructuring of certain debt and lease obligations.
Upon the closing of the acquisition of STI, the Company paid to the sole
shareholder of STI $835,294 in cash and issued an unsecured note for
approximately $9.2 million and approximately 1.9 million shares of our Class A
common stock valued at approximately $22.9 million as the purchase price for the
acquisition of STI. We will also pay additional consideration to the sole
shareholder of STI equal to the amount of the net proceeds, after satisfaction
of certain liabilities of STI and its subsidiaries, from the sale or liquidation
of the assets of one of STI's subsidiaries. We also reimbursed the sole
shareholder of STI for a $1.5 million advance made to STI, the proceeds of which
were used to fund the balance of the cash portion of the purchase price for
STI's acquisition of the EasyLink Services business and certain other
obligations to AT&T. The $9.2 million note was non-interest bearing and payable
in four equal semi-annual installments over two years. In November 2001, this
note was exchanged for a new note in the principal amount of $2.7 million,
268,296 shares of the Company's Class A common stock and warrants to purchase
268,296 shares of stock. See Note 6 for a description of the Restructuring of
Certain Debt and Lease Obligations.
In connection with the acquisition of STI on February 23, 2001, we also entered
into a conditional commitment to acquire Telecom International, Inc. ("TII").
TII was an affiliate of STI prior to the acquisition of STI by us. The sole
shareholder of STI, who is an officer of EasyLink, is a principal beneficial
shareholder of TII. The purchase price for TII was originally agreed to be
$117,646 in cash, a promissory note in the aggregate principal amount of
approximately $1,294,118 and 267,059 shares of our Class A common stock. In
order to facilitate the debt restructuring and to reduce our debt obligations
and cash commitments, the parties agreed to modify our commitments in respect of
TII. In lieu of acquiring TII, we purchased certain assets owned by TII for
$250,000, payable in six monthly payments of $10,000 commencing May 27, 2002 and
one payment of $190,000 on November 27, 2002. We also agreed to reimburse TII
for up to 50% of TII's payments on certain accounts payable up to a maximum
reimbursement of $200,000, to cancel a $236,490 payable owed by STI to us and to
issue up to 20,000 shares of Class A common stock to TII valued at $122,000. In
addition, we issued 300,000 shares of Class A common stock to TII valued at
$1,890,000.
As part of the transaction with STI, we also entered into a conditional
commitment to acquire the 25% minority interests in two STI subsidiaries for
$47,059 in cash, promissory notes in the aggregate principal amount of
approximately $517,647 and 106,826 shares of Class A Common Stock. This
transaction is subject to certain conditions, including satisfactory completion
of due diligence, receipt of regulatory approvals and other customary
conditions.
Discontinued Operations
In March 2000, the Company formed World.com, Inc. in order to develop the
Company's portfolio of domain names into independent web properties and
subsequently acquired or formed its subsidiaries Asia.com, Inc. and India.com,
Inc., in which World.com was the majority owner. On November 2, 2000, the
Company announced its intention to sell all assets not related to its core
outsourced messaging business including Asia.com, Inc., India.com, Inc. and its
portfolio of domain names. Accordingly, World.com has been reflected as a
discontinued operation. During the nine months ended September 30, 2001, the
Company recorded a loss of $67.1 million to recognize the loss on discontinued
operations. This loss includes a write-down of $52.6 million of assets,
primarily goodwill, to net realizable value, operating losses of $12.4 million,
severance and related benefits of $1.3 million, and other related cost and
expenses including the closure of facilities of $0.8 million.
The information below pertains to certain events and activities associated with
the operations of World.com and include: financings in connection with
India.com, domain names included in discontinued operations, the acquisition and
subsequent disposition of eLong.com, which was renamed to Asia.com, Inc., and
other acquisitions made by World.com.
31
On March 14, 2000, we acquired eLong.com, Inc., a Delaware corporation
("eLong.com") for approximately $62 million including acquisition costs of
approximately $365,000. eLong.com, through its wholly owned subsidiary in the
People's Republic of China, operates the Web Site www.eLong.com, which is a
provider of local content and other internet services. The acquisition was
accounted for as a purchase business combination. Concurrently with the merger,
eLong.com changed its name to Asia.com, Inc. ("Asia.com"). In the merger, we
issued to the former stockholders of eLong.com an aggregate of 359,949 shares of
Class A common stock valued at approximately $57.2 million, based upon our
average trading at the date of acquisition. All outstanding options to purchase
eLong.com common stock were converted into options to purchase an aggregate of
27,929 shares of Class A common stock. The options were valued at approximately
$4.4 million.
During the fourth quarter of 2000, we wrote off approximately $7.8 million of
goodwill, as it was determined that the carrying value had become permanently
impaired as a result of our November 2, 2000 decision, as approved by the Board
of Directors, to sell all assets not related to its core outsourcing business,
including its Asia-based businesses.
In addition, we were obligated to issue up to an additional 71,990 shares of
Class A common stock in the aggregate to the former stockholders of eLong.com if
EasyLink or Asia.com acquired less than $50.0 million in value of businesses
engaged in developing, marketing or providing consumer or business internet
portals and related services focused on the Asian market or a portion thereof,
or businesses in furtherance of such a business, prior to March 14, 2001. The
actual amount of shares to be issued was based upon the amount of any shortfall
in acquisitions below the $50.0 million target amount. Based upon the value of
the acquisitions completed as of March 14, 2001, we issued approximately 7,500
shares of our Class A common stock to the former stockholders of eLong.com. See
Note 7 to our consolidated financial statements for additional information.
In the merger, certain former stockholders of eLong.com retained shares of Class
A common stock of Asia.com representing approximately 4.0% of the outstanding
common stock of Asia.com. Under a separate Contribution Agreement with Asia.com
these stockholders contributed an aggregate of $2.0 million in cash to Asia.com
in exchange for additional shares of Class A common stock of Asia.com,
representing approximately 1.9% of the outstanding common stock of Asia.com.
Pursuant to the Contribution Agreement, EasyLink (1) contributed to Asia.com the
domain names Asia.com and Singapore.com and $10.0 million in cash and (2) agreed
to contribute to Asia.com up to an additional $10.0 million in cash over the
next 12 months and to issue, at the request of Asia.com, up to an aggregate of
24,242 shares of Class A common stock for future acquisitions. As a result of
the transactions effected pursuant to the Merger Agreement and the Contribution
Agreement, EasyLink initially owned shares of Class B common stock of Asia.com
representing approximately 94.1% of the outstanding common stock of Asia.com.
Our ownership percentage decreased to 92% as of December 31, 2000. Asia.com
granted to management employees of Asia.com options to purchase Class A common
stock of Asia.com representing, as of December 31, 2000, 9% of the outstanding
shares of common stock after giving effect to the exercise of such options.
On May 3, 2001, the Company's majority owned subsidiary Asia.com, Inc. sold its
business to an investor group. Under the terms of the sale, the buyer paid
Asia.com $1.5 million and assumed eLong.com liabilities of approximately $1.5
million. The consideration paid was determined as a result of negotiations
between the buyer and EasyLink. In addition, the Company issued 20,000 shares of
its Class A common stock valued at $138,000 in exchange for the cancellation of
certain options granted to the former owners of eLong.com. The Company accounted
for this transaction as part of the sale of the business of Asia.com. As a
result of the sale, the Company recorded a loss on the sale of eLong.com, Inc.
of $264,000. After the closing of the sale, the Company issued 36,232 shares to
eLong.com, Inc. in full satisfaction of an indemnity obligation. The indemnity
obligation arose out of eLong.com's settlement of a claim brought by former
Lohoo shareholders for a contingent payment. Lohoo was previously acquired by
eLong.com, Inc.
During the second quarter of 2001, the Company acquired a US and India based
company for approximately $600,000, including acquisition costs. The terms were
$300,000 in cash and 19,600 shares of EasyLink Class A common stock valued at
approximately $272,000 based upon our average trading price surrounding the date
of acquisition. The acquisition was accounted for as a purchase business
combination. The excess of the purchase price over the fair market value of the
assets acquired and assumed liabilities has been allocated to goodwill
($831,000), which was being amortized over a period of three years, the expected
estimated period of benefit. The Company subsequently transferred this acquired
business to the former management of its India.com subsidiary. As part of the
transaction, the transferred business assumed all of the liabilities of the
transferred business and certain liabilities of India.com. In consideration for
the assumption of these liabilities, the Company contributed to the transferred
business immediately prior to the sale in January 2002 56,075 shares of Class A
common stock valued at $314,000 and $300,000 in cash.
32
RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
Three months ended September 30, 2002 and 2001
Revenues
Revenues for the three months ended September 30, 2002 were $28.0 million, as
compared to $36.5 million for the comparable period in 2001. The decrease of
$8.5 million primarily occurred in production messaging services ($5.9 million),
boundary and hosted email services ($1.4 million) and legacy fax services ($0.8
million). The decline in production messaging services, which includes fax,
email and telex, resulted from reduced volumes and negotiated price reductions
at the time of customer contract renewals for certain of our larger customers
and a reduction in revenues from smaller customers. The decrease in hosted email
services includes the loss of hosting revenues from Net2Phone (an arrangement
related to the sale of our advertising network to Net2Phone in March 2001),
which amounted to $0.6 million in revenues for the third quarter of 2001.
Revenues for the three months ended September 30, 2002 and 2001 consist of
revenues from providing information exchange services to businesses and are
derived from electronic data interchange services or `EDI;" production messaging
services; integrated desktop messaging services; boundary and managed email
services; and other services largely consisting of legacy real time fax
services.
Cost of Revenues
Cost of revenues for the three months ended September 30, 2002 decreased to
$14.0 million and 50% of revenues, as compared to $18.2 million and 50% of
revenues for the comparable period in 2001. Cost of revenues consists primarily
of costs incurred in the delivery and support of our services, including
depreciation of equipment used in our computer systems, the cost of
telecommunications services including local access charges, leased network
backbone circuit costs and long distance domestic and international termination
charges, and personnel costs associated with our systems, databases and
graphics. The reduction in cost in 2002 is attributable to the on-going benefit
of the cost reduction programs implemented throughout 2001; $0.9 million of
reduced charges for network support costs under the Transition Services
Agreement with AT&T Corp. (the "TSA") related to the acquired Easylink Services
business; and $2.3 million in lower telecommunications costs from negotiated
price reductions and from reduced volumes in certain product lines.
Sales and Marketing Expenses
Sales and marketing expenses were $5.6 million for the three months ended
September 30, 2002 as compared to $5.4 million for the comparable period in
2001. However, in the 2001 quarter the Company recognized $1.6 million in gains
related to favorable advertising and marketing cost settlements as net cost
reductions. Without these net cost reductions in 2001, sales and marketing
expenses for the 2002 quarter would have decreased by $1.4 million in comparison
to 2001 primarily due to a $1.3 million reduction in sales expenses related to
the reduction in headcount. Included in sales and marketing expenses are costs
related to salaries and commissions for sales, marketing, and business
development personnel, marketing consultant services and costs associated with
various advertising and promotion campaigns to build our brand.
General and Administrative Expenses
General and administrative expenses were $7.4 million during the three months
ended September 30, 2002 as compared to $10.6 million during the comparable
period of 2001. The $3.2 million decrease included $0.8 million in reduced
charges under the TSA as support for these functions from AT&T ceased by the end
of 2001, a $0.6 million decrease in consultant costs mostly related to the
customer billing process while salaries and related costs for employees remained
approximately the same, $0.3 million in reduced professional fees and a decrease
of $0.7 million in our provision for doubtful accounts over the comparable
period due to enhanced billing and collection efforts. General and
administrative expenses consist primarily of compensation and other employee
costs for corporate office functions, customer support and customer billing
operations. These costs also include our provision for doubtful accounts and
corporate wide overhead expenses.
33
Product Development Expenses
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize, and test product launches and
enhancements to our products, were $2.0 million for the three months ended
September 30, 2002 as compared to $1.8 million in comparable period of 2001. The
increase of $0.2 million results from an increase in the number of development
staff employed in connection with the Company's plans for the development of new
and enhanced Trading Community Enablement Services.
Amortization of Goodwill and Other Intangible Assets
Amortization of intangibles of $1.7 million for the three months ended September
30, 2002 decreased from $12.8 million for the comparable period of 2001. The
primary reason for the decrease was the adoption of SFAS No. 142 - "Goodwill and
Other Intangible Assets." The standard eliminates goodwill amortization upon
adoption and requires an initial assessment for goodwill impairment within six
months of adoption and at least annually thereafter. For the three months ended
September 30, 2001, goodwill amortization from continuing operations was $10.6
million or $1.14 per share and $0.1 million or $0.01 per share from discontinued
operations.
In connection with the adoption of Statement 142 on January 1, 2002, the Company
reclassified $3.6 million in net book value associated with assembled workforce
to goodwill.
Restructuring Charges
During the three months ended September 30, 2002, restructuring charges of $1.7
million were recorded by the Company in accordance with the provisions of EITF
94-3, and Staff Accounting Bulletin 100. During 2002, the Company's
restructuring initiatives are related to the relocation and consolidation of its
New Jersey-based office facilities into one location. The relocation process
will begin in the first quarter of 2003. The restructuring charges are comprised
of net abandonment costs with respect to leases and the write-off of leasehold
improvements. No restructuring charges were recorded during the three months
ended September 30, 2001.
Gain on Sale of Business
In 2002 we recorded a $0.3 million gain attributable to the sale of our customer
contracts for hosted email services (NIMS) on September 20, 2002.
Impairment Charges
During 2001, management performed on-going business reviews and, based on
quantitative and qualitative measures, assessed the need to record impairment
losses on long-lived assets used in operations when impairment indicators are
present.
Where impairment indicators were identified, management determined the amount of
the impairment charge by comparing the carrying value of goodwill and other
long-lived assets to their fair values. These evaluations of impairments were
based upon an achievement of business plan objectives and milestones of each
business, the fair value of each ownership interest relative to its carrying
value, the financial condition and prospects of the business and other relevant
factors. The business plan objectives and milestones that were considered
include among others, those related to financial performance, such as
achievement of planned financial results and completion of capital raising
activities, if any, and those that were not primarily financial in nature, such
as launching or enhancements of a web site or product, the hiring of key
employees, and the number of messages generated by a customer. Management
determined fair value based on the market approach, which included analysis of
market price multiples of companies engaged in lines of business similar to the
business being evaluated. The market price multiples were selected and applied
to the business based on the relative performance, future prospects and risk
profile of the business in comparison to the guideline companies. As a result,
during management's 2001 quarterly review of the value and periods of
amortization of both goodwill and other long-lived assets, it was determined
that the carrying value of goodwill and certain other intangible assets were not
fully recoverable.
Other Income (Expense), Net
Interest income for the three months ended September 30, 2002 was $28,000 as
compared to $125,000 during the comparable period of 2001. The decrease was due
to lower cash balances and lower interest rates on temporary investments.
34
Interest expense was $1.1 million for the three months ended September 30, 2002
as compared to $2.4 million in the comparable period of 2001. The decrease was
primarily due to reductions in the total debt balances outstanding during the
quarter ended September 30, 2002 as compared to the same quarter in 2001 largely
as a result of the debt restructuring that was completed on November 27, 2001.
The debt restructuring consisted of the exchange of approximately $63 million of
debt and equipment lease obligations for an aggregate of approximately $20
million of restructured notes and obligations in addition to 1.97 million shares
of Class A Common Stock and warrants to purchase 1.8 million of Class A Common
Stock. In addition, no interest expense is recognized on the restructured notes
issued to AT&T and the former shareholder of STI in accordance with FASB
Statement No. 15, "Accounting by Debtors and Creditors for Troubled Debt
Restructuring" (See Note 6 of Notes to the Unaudited Interim Condensed
Consolidate Financial Statements).
Gain (Loss) on Debt Restructurings
On July 15, 2002, the Company entered into a transfer and assignment agreement
to repurchase a 12% Senior Restructure Note and a restructuring balloon payment
in the amount of $0.5 million for $90,000 in cash and 5,415 shares in Class A
common stock, valued at approximately $6,000. This transaction was accounted for
in accordance with FASB No. 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructurings." As a result of this transaction, the Company
recorded a $0.4 million gain on the transaction during the three months ended
September 30, 2002.
On September 27, 2002, the Company entered into a transaction agreement to
repurchase 10% Senior Convertible Notes in the amount of $4.95 million for
$495,000. This transaction was accounted for in accordance with FASB
No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings."
As a result of this transaction, the Company recorded a $6.2 million gain during
the three months ended September 30, 2002 which includes the impact of a $1.7
million reversal of interest previously capitalized in connection with the
February 14, 2001 exchange agreement related to such notes.
During the third quarter of 2001, pending the completion of the subsequent debt
restructuring, the Company issued $16.3 million of interim notes, bearing
interest at a rate of 12% per annum, in exchange for present and future lease
obligations in the amount of $15.1 million. These notes were cancelled upon
completion of the fourth quarter debt restructuring. This interim transaction
resulted in a loss of $1.1 million in accordance with FASB No. 15 (see Note 6).
Discontinued Operations
The 2001 loss from discontinued operations includes the results and other costs
related to the Company's discontinued WORLD.com business, including its
subsidiaries, Asia.com, Inc. and India.com, Inc. During the three months ended
September 30, 2002, there were no losses incurred from the discontinued
operations. During the three months ended September 30, 2001, discontinued
operations incurred an operating loss of $1.1 million.
Extraordinary Gain
During July 2001, the Company acquired the assets of GN Comtext ("GN") for $1.
The excess of fair market value of the assets acquired and the liabilities
assumed over the purchase price resulted in negative goodwill of $782,000 which
was recognized as an extraordinary gain during the quarter ended September 30,
2001 in accordance with FASB Statement No. 141 (see Note 2).
Nine months ended September 30, 2002 and 2001
Revenues
Revenues for the nine months ended September 30, 2002 were $88.4 million, as
compared to $90.1 million for the comparable period in 2001. The decrease of
$1.7 million occurred even as revenues from the acquisition of STI, including
the EasyLink Services business acquired by STI from AT&T Corp., were included
for the full nine month period in 2002 as compared to the shorter 2001 period of
February 23, 2001, the date of acquisition, to September 30, 2001. The expected
increase in revenues was partially reduced by reduced volumes associated with
our production messaging services and negotiated customer price reductions. Also
impacting the comparative results were (1) a decrease in advertising revenues of
$1.6 million as a result of the sale of our advertising network in March 2001
and (2) the loss of $1.2 million in email hosting revenues resulting from the
termination of a hosting arrangement related to the sale of our advertising
network.
Revenues for the nine months ended September 30, 2002 and 2001 consist almost
entirely of revenues from providing information exchange services to businesses
and are derived from electronic data interchange services or `EDI;" production
messaging services; integrated desktop messaging services; boundary and managed
email services; and other services largely consisting of legacy real time fax
services. In the 2001 period, $1.6 million or 2% of revenues were from the
advertising network.
35
Cost of Revenues
Cost of revenues for the nine months ended September 30, 2002 decreased to $44.2
million as compared to $58.4 million for the comparable period in 2001. The
decreased cost resulted in a gross profit of 50% in the 2002 period,
representing an improvement of 14.8 percentage points over the comparable 2001
period results of 35.2%. Cost of revenues consists primarily of costs incurred
in the delivery and support of our services, including depreciation of equipment
used in our computer systems, the cost of telecommunications services including
local access charges, leased network backbone circuit costs and long distance
domestic and international termination charges, and personnel costs associated
with our systems, databases and graphics. The reduction in cost in 2002, both in
total amount and as a percentage of revenues, and the increase in gross profit
percentage, is attributable to the increase in higher margin revenues from the
STI acquisition, including the EasyLink Services business, the on-going benefit
of cost reduction programs implemented throughout 2001; $3.0 million of reduced
charges for network support under the TSA; $6.0 million in lower depreciation
charges; negotiated cost reductions in certain telecommunications services; and
the elimination of $2.0 million of advertising costs associated with our
advertising network business that was sold on March 30, 2001.
Sales and Marketing Expenses
Sales and marketing expenses were $16.2 million for the nine months ended
September 30, 2002 as compared to $23.5 million for the comparable period in
2001. However, in the 2001 quarter the Company recognized $1.6 million in gains
related to favorable advertising and marketing cost settlements as net cost
reductions. Without these net cost reductions in 2001, sales and marketing
expenses for the nine months ended September 30, 2002 would have decreased in
comparison to 2001 by $8.9 million. This decrease was primarily due to
eliminating $4.1 million in costs associated with our advertising network
business that was sold on March 31, 2001; $3.0 million in reduced sales
expenses; and $0.7 million in reduced advertising spending. Included in this
category are costs related to salaries and commissions for sales, marketing, and
business development personnel and costs associated with various advertising
campaigns mostly in 2001 to build our brand.
General and Administrative Expenses
General and administrative expenses were $21.8 million during the nine months
ended September 30, 2002 as compared to $31.8 million during the comparable
period of 2001. The $10.0 million decrease was primarily attributable to $3.3
million in reduced charges under the TSA as support for these functions from
AT&T ceased in 2001, $2.1 million in reduced costs for consultants without a
corresponding increase in salaries and related costs, the reversal of $0.6
million of prior years' accrued employee cash bonuses in 2002 and a decrease of
$1.3 million in our provision for doubtful accounts over the comparable period
due to enhanced billing and collection efforts. General and administrative
expenses consist primarily of compensation and other employee costs for
corporate office functions, customer support and customer billing operations.
These costs also include our provision for doubtful accounts and corporate wide
overhead expenses.
Product Development Expenses
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize, and test product launches and
enhancements to our products, were $5.3 million for the nine months ended
September 30, 2002 as compared to $7.5 million in comparable period of 2001. The
prior year's costs were significantly higher as the first quarter of 2001
included the development expenses related to our advertising network, which we
sold on March 31, 2001, and we utilized consultants to a greater degree during
2001.
Amortization of Goodwill and Other Intangible Assets
Amortization of intangibles of $5.1 million for the nine months ended September
30, 2002 decreased from $37.9 million for the comparable period of 2001. The
primary reason for the decrease was the adoption of SFAS No. 142 - "Goodwill and
Other Intangible Assets." The standard eliminates goodwill amortization upon
adoption and requires an initial assessment for goodwill impairment within six
months of adoption and at least annually thereafter. For the nine months ended
September 30, 2001, goodwill amortization from continuing operations was $32.2
million or $3.85 per share and $3.8 million or $0.45 per share from discontinued
operations.
In connection with the adoption of Statement 142 on January 1, 2002, the Company
reclassified $3.6 million in net book value associated with assembled workforce
to goodwill.
36
Restructuring Charges
During the nine months ended September 30, 2002 and 2001, restructuring charges
of $1.7 million and $25.3 million, respectively, were recorded by the Company in
accordance with the provisions of EITF 94-3, and Staff Accounting Bulletin 100.
During 2002, the Company's restructuring initiatives are related to the
relocation and consolidation of its New Jersey-based office facilities into one
location. The relocation process will begin in the first quarter of 2003. The
restructuring charges are comprised of net abandonment costs with respect to
leases and the write-off of leasehold improvements. During 2001, the Company's
restructuring initiatives were related to our strategic decisions to exit the
consumer messaging business and to focus on the Company's business messaging
services.
(Gain) Loss on Sale of Businesses
In 2002, we recorded a $0.3 million gain attributable to the sale of our
customer contracts for hosted email services (NIMS) on September 20, 2002. In
2001, we recorded a $2.3 million loss attributable to the sale of our
advertising network, which was sold on March 30, 2001.
Impairment Charges
During 2001, management performed on-going business reviews and, based on
quantitative and qualitative measures, assessed the need to record impairment
losses on long-lived assets used in operations when impairment indicators are
present.
Where impairment indicators were identified, management determined the amount of
the impairment charge by comparing the carrying value of goodwill and other
long-lived assets to their fair values. These evaluations of impairments were
based upon an achievement of business plan objectives and milestones of each
business, the fair value of each ownership interest relative to its carrying
value, the financial condition and prospects of the business and other relevant
factors. The business plan objectives and milestones that were considered
include among others, those related to financial performance, such as
achievement of planned financial results and completion of capital raising
activities, if any, and those that were not primarily financial in nature, such
as launching or enhancements of a web site or product, the hiring of key
employees, and the number of messages generated by a customer. Management
determined fair value based on the market approach, which included analysis of
market price multiples of companies engaged in lines of business similar to the
business being evaluated. The market price multiples were selected and applied
to the business based on the relative performance, future prospects and risk
profile of the business in comparison to the guideline companies. As a result,
during management's 2001 quarterly review of the value and periods of
amortization of both goodwill and other long-lived assets, it was determined
that the carrying value of goodwill and certain other intangible assets were not
fully recoverable.
Other Income (Expense), Net
Interest income for the nine months ended September 30, 2002 was $175,000 as
compared to $488,000 during the comparable period of 2001. The decrease was due
to lower cash balances and lower interest rates on temporary investments.
Interest expense was $3.7 million for the nine months ended September 30, 2002
as compared to $8.0 million in the comparable period of 2001. The decrease was
primarily due to reductions in the total debt balances outstanding during the
2002 period as compared to the same period in 2001 as a result of the exchange
transactions and debt restructuring completed in the latter half of 2001 as
previously described. In addtion, no interest expense is recognized on the notes
issued in connection with the exchange transactions or on the restructured notes
issued to AT&T and the former shareholder of STI in accordance with FASB
Statement No. 15 "Accounting by Debtors and Creditors for Troublred Debt
Restructurings" (See Note 6 to the Unaudited Interim Condensed Consolidated
Financial Statements).
Gain (Loss) on Debt Restructurings
2002 Transactions
On July 15, 2002, the Company entered into a transfer and assignment agreement
to repurchase a 12% Senior Restructure Note and a restructuring balloon payment
in the amount of $0.5 million for $90,000 in cash and 5,415 shares in Class A
common stock, valued at approximately $6,000. This transaction was accounted for
in accordance with FASB No. 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructurings." As a result of this transaction, the Company
recorded a $0.4 million gain during the three months ended September 30, 2002.
37
On September 27, 2002, the Company entered into a transaction agreement to
repurchase 10% Senior Convertible Notes in the amount of $4.95 million for
$495,000. This transaction was accounted for in accordance with FASB No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings." As a
result of this transaction, the Company recorded a $6.2 million gain during the
nine months ended September 30, 2002 which includes the impact of a $1.7 million
reversal of interest previously capitalized in connection with the February 14,
2001 exchange agreement related to such notes.
2001 Transactions
On March 28, 2001, we completed the issuance of $23,840,250 principal amount of
10% Senior Convertible Notes ("Exchange Notes") in exchange for the cancellation
of $75,905,000 principal amount of 7% Convertible Subordinated Notes (the
"Notes"). In addition, on June 12, 2001, we completed the issuance of 142,071
shares of Class A common stock in exchange for the cancellation of $2,531,250
principal amount of 10% Senior Convertible Notes. The above exchange
transactions have been accounted for in accordance with Financial Accounting
Standards Board Statement No. 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructurings." As a result of these exchanges, we recorded $40.4
million of gains on the exchange of convertible notes during the nine months
ended September 30, 2001 (see Note 6).
During the third quarter of 2001, pending the completion of the subsequent debt
restructuring, the Company issued $16.3 million of interim notes, bearing
interest at a rate of 12% per annum, in exchange for present and future lease
obligations in the amount of $15.1 million. These notes were cancelled upon
completion of the fourth quarter debt restructuring. This interim transaction
resulted in a loss of $1.1 million in accordance with FASB No. 15 (see Note 6).
Impairment of Investments
As indicated above, management performs on-going business reviews and, based on
quantitative and qualitative measures, assesses the need to record impairment
losses on its investments when impairment indicators are present. Management
determined that the decline in value of its cost investment in BulletN.net was
other-than-temporary and recorded an impairment charge of $2.6 million for the
quarter ended March 31, 2001. Additionally we recorded an impairment charge of
$59,000 relating to our investment in 3Cube, as management determined that the
decline in the value of its investment was other-than-temporary. During the
second quarter of 2001, we recorded additional impairment charges of
approximately $7.5 million as management determined that the carrying value of
certain cost investments were permanently impaired.
Loss from Continuing Operations
Loss from continuing operations for the nine months ended September 30, 2002 of
$2.2 million was favorably impacted by a net release of $1.7 million in accrued
expenses during the second quarter of 2002 resulting from the decision not to
pay prior year cash bonuses in 2002.
Discontinued Operations
The loss from discontinued operations includes the results and other costs
related to the Company's discontinued WORLD.com business, including its
subsidiaries, Asia.com, Inc. and India.com, Inc. During the nine months ended
September 30, 2002, there were no losses incurred from the discontinued
operations. During the nine months ended September 30, 2001, the $67.1 million
loss from discontinued operations included a write-down of $52.6 million of
assets, primarily goodwill, to net realizable value, operating losses of $12.4
million, severance and related benefits of $1.3 million and other related costs
and expenses including the closure of facilities of $0.8 million.
Extraordinary Gain
During July 2001, the Company acquired the assets of GN Comtext ("GN") for $1.
The excess of fair market value of the assets acquired and the liabilities
assumed over the purchase price resulted in negative goodwill of $782,000 which
was recognized as an extraordinary gain during the quarter ended September 30,
2001 in accordance with FASB Statement No. 141 (see Note 2).
Liquidity and Capital Resources
Since our inception, we have obtained financing through private placements of
convertible debt and equity securities, equipment leases, our initial public
offering including the exercise of the over-allotment option and through a
convertible debt offering.
38
On January 8, 2001, we received approximately $10.26 million relating to our
issuing 10% Senior Convertible Notes due on January 8, 2006.
On February 14, 2001, we announced that we entered into a bridge funding and
amendment agreement that would allow us to borrow up to $5 million from our
majority-owned subsidiary India.com pursuant to a bridge note. As of June 30,
2001, we borrowed $5 million against this agreement. In July 2001, the holders
of India.com preferred stock agreed to exchange India.com preferred stock for
1,420,400 shares of the Company's Class A common stock. This agreement resulted
in the elimination of the notes and warrants that EasyLink committed to issue
for the draw downs and commitment under the bridge funding agreement. The
exchange of the Company's Class A common stock for the India.com preferred stock
was completed on October 17, 2001.
On March 19, 2001, we completed the issuance of $3.9 million principal amount of
10% Senior Convertible Notes due January 8, 2006.
On March 20, 2001, we completed the private placement of 3,000,000 shares of our
Class A common stock to a private investor for an aggregate price of $3 million.
During the first nine months of 2001, we took additional actions to further
reduce our cash burn. These actions included additional staff layoffs in some of
our businesses as well as the completion of the sale of our advertising
business. Accordingly, we incurred additional restructuring and impairment
charges to reduce the value of certain of our acquisitions and investments. This
is due to the continuous and prolonged decline in valuations of U.S. businesses,
including revenue multiples, as well as the lack of capital funding available to
businesses in order to fund their operating losses, and continual investments
that their management teams believe are necessary to sustain operations. Such
charges amounted to $25.3 million. Most of these charges covered additional
write-downs of tangible and intangible assets.
On March 28, 2001, we completed the issuance of an aggregate of $23,840,250
principal amount of senior convertible notes in exchange for the cancellation of
$75,905,000 principal amount of 7% Convertible Subordinated Notes. $2,531,250 of
the Senior Convertible Notes is subject to cancellation in exchange for the
issuance of 1,420,714 shares of Class A common stock, subject to satisfaction of
certain conditions. The reduction in outstanding indebtedness, together with the
ability to pay up to one-half of interest on the Senior Convertible Notes in
shares of Class A common stock, has reduced our cash interest requirements.
On March 30, 2001, we sold our advertising network to Net2Phone, Inc. who paid
us $3 million in cash at the closing and paid us an additional $500,000 in April
2001 based upon the achievement of certain milestones by us. In connection with
the sale the parties entered into a hosting agreement whereby we would receive
payments for hosting the consumer mailboxes for a minimum of one year. During
the second quarter of 2001, the Company completed the migration of the hosting
of these consumer mailboxes to a third party provider who is paid for this
service. The hosting agreement was terminated as of September 30, 2001.
On May 3, 2001, our majority owned subsidiary Asia.com, Inc. sold its business
for $1.5 million in cash and the assumption of $1.5 million of liabilities.
Net cash provided by operating activities was $0.2 million for the nine months
ended September 30, 2002 as compared to net cash used in operating activities of
$7.8 million for the nine months ended September 30, 2001.
Net cash used in investing activities was $2.0 million for the nine months ended
September 30, 2002 as compared to net cash provided by investing activities of
$0.5 million for the nine months ended September 30, 2001. In 2002, $2.3 million
of cash was used for the purchases of equipment offset by $0.3 million in
proceeds from the sale of a business. In 2001, net cash provided by investing
activities consisted of $6.6 million in proceeds received from the sale of the
ad network, eLong.com, Inc. and investments and $12.5 million in proceeds from
the sales and maturities of marketable securities, net of $15.3 million for
acquisitions and $3.3 million for purchases of intangible assets and equipment.
Net cash used in financing activities was $1.8 million for the nine months ended
September 30, 2002 as compared to cash provided by these activities of $12.1
million for the nine months ended September 30, 2001. During the nine months
ended September 30, 2002, we made $0.5 million in payments against capital lease
obligations, $0.9 million in interest payments on restructured notes and $0.7
million in principal payments on notes payable. Included within the $0.7 million
in principal payments on notes payable is $0.6 million of payments extinguishing
$7.1million of debt and capitalized interest (see Note 6). During the nine
months ended September 30, 2001, we received $14.1 million from the issuance of
senior convertible notes, $3.3 million from the issuance of our Class A Common
Stock, $1.1 million from a loan offset by $4.2 million in payments under capital
lease obligations and $2.2 million of principal payments on notes payable.
39
At September 30, 2002, we had $9.3 million of cash and cash equivalents. Our
principal commitments consist of $24.1 million in subordinated convertible notes
due in 2005; $31.1 million in senior convertible notes due in 2006; $18.7
million of 12% restructured notes payable due in quarterly installments
beginning in June 2003; and obligations under capital leases and commitments for
telecommunications services. During 2003, we will be required to pay
approximately $4.7 in interest payments on our existing debt, and, commencing
June 2003, approximately $4.2 million of principal payments. For the years ended
December 31, 2001 and 2000, we received a report from our independent
accountants containing an explanatory paragraph stating that we suffered
recurring losses from operations since inception and have a working capital
deficiency that raise substantial doubt about our ability to continue as a going
concern. We incurred a net loss of $2.2 million during the nine months ended
September 30, 2002, and have an accumulated deficit of $515.6 million as of
September 30, 2002. The Company will need additional financing or will need to
generate additional cash flow or will need to restructure some or all of its
debt service requirements in order to meet cash requirements for its operations
and to service its debt and other obligations. If we are unable to raise
additional financing, generate sufficient cash flow, or otherwise restructure
our debt service obligations we may be unable to continue as a going concern.
Our unaudited condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that might be necessary
should we be unable to continue as a going concern. We believe our ability to
continue as a going concern is dependent upon our ability to generate sufficient
cash flow to meet our obligations on a timely basis, to obtain additional
financing or refinancing as may be required, and ultimately to achieve
profitable operations. Management is continuing the process of further reducing
operating costs and increasing its sales efforts. The Company expects that it
will also seek to enter into additional debt restructuring arrangements with
holders of its debt obligations from time to time in the future. These
arrangements may include, among others, rescheduling of payment due dates and
exchange or conversion of debt obligations into equity. There can be no
assurance that the Company will be successful in these efforts.
Sales of additional equity securities could result in additional dilution to our
stockholders. In addition, on an ongoing basis, we continue to evaluate
potential acquisitions to complement our business messaging services. In order
to complete these potential acquisitions, we may need additional equity or debt
financing in the future.
Recent Accounting Pronouncements
In June 2001, Statement of Financial Accounting Standards No. 143, "Accounting
for Asset Retirement Obligations" ("Statement 143") was issued. Statement 143
addresses financial accounting and reporting for legal obligations associated
with the retirement of tangible long-lived assets and the associated retirement
costs that result from the acquisition, construction, or development and normal
operation of a long-lived asset. Upon initial recognition of a liability for an
asset retirement obligation, Statement 143 requires an increase in the carrying
amount of the related long-lived asset. The asset retirement cost is
subsequently allocated to expense using a systematic and rational method over
the asset's useful life. Statement 143 is effective for fiscal years beginning
after June 15, 2002. The adoption of this statement is not expected to have a
material impact on the Company's financial position or results of operations.
In August 2001, Statement of Financial Accounting Standards 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("Statement 144"), which
supersedes both Statement 121, and the accounting and reporting provisions of
APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" ("Opinion 30"), for the disposal
of a segment of a business (as previously defined in that Opinion). Statement
144 retains the fundamental provisions in Statement 121 for recognizing and
measuring impairment losses on long-lived assets held for use and long-lived
assets to be disposed of by sale, while also resolving significant
implementation issues associated with Statement 121. For example, Statement 144
provides guidance on how a long-lived asset that is used as part of a group
should be evaluated for impairment, establishes criteria for when a long-lived
asset is held for sale, and prescribes the accounting for a long-lived asset
that will be disposed of other than by sale. Statement 144 retains the basic
provisions of Opinion 30 on how to present discontinued operations in the income
statement but broadens that presentation to include a component of an entity
(rather than a segment of a business). Unlike Statement 121, an impairment
assessment under Statement 144 will never result in a write-down of goodwill.
Rather, goodwill is evaluated for impairment under Statement 142, Goodwill and
Other Intangible Assets.
The Company adopted Statement 144 effective January 1, 2002. The adoption of
Statement 144 for long-lived assets held for use did not have an impact on the
Company's financial position and results of operations because the impairment
assessment under Statement 144 is largely unchanged from Statement 121 and the
provisions of the Statement for assets held for sale or other disposals
generally are required to be applied prospectively after the adoption date to
newly initiated disposal activities.
40
In April 2002, Statement of Financial Accounting Standards No. 145, "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("Statement 145") was issued. FASB Statement No. 4
required all gains and losses from the extinguishment of debt to be reported as
extraordinary items and Statement No. 64 related to the same matter. Statement
145 requires gains and losses from certain debt extinguishment to not be
reported as extraordinary items when the use of debt extinguishment is part of
the risk management strategy. Statement 44 was issued to establish transitional
requirements for motor carriers relative to intangible assets. Those transitions
are completed, therefore Statement 44 is no longer necessary. Statement 145 also
amends Statement No. 13 requiring sale-leaseback accounting for certain lease
modifications. Statement 145 is effective for fiscal years beginning after May
15, 2002. The provisions relating to sale-leaseback are effective for
transactions after May 15, 2002. The Company adopted Statement 145 effective
July 1, 2002. The adoption of this Statement resulted in gains from debt
restructuring and extinguishments of debt that were previously recorded as
extraordinary being reclassified as operating activities. During the quarter
ended September 30, 2002, the gains from extinguishment of debt were recorded as
part of continuing operations in accordance with Statement 145. The following
sets forth the impact of the reclassifications on the income (loss) from
continuing operations and earnings per share from continuing operations:
2002 2001
---------------------------- ------------------------------
Q3 Q2 Q1 Q3 Q2 Q1
Loss from continuing operations - pre FAS 145 $(4,800) $(1,279) $(2,652) $(14,329) $(48,225) $(53,855)
Extraordinary gain (loss) reclassified to:
Gain (loss) on debt restructuring $6,558 $ - $ - $(1,116) $1,079 $39,349
Income (loss) from continuing operations - post FAS 145 $1,758 $(1,279) $(2,652) $(15,445) $(47,146) $(14,506)
Loss per share from continuing operations - pre FAS 145 $(0.28) $(0.08) $(0.16) $(1.54) $(5.48) $(7.64)
Income (loss) per share from continuing operations
- - post FAS 145 $0.10 $(0.08) $(0.16) $(1.66) $(5.36) $(2.06)
Change in income (loss) per share on continuing operations $0.38 $ - $ - $(0.12) $0.12 $5.58
In July 2002, Statement of Financial Accounting Standards No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities" ("Statement 146") was
issued. This Statement addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue ("EITF") 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The principle difference between Statement
146 and EITF 94-3 relates to the timing of liability recognition. Under
Statement 146, a liability for a cost associated with an exit or disposal
activity is recognized when the liability is incurred. Under EITF 94-3, a
liability for an exit cost was recognized at the date of an entity's commitment
to an exit plan. The provisions of Statement 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The adoption of
this statement is not expected to have a material impact on the Company's
financial position or results of operations.
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk, primarily from changes in interest rates,
foreign exchange rates and credit risk. The Company maintains continuing
operations in Europe (mostly in England) and, to a lesser extent, in Singapore
and Malaysia. Fluctuations in exchange rates may have an adverse effect on the
Company's results of operations and could also result in exchange losses. The
impact of future rate fluctuations cannot be predicted adequately. To date the
Company has not sought to hedge the risks associated with fluctuations in
exchange rates.
Market Risk - Our accounts receivables are subject, in the normal course of
business, to collection risks. We regularly assess these risks and have
established policies and business practices to protect against the adverse
effects of collection risks. As a result we do not anticipate any material
losses in this area.
Interest Rate Risk - Interest rate risk refers to fluctuations in the value of a
security resulting from changes in the general level of interest rates.
Investments that are classified as cash and cash equivalents have original
maturities of three months or less. Changes in the market's interest rates do
not affect the value of these investments. Marketable securities are comprised
of U.S. Treasury Notes and are classified as available-for-sale and subject to
interest rate fluctuations.
41
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
We have only a limited operating history and some of our services are in a new
and unproven industry.
We have only a limited operating history upon which you can evaluate our
business and our prospects. We have offered a commercial email service since
November 1996 under the name iName. We changed our company name to Mail.com,
Inc. in January 1999. In February 2000, we acquired NetMoves Corporation, a
provider of a variety of transaction delivery services to businesses. In March
2000, we formed WORLD.com to develop and operate our domain name properties as
independent Web sites. In the fourth quarter of 2000, we announced our intention
to focus exclusively on the business market and to sell all assets not related
to this business. In February 2001, we acquired Swift Telecommunications, Inc.
which had contemporaneously acquired the EasyLink Services business from AT&T
Corp. The EasyLink Services business is a provider of transaction delivery
services such as electronic data interchange or EDI and production messaging
services. Swift was a provider of production messaging services, principally
telex services. On March 30, 2001, we announced that we had sold our advertising
network business to Net2Phone, Inc. and on May 3, 2001 our Asia.com, Inc.
subsidiary completed the sale of its business. In October 2001, we sold a
subsidiary of India.com, Inc. and have since ceased the conduct of the portal
operations of India.com, Inc. In January 2002, we announced our strategy to
expand our position in the transaction delivery segment of the electronic
commerce market and to begin to offer to our large customer base additional
transaction delivery services and related transaction management services that
automate more components of our customers' business processes. Our success will
depend in part upon our ability to maintain or expand our sales of transaction
delivery services such as EDI, production messaging and integrated desktop
messaging to enterprises, our ability to successfully develop transaction
management services, the development of a viable market for fee-based
transaction delivery and transaction management services on an outsourced basis
and our ability to compete successfully in those markets. For the reasons
discussed in more detail below, there are substantial obstacles to our achieving
and sustaining profitability.
We have incurred losses since inception.
We have not achieved profitability in any period, and we may not be able to
achieve or sustain profitability. We incurred a net loss of $2.2 million for the
nine months ended September 30, 2002 and $206.3 million for the year ended
December 31, 2001. We had an accumulated deficit of $515.6 million as of
September 30, 2002. We intend to expand our sales and marketing operations,
upgrade and enhance our technology, continue our international expansion, and
improve and expand our management information and other internal systems. We
intend to continue to make strategic acquisitions and investments, which may
result in significant amortization of intangibles and other expenses or a later
impairment charge arising out of the write-off of goodwill booked as a result of
such acquisitions or investments. We are making these expenditures in
anticipation of higher revenues, but there will be a delay in realizing higher
revenues even if we are successful. We have experienced declining revenues in
the three and nine months periods ended September 30, 2002 as compared to the
comparable periods ended September 30, 2001. See Item 2: Management's Discussion
and Analysis of Financial Condition and Results of Operations. If we do not
succeed in substantially increasing our revenues or integrating the EasyLink
Services and Swift businesses with our historical business, our losses may
continue.
If we are unable to raise necessary capital in the future, we may be unable to
invest in the growth of our business or fund necessary expenditures.
We may need to raise additional capital in the future.
See -"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources." At September 30, 2002, we had
$9.3 million of cash, cash equivalents and marketable securities. Our principal
commitments consist of subordinated convertible notes, senior convertible notes,
notes payable, obligations under capital leases, accounts payable and other
current obligations, commitments for capital expenditures and commitments for
telecommunications services. For each of the years ended December 31, 2001 and
2000, we received a report from our independent accountants containing an
explanatory paragraph stating that we suffered recurring losses from operations
since inception and have a working capital deficiency that raise substantial
doubt about our ability to continue as a going concern. We may need additional
financing to invest in the growth of our business and to pay other obligations,
and the availability of such financing when needed, on terms acceptable to us,
or at all, is uncertain. See "Risk Factors - We May Be Unable to Pay Debt
Service on Our Indebtedness for Money Borrowed and Other Obligations." If we are
unable to raise additional financing, generate sufficient cash flow or
restructure our debt obligations before they become due and payable, we may be
unable to continue as a going concern.
If we raise additional funds by issuing equity securities or debt convertible
into equity securities, stockholders may experience dilution of their ownership
interest. The amount of dilution resulting from issuance of additional shares of
Class A common stock and securities convertible into Class A common stock and
the potential dilution that may result from future issuances has significantly
increased in light of the decline in our stock price. Moreover, we could issue
preferred stock that has rights senior to those of the Class A common stock.
Some of our stockholders have registration rights that could interfere with our
ability to raise needed capital. If we raise funds by issuing debt, our lenders
may place limitations on our operations, including our ability to pay dividends.
42
We intend to continue to acquire, or make strategic investments in, other
businesses and acquire or license technology and other assets and we may have
difficulty integrating these businesses or generating an acceptable return.
We have completed a number of acquisitions and strategic investments since our
initial public offering. For example, we acquired NetMoves Corporation, a
provider of production messaging services and integrated desktop messaging
services to businesses, and The Allegro Group, Inc., a provider of email and
email related services, such as virus blocking and content screening, to
businesses. We also acquired Swift Telecommunications, Inc. and the EasyLink
Services business that it had contemporaneously acquired from AT&T Corp. We will
continue our efforts to acquire or make strategic investments in businesses and
to acquire or license technology and other assets, and any of these acquisitions
may be material to us. We cannot assure you that acquisition or licensing
opportunities will continue to be available on terms acceptable to us or at all.
Such acquisitions involve risks, including:
o inability to raise the required capital;
o difficulty in assimilating the acquired operations and personnel;
o inability to retain any acquired customers;
o disruption of our ongoing business;
o the need for additional capital to fund losses of acquired businesses;
o inability to successfully incorporate acquired technology into our
service offerings and maintain uniform standards, controls, procedures
and policies; and
o lack of the necessary experience to enter new markets.
We may not successfully overcome problems encountered in connection with
potential acquisitions. In addition, an acquisition could materially impair our
operating results by diluting our stockholders' equity, causing us to incur
additional debt or requiring us to amortize acquisition expenses and acquired
assets or to incur impairment charges as a result of the write-off of goodwill
booked as a result of such acquisition.
We may be unable to successfully complete the integration of the EasyLink
Services Business acquired from AT&T.
On February 23, 2001, we completed the acquisition of Swift Telecommunications,
Inc. which had contemporaneously acquired the EasyLink Services business of AT&T
Corp. The EasyLink Services business acquired from AT&T provides a variety of
transaction delivery services. This business was a division of AT&T and was not
a separate independent operating entity. We hired only a portion of the
employees of the business.
Under a Transition Services Agreement entered into in connection with the
acquisition, AT&T agreed to provide us with a variety of services to enable us
to continue to operate the business pending the transition to EasyLink. We have
transitioned many of these services provided by AT&T under the Transition
Services Agreement to ourselves, including customer service, network operations
center, telex switching equipment and services and office space in a variety of
locations. However, the network for the portion of this business relating to
EDI, fax and email services continues to reside on AT&T's managed network but is
being operated and maintained by EasyLink. We plan to migrate off the AT&T
network to the EasyLink network over the next two years.
We cannot assure you that we will be able to successfully transition the
remaining EasyLink Services network and other operations from AT&T to us, or
successfully integrate them into our operations, in a timely manner or without
incurring substantial unforeseen expense. Even if successfully transitioned and
integrated, we may be unable to operate the business at expense levels that are
ultimately profitable for us. We cannot assure you that we will be able to
retain all of the customers of the EasyLink Services business. Our inability to
successfully transition, integrate or operate the network and operations, or to
retain customers, of the EasyLink Services business will result in a material
adverse effect on our business, results of operations and financial condition.
43
We have incurred significant indebtedness for money borrowed.
As of September 30, 2002, we had approximately $87 million of outstanding
indebtedness for borrowed money, including $10.7 million of capitalized future
interest, and capital leases. We may incur substantial additional indebtedness
in the future. The level of our indebtedness, among other things, could (1) make
it difficult for us to make payments on our indebtedness, (2) make it difficult
to obtain any necessary financing in the future for working capital, capital
expenditures, debt service requirements or other purposes, (3) limit our
flexibility in planning for, or reacting to changes in, our business, and (4)
make us more vulnerable in the event of a downturn in our business.
We may be unable to pay debt service on our indebtedness for money borrowed and
other obligations.
We had an operating loss and negative cash flow for the nine months ended
September 30, 2002. In addition, we have a substantial amount of outstanding
accounts payable and other obligations. Accordingly, cash generated by our
operations would have been insufficient to pay the amount of interest payable
annually on our outstanding indebtedness or to pay our other obligations. We
cannot assure you that we will be able to pay interest and other amounts due on
our outstanding indebtedness, or our other obligations, on the scheduled dates
or at all. If our cash flow and cash balances are inadequate to meet our
obligations, we could face substantial liquidity problems. If we are unable to
generate sufficient cash flow or otherwise obtain funds necessary to make
required payments, or if we otherwise fail to comply with any covenants in our
indebtedness, we would be in default under these obligations, which would permit
these lenders to accelerate the maturity of the obligations and could cause
defaults under our indebtedness. Any such default could have a material adverse
effect on our business, results of operations and financial condition. We cannot
assure you that we would be able to repay amounts due on our indebtedness if
payment of the indebtedness were accelerated following the occurrence of an
event of default under, or certain other events specified in, the agreements
governing our outstanding indebtedness and capital leases, including any deemed
sale of all or substantially all of our assets.
Outsourcing of transaction delivery and transaction management services may not
prove to be viable businesses.
An important part of our business strategy is to leverage our existing global
customer base and global network by continuing to provide our existing
transaction delivery services and by offering these customers additional
transaction delivery and new transaction management services in the future. The
market for transaction management services is only beginning to develop. Our
success will depend on the continued expansion of the market for outsourced
transaction delivery services such as EDI, production messaging services and
integrated desktop messaging services and the development of viable markets for
the outsourcing of additional transaction delivery services and new transaction
management services. Each of these developments is somewhat speculative.
There are significant obstacles to the full development of a sizable market for
the outsourcing of transaction delivery and transaction management services.
Outsourcing is one of the principal methods by which we will attempt to reach
the size we believe is necessary to be successful. Security and the reliability
of the Internet, however, are likely to be of concern to enterprises and service
providers deciding whether to outsource their transaction delivery and
transaction management or to continue to provide it themselves. These concerns
are likely to be particularly strong at larger businesses and service providers,
which are better able to afford the costs of maintaining their own systems.
While we intend to focus exclusively on our outsourced transaction delivery and
transaction management services, we cannot be sure that we will be able to
maintain or expand our business customer base. In addition, the sales cycle for
many of these services is lengthy and could delay our ability to generate
revenues in this market.
Our strategy of developing and offering to existing customers additional
transaction delivery and transaction management services may be unsuccessful.
As part of our recently announced business strategy, we plan to develop and
offer to existing customers additional transaction delivery and transaction
management services that will automate more of our customers business processes.
We cannot assure you that we will be able to successfully develop these
additional services in a timely manner or at all or, if developed, that our
customers will purchase these services or will purchase them at prices that we
wish to charge. Standards for pricing in the market for new transaction delivery
and transaction management services are not yet well defined and some businesses
and service providers may not be willing to pay the fees we wish to charge. We
cannot assure you that the fees we intend to charge will be sufficient to offset
the related costs of providing these services.
We may fail to meet market expectations because of fluctuations in our quarterly
operating results, which would cause our stock price to decline.
We may experience significant fluctuations in our quarterly results. It is
likely that our operating results in some quarters will be below market
expectations. In this event, the price of our Class A common stock is likely to
decline.
44
The following are among the factors that could cause significant fluctuations in
our operating results:
o incurrence of other cash and non-cash accounting charges, including
charges resulting from acquisitions or dispositions of assets,
including from the disposition of our remaining non-core assets, and
write-downs of impaired assets;
o increases or decreases in the number of transactions generated by our
customers (such as insurance claims, trade and travel confirmations,
purchase orders, invoices, shipping notices, funds transfers, among
others), which is affected by factors that affect specific customers,
the respective industries in which our customers conduct business and
the economy generally;
o non-cash charges associated with repriced stock options, if our stock
price rises above $16.90;
o system outages, delays in obtaining new equipment or problems with
planned upgrades;
o disruption or impairment of the Internet;
o demand for outsourced transaction delivery and transaction management
services;
o attracting and retaining customers and maintaining customer
satisfaction;
o introduction of new or enhanced services by us or our competitors;
o changes in our pricing policy or that of our competitors;
o changes in governmental regulation of the Internet and transaction
delivery and transaction management services in particular; and
o general economic and market conditions.
Other such factors in our non-core assets include:
o incurrence of additional expenditures without receipt of offsetting
o revenues pending the sale of these assets.
We may incur significant stock based compensation charges related to repriced
options if our stock price rises above $16.90.
In light of the decline in our stock price and in an effort to retain our
employee base, on November 14, 2000, the Company offered to certain of its
employees, officers and directors, other than Gerald Gorman, the right to
reprice certain outstanding stock options to an exercise price equal to $16.90
per share, the closing price of the Company's Class A common stock on Nasdaq on
November 14, 2000 as adjusted for our reverse stock split effected on January
23, 2002. Options to purchase 632,799 shares were repriced. The repriced options
vest at the same rate that they would have vested under their original terms. In
March 2000, Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25" ("Interpretation"). Among
other issues, this Interpretation clarifies (a) the definition of employee for
purposes of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. As a result, under the Interpretation, stock options repriced after
December 15, 1998 are subject to variable plan accounting treatment. This
guidance requires the Company to remeasure compensation cost for outstanding
repriced options each reporting period based on changes in the market value of
the underlying common stock. If our stock price rises above the $16.90 exercise
price of the repriced options, this accounting treatment may result in
significant non-cash compensation charges in future periods.
Several of our competitors have substantially greater resources, longer
operating histories, larger customer bases and broader product offerings.
Our business is, and we believe will continue to be, intensely competitive. See
"Part I Item 1 - Business - Competition" in our Form 10-K and subsequent reports
filed with the Securities and Exchange Commission.
45
Many of our competitors have greater market presence, engineering and marketing
capabilities, and financial, technological and personnel resources than those
available to us. As a result, they may be able to develop and expand their
communications and network infrastructures more quickly, adapt more swiftly to
new or emerging technologies and changes in customer requirements, take
advantage of acquisition and other opportunities more readily, and devote
greater resources to the marketing and sale of their products and services. In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the
ability of their services to address the needs of our current and prospective
customers. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. In addition
to direct competitors, many of our larger potential customers may seek to
internally fulfill their messaging needs through the deployment of their own on
premises messaging systems.
Some of our competitors provide a variety of telecommunications services and
other business services, as well as software and hardware solutions, in addition
to transaction delivery or transaction management services. The ability of these
competitors to offer a broader suite of complementary services and software or
hardware may give them a considerable advantage over us.
The level of competition is likely to increase as current competitors increase
the sophistication of their offerings and as new participants enter the market.
In the future, as we expand our service offerings, we expect to encounter
increased competition in the development and delivery of these services. We may
not be able to compete successfully against our current or future competitors.
Our rapid expansion has strained our existing resources, and if we are not able
to manage our growth effectively, our business and operating results will
suffer.
We have aggressively expanded our operations in anticipation of continued growth
in our business and as a result of our acquisitions. We have also developed the
technology and infrastructure to offer a range of services in our target market.
This expansion has placed, and we expect it to continue to place, a significant
strain on our managerial, operational and financial resources. If we cannot
manage our growth effectively, our business, operating results and financial
condition will suffer.
It is difficult to retain key personnel and attract additional qualified
employees in our business and the loss of key personnel and the burden of
attracting additional qualified employees may impede the operation and growth of
our business and cause our revenues to decline.
Our future success depends to a significant extent on the continued service of
our key technical, sales and senior management personnel, but they have no
contractual obligation to remain with us. In particular, our success depends on
the continued service of Gerald Gorman, our Chairman, Thomas Murawski, our
President and Chief Executive Officer, George Abi Zeid, our
President-International Operations, and Debra McClister, our Executive Vice
President and Chief Financial Officer. The loss of the services of Messrs.
Gorman, Murawski, Abi Zeid or of Ms. McClister, or several other key employees,
would impede the operation and growth of our business.
To manage our existing business and handle any future growth, we will have to
attract, retain and motivate additional highly skilled employees. In particular,
we will need to hire and retain qualified sales people if we are to meet our
sales goals. We will also need to hire and retain additional experienced and
skilled technical personnel in order to meet the increasing technical demands of
our expanding business. Competition for employees in messaging-related
businesses is intense. We have in the past experienced, and expect to continue
to experience, difficulty in hiring and retaining employees with appropriate
qualifications. If we are unable to do so, our management may not be able to
effectively manage our business, exploit opportunities and respond to
competitive challenges.
Our business is heavily dependent on technology, including technology that has
not yet been proven reliable at high traffic levels and technology that we do
not control.
The performance of our computer systems is critical to the quality of service we
are able to provide to our customers. If our services are unavailable or fail to
perform to their satisfaction, they may cease using our service. In addition,
our agreements with several of our customers establish minimum performance
standards. If we fail to meet these standards, our customers could terminate
their relationships with us and assert claims for monetary damages.
We may need to upgrade our computer systems to accommodate increases in traffic
and to accommodate increases in the usage of our services, but we may not be
able to do so while maintaining our current level of service, or at all.
We must continue to expand and adapt our computer systems as the number of
customers and the amount of information they wish to transmit increases and as
their requirements change, and as we further develop our services. Because we
have only been providing some of our services for a limited time, and because
our computer systems for these services have not been tested at greater
capacities, we cannot guarantee the ability of our computer systems to connect
and manage a substantially larger number of customers or meet the needs of
business customers at high transmission speeds. If we cannot provide the
necessary service while maintaining expected performance, our business would
suffer and our ability to generate revenues through our services would be
impaired.
46
The expansion and adaptation of our computer systems will require substantial
financial, operational and managerial resources. We may not be able to
accurately project the timing of increases in traffic or other customer
requirements. In addition, the very process of upgrading our computer systems
could cause service disruptions. For example, we may need to take various
elements of the network out of service in order to install some upgrades.
Our computer systems may fail and interrupt our service.
Our customers have in the past experienced interruptions in our services. We
believe that these interruptions will continue to occur from time to time. These
interruptions are due to hardware failures, failures in telecommunications and
other services provided to us by third parties and other computer system
failures. These failures have resulted and may continue to result in significant
disruptions to our service. Some of our operations have redundant switch-over
capability. Although we plan to install backup computers and implement
procedures on other parts of our operations to reduce the impact of future
malfunctions in these systems, the presence of single points of failure in our
network increases the risk of service interruptions. Some aspects of our
computer systems are not redundant. These include our database system and our
email storage system, which stores emails and other data. In addition,
substantially all of our computer and communications systems relating to our
services other than the systems located and operated by AT&T Corp. under our
Transition Services Agreement with them are currently located in Manhattan,
Jersey City, New Jersey, Edison, New Jersey, Washington, DC and Dayton, Ohio. We
currently do not have alternate sites from which we could conduct these
operations in the event of a disaster. Our computer and communications hardware
is vulnerable to damage or interruption from fire, flood, earthquake, power
loss, telecommunications failure and similar events. Our services would be
suspended for a significant period of time if any of our primary data centers
was severely damaged or destroyed. We might also lose stored emails and other
customer files, causing significant customer dissatisfaction and possibly giving
rise to claims for monetary damages. As a result of the planned relocation of
our corporate headquarters during the first quarter of 2003, we plan to
consolidate over time an increasing portion of our computer systems and networks
at the new location. This consolidation may result in interruptions in our
services to some of our customers.
Our services will become less desirable or obsolete if we are unable to keep up
with the rapid changes characteristic of our business.
Our success will depend on our ability to enhance our existing services and to
introduce new services in order to adapt to rapidly changing technologies,
industry standards and customer demands. To compete successfully, we will have
to accurately anticipate changes in business demand and add new features to our
services very rapidly. We may not be able to integrate the necessary technology
into our computer systems on a timely basis or without degrading the performance
of our existing services. We cannot be sure that, once integrated, new
technology will function as expected. Delays in introducing effective new
services could cause existing and potential customers to forego use of our
services and to use instead those of our competitors.
Our business will suffer if we are unable to provide adequate security for our
service, or if our service is impaired by security measures imposed by third
parties.
Security is a critical issue for any outsourced transaction delivery or
transaction management service, and presents a number of challenges for us.
If we are unable to maintain the security of our service, our reputation and our
ability to attract and retain customers may suffer, and we may be exposed to
liability. Third parties may attempt to breach our security or that of our
customers whose networks we may maintain or for whom we provide services. If
they are successful, they could obtain information that is sensitive or
confidential to a customer or otherwise disrupt a customer's operations or
obtain confidential information, including our customer's profiles, passwords,
financial account information, credit card numbers, stored email or other
personal or business information. Our customers or their employees may assert
claims for money damages for any breach in our security and any breach could
harm our reputation.
Our computers are vulnerable to computer viruses, physical or electronic
break-ins and similar incursions, which could lead to interruptions, delays or
loss of data. We expect to expend significant capital and other resources to
license or create encryption and other technologies to protect against security
breaches or to alleviate problems caused by any breach. Nevertheless, these
measures may prove ineffective. Our failure to prevent security breaches may
expose us to liability and may adversely affect our ability to attract and
retain customers and develop our business market. Security measures taken by
others may interfere with the efficient operation of our service, which may harm
our reputation, adversely impact our ability to attract and retain customers.
"Firewalls" and similar network security software employed by third parties can
interfere with the operation of our services.
47
We are dependent on licensed technology.
We license a significant amount of technology from third parties, including
technology related to our managed e-mail and groupware services, virus
protection, spam control and content filtering services, Internet fax services,
billing processes and database. We anticipate that we will need to license
additional technology to remain competitive. We may not be able to license these
technologies on commercially reasonable terms or at all. Third-party licenses
expose us to increased risks, including risks relating to the integration of new
technology, the diversion of resources from the development of our own
proprietary technology, a greater need to generate revenues sufficient to offset
associated license costs, and the possible termination of or failure to renew an
important license by the third-party licensor.
If the Internet and other third-party networks on which we depend to deliver our
services become ineffective as a means of transmitting data, the benefits of our
service may be severely undermined.
Our business depends on the effectiveness of the Internet as a means of
transmitting data. The recent growth in the use of the Internet has caused
frequent interruptions and delays in accessing and transmitting data over the
Internet. Any deterioration in the performance of the Internet as a whole could
undermine the benefits of our services. Therefore, our success depends on
improvements being made to the entire Internet infrastructure to alleviate
overloading and congestion. We also depend on telecommunications network
suppliers such as AT&T Corp. and WorldCom for a variety of telecommunications
and Internet services. Pending the transition of the network and operations for
the EasyLink Services business acquired from AT&T, we are dependent on the
services being provided to us under our Transition Services Agreement with AT&T.
See "Risk Factors - We May Be Unable to Successfully Integrate the EasyLink
Services Business Acquired From AT&T" above, "Item 1. Business - Technology" in
our Form 10-K and subsequent filings with the Securities and Exchange
Commission.
Gerald Gorman and George Abi Zeid collectively held as of October 31, 2002
approximately 48.7% of the total outstanding voting power of EasyLink and will
likely be able to prevent a change of control.
Gerald Gorman, our Chairman, held as of October 31, 2002 Class A and Class B
common stock representing approximately 39.4% of the voting power of our
outstanding common stock. Each share of Class B common stock entitles the holder
to 10 votes on any matter submitted to the stockholders. George Abi Zeid, our
President-International Operations and Director, beneficially owned as of
October 31, 2002 Class A common stock representing approximately 9.3% of the
voting power of our outstanding common stock and, after giving effect to the
issuance of shares issuable upon conversion or exercise of convertible
securities and warrants held by Mr. Abi Zeid, approximately 11.2% of such voting
power. Based on their voting power as of October 31, 2002, Mr. Gorman and Mr.
Abi Zeid will effectively be able to determine the outcome of all matters
requiring stockholder approval, including the election of directors, amendment
of our charter and approval of significant corporate transactions. Mr. Gorman
and Mr. Abi Zeid will likely be in a position to prevent a change in control of
EasyLink even if the other stockholders were in favor of the transaction.
We have agreed to permit Federal Partners, L.P., a holder of our senior
convertible notes and Class A common stock, to designate one member of our board
of directors. In addition, in connection with the acquisition of Swift
Telecommunications, Inc., we agreed to appoint George Abi Zeid, the former sole
shareholder of Swift, as a director and as our President of International
Operations.
Our charter contains provisions that could deter or make more expensive a
takeover of EasyLink. These provisions include the ability to issue "blank
check" preferred stock without stockholder approval.
Our goal of building brand identity is likely to be difficult and expensive.
We announced on April 2, 2001 that we have changed our corporate name to
EasyLink Services Corporation to more accurately reflect the strengths,
relationships and solutions that we offer. We believe that a quality brand
identity will be essential if we are to develop our business services market. If
our marketing efforts cost more than anticipated or if we cannot increase our
brand awareness, our losses will increase and our ability to succeed will be
seriously impeded.
Our expansion into international markets is subject to significant risks and our
losses may increase and our operating results may suffer if our revenues from
international operations do not exceed the costs of those operations.
We intend to continue to expand into international markets and to expend
significant financial and managerial resources to do so. We have limited
experience in international operations and may not be able to compete
effectively in international markets. If our revenues from international
operations do not exceed the expense of establishing and maintaining these
operations, our losses will increase and our operating results will suffer. We
face significant risks inherent in conducting business internationally, such as:
48
o uncertain demand in foreign markets for transaction delivery and
transaction management services;
o difficulties and costs of staffing and managing international
operations;
o differing technology standards;
o difficulties in collecting accounts receivable and longer collection
periods;
o economic instability and fluctuations in currency exchange rates and
imposition of currency exchange controls;
o potentially adverse tax consequences;
o regulatory limitations on the activities in which we can engage and
foreign ownership limitations on our ability to hold an interest in
entities through which we wish to conduct business;
o political instability, unexpected changes in regulatory requirements,
and reduced protection for intellectual property rights in some
countries;
o export restrictions, and
o difficulties in enforcing contracts and potentially adverse
consequences.
Regulation of transaction delivery and transaction management services and
Internet use is evolving and may adversely impact our business.
There are currently few laws or regulations that specifically regulate activity
on the Internet. However, laws and regulations may be adopted in the future that
address issues such as user privacy, pricing, and the characteristics and
quality of products and services. For example, the Telecommunications Act of
1996 restricts the types of information and content transmitted over the
Internet. Several telecommunications companies have petitioned the FCC to
regulate ISPs and online service providers in a manner similar to long distance
telephone carriers and to impose access fees on these companies. This could
increase the cost of transmitting data over the Internet. Any new laws or
regulations relating to the Internet could adversely affect our business.
Moreover, the extent to which existing laws relating to issues such as property
ownership, pornography, libel and personal privacy are applicable to the
Internet is uncertain. We could face liability for defamation, copyright, patent
or trademark infringement and other claims based on the content of messages
transmitted over our system. We may also face liability for unsolicited
commercial and other email and fax messages sent by users of our services. We do
not and cannot screen all the content generated and received by users of our
services. Some foreign governments, such as Germany, have enforced laws and
regulations related to content distributed over the Internet that are more
strict than those currently in place in the United States. We may be subject to
legal proceedings and damage claims if we are found to have violated laws
relating to email content.
A majority of our services are currently classified by the FCC as "information
services," and therefore are exempt from public utility regulation. To the
extent that we are permitted to offer all of our services as a single "bundle of
interrelated products," then the whole bundle is currently exempt from
regulation as a "hybrid service." If considered independent of the bundle,
however, our fax-to-fax services, when conducted over circuit-switched network
lines, and our telex services, qualify as "telecommunications services," and
would thus be subject to federal regulation. Moreover, while the FCC has until
now exercised forbearance in regulating IP communications, it has indicated that
it might regulate certain IP communications as "telecommunications services" in
the future. There can be no assurance that the FCC will not change its
regulatory classification system and thereby subject us to unexpected and
burdensome additional regulation. In addition, a variety of states regulate
certain of our services when provided on an intrastate basis.
We obtained authorizations from the FCC to provide such telecommunications
services in conjunction with our acquisition of these telecommunications
services from NetMoves, and are classified as a "non-dominant interexchange
carrier." While the FCC has generally chosen not to exercise its statutory power
to closely regulate the charges or practices of non-dominant carriers, it will
act upon complaints against such carriers for failure to comply with statutory
obligations or with the FCC's rules, regulations and policies - to the extent
that such services are, in the FCC's view, subject to regulation.
49
Continued changes in telecommunications regulations may significantly reduce the
cost of domestic and international calls. To the extent that the cost of
domestic and international calls decreases, we will face increased competition
for our fax services, which may have a material adverse effect on our business,
financial condition or results in operations.
In connection with the deployment of Internet-capable nodes in countries
throughout the world, we are required to satisfy a variety of foreign regulatory
requirements. We intend to explore and seek to comply with these requirements on
a country-by-country basis as the deployment of Internet-capable fax nodes
continues. There can be no assurance that we will be able to satisfy the
regulatory requirements in each of the countries currently targeted for node
deployment, and the failure to satisfy such requirements may prevent us from
installing Internet-capable fax nodes in such countries. The failure to deploy a
number of such nodes could have a material adverse effect on our business,
operating results and financial condition.
Our fax nodes and our faxLauncher service utilize encryption technology in
connection with the routing of customer documents through the Internet. The
export of such encryption technology is regulated by the United States
government. We have authority for the export of such encryption technology other
than to Cuba, Iran, Iraq, Libya, North Korea, and Rwanda. Nevertheless, there
can be no assurance that such authority will not be revoked or modified at any
time for any particular jurisdiction or in general. In addition, there can be no
assurance that such export controls, either in their current form or as may be
subsequently enacted, will not limit our ability to distribute our services
outside of the United States or electronically. While we take precautions
against unlawful exportation of our software, the global nature of the Internet
makes it virtually impossible to effectively control the distribution of our
services. Moreover, future Federal or state legislation or regulation may
further limit levels of encryption or authentication technology. Any such export
restrictions, the unlawful exportation of our services, or new legislation or
regulation could have a material adverse effect on our business, financial
condition and results of operations.
The legal structure and scope of operations of our subsidiaries in some foreign
countries may be subject to restrictions which could result in severe limits to
our ability to conduct business in these countries and this could have a
material adverse effect on our financial position, results of operations and
cash flows. To the extent that we develop or offer messaging services in foreign
countries, we will be subject to the laws and regulations of these countries.
The laws and regulations relating to the Internet in many countries are evolving
and in many cases are unclear as to their application. For example, in India,
the PRC and other countries we may be subject to licensing requirements with
respect to the activities in which we propose to engage and we may also be
subject to foreign ownership limitations or other approval requirements that
preclude our ownership interests or limit our ownership interests to up to 49%
of the entities through which we propose to conduct any regulated activities. If
these limitations apply to our activities, including our activities conducted
through our subsidiaries, our opportunities to generate revenue will be reduced,
our ability to compete successfully in these markets will be adversely affected,
our ability to raise capital in the private and public markets may be adversely
affected and the value of our investments and acquisitions in these markets may
decline. Moreover, to the extent we are limited in our ability to engage in
certain activities or are required to contract for these services from a
licensed or authorized third party, our costs of providing our services will
increase and our ability to generate profits may be adversely affected.
Our intellectual property rights are critical to our success, but may be
difficult to protect.
We regard our copyrights, service marks, trademarks, trade secrets, domain names
and similar intellectual property as critical to our success. We rely on
trademark and copyright law, trade secret protection and confidentiality and/or
license agreements with our employees, customers, strategic partners and others
to protect our proprietary rights. Despite our precautions, unauthorized third
parties may improperly obtain and use information that we regard as proprietary.
Third parties may submit false registration data attempting to transfer key
domain names to their control. Our failure to pay annual registration fees for
domain names may result in the loss of these domains to third parties. Third
parties have challenged our rights to use some of our domain names, and we
expect that they will continue to do so, which may affect the value that we can
derive from the planned disposition of the domain names included among our
non-core assets.
The status of United States patent protection for software products is not well
defined and will evolve as additional patents are granted. If we apply for a
patent in the future, we do not know if our application will be issued with the
scope of the claims we seek, if at all. The laws of some foreign countries do
not protect proprietary rights to the same extent as do the laws of the United
States. Our means of protecting our proprietary rights in the United States or
abroad may not be adequate and competitors may independently develop similar
technology.
Third parties may infringe or misappropriate our copyrights, trademarks and
similar proprietary rights. In addition, other parties have asserted and may in
the future assert infringement claims against us. We cannot be certain that our
services do not infringe issued patents. Because patent applications in the
United States are not publicly disclosed until the patent is issued,
applications may have been filed which relate to our services.
50
We have been and may continue to be subject to legal proceedings and claims from
time to time in the ordinary course of our business, including claims related to
the use of our domain names and claims of alleged infringement of the trademarks
and other intellectual property rights of third parties. Third parties have
challenged our rights to register and use some of our domain names based on
trademark principles and on the Anticybersquatting Consumer Protection Act. If
domain names become more valuable to businesses and other persons, we expect
that third parties will continue to challenge some of our domain names and that
the number of these challenges may increase. In addition, the existing or future
laws of some countries, in particular countries in Europe, may limit or prohibit
the use in those countries or elsewhere of some of our geographic names that
contain the names of a city in those countries or the name of those countries.
Intellectual property litigation is expensive and time-consuming and could
divert management's attention away from running our business. These claims and
the potential for such claims may reduce the value that we can expect to receive
from the disposition of our domain names.
A substantial amount of our common stock may come onto the market in the future,
which could depress our stock price.
Sales of a substantial number of shares of our common stock in the public market
could cause the market price of our Class A common stock to decline. As of
October 31, 2002, we had an aggregate of 16,935,526 shares of Class A and Class
B common stock outstanding. As of October 31, 2002 we had options to purchase
approximately 2.9 million shares of Class A common stock outstanding. As of
October 31, 2002, we had warrants to purchase approximately 1.84 million shares
of Class A common stock outstanding. As of October 31, 2002, we had
approximately 4.4 million shares of Class A common stock issuable upon
conversion of outstanding senior convertible notes and an indeterminate number
of additional shares of Class A common stock issuable over five years in payment
of interest on such senior notes. In addition, we had 127,151 shares of Class A
common stock issuable upon conversion of our remaining outstanding 7%
Convertible Subordinated Notes due 2005 at an exercise price of $189.50 per
share.
As of October 31, 2002, approximately 12.8 million shares of Class A common
stock and Class B common stock were freely tradable, in some cases subject to
the volume and manner of sale limitations contained in Rule 144. As of such
date, approximately 4.1 million shares of Class A common stock will become
available for sale at various later dates upon the expiration of one-year
holding periods or upon the expiration of any other applicable restrictions on
resale. We are likely to issue large amounts of additional Class A common stock,
which may also be sold and which could adversely affect the price of our stock.
As of October 31, 2002, the holders of approximately 6.3 million shares of
outstanding Class A common stock, the holders of approximately 1.8 million
shares of Class A common stock issuable upon exercise of our outstanding
warrants and the holders of approximately 5.7 million shares of Class A common
stock issuable upon conversion of our outstanding senior or subordinated
convertible notes and issuable in payment of interest over the first 18 months
after the date of issuance on our senior convertible notes, had the right,
subject to various conditions, to require us to file registration statements
covering their shares, or to include their shares in registration statements
that we may file for ourselves or for other stockholders. By exercising their
registration rights and selling a large number of shares, these holders could
cause the price of the Class A common stock to fall. An undetermined number of
these shares have been sold publicly pursuant to Rule 144.
Our Class A common stock may be subject to delisting from the Nasdaq National
Market.
Our Class A common stock faces potential delisting from the Nasdaq National
Market which could hurt the liquidity of our Class A common stock. We may be
unable to comply with the standards for continued listing on the Nasdaq National
Market. These standards require, among other things, that our Class A common
stock have a minimum bid price of either $1 or $3. Specifically, an issuer will
be considered non-compliant with the minimum bid price requirement only if it
fails to satisfy the applicable requirement for any 30 consecutive trading day
period following January 1, 2002. It would then be afforded a 90 calendar day
grace period in which to regain compliance. If we do not comply with the $3
minimum bid price, but we do comply with the $1 minimum bid price, then we must
comply with certain other standards, including a $10 million minimum
stockholders' equity requirement. The minimum bid price of our stock was below
$1 during various periods in the fourth quarter of 2000 and the first quarter of
2001 and was below $1 during the period from March 14, 2001 through January 22,
2002. On January 23, 2002, we effected a ten-for-one reverse stock split. Since
the time of our reverse stock split, our stock price was also below $1.00 during
the period from July 10, 2002 through July 26, 2002 and from July 30, 2002
through August 16, 2002.
In addition, the listing standards require that we maintain compliance with
various other standards, including market capitalization or total assets and
total revenue, number of publicly held shares, which are shares held by persons
who are not officers, directors or beneficial owners of 10% of our outstanding
shares, and market value of publicly held shares. We are also required to
maintain at least 3 independent directors on our board to satisfy the Nasdaq's
audit committee requirements. As a result of the resignation of Mr. Donaldson
from our Board of Directors, we will need to appoint a qualified independent
director in order to be in compliance with this requirement. Nasdaq has granted
the Company a 90-day extension until February 11, 2003 to regain compliance with
the independent director requirement. If we are unable to find a suitable
candidate by February 11, 2003, we may be subject to delisting.
51
No assurance can be given that our stock price will remain above the minimum
level required or that we will maintain compliance with all of the other
applicable listing standards in the future.
If our common stock were to be delisted from trading on the Nasdaq National
Market and were neither re-listed thereon nor listed for trading on the Nasdaq
Small Cap Market or other recognized securities exchange, trading, if any, in
the Class A common stock may continue to be conducted on the OTC Bulletin Board
or in the non-Nasdaq over-the-counter market. Delisting would result in limited
release of the market price of the Class A common stock and limited news
coverage of EasyLink and could restrict investors' interest in our Class A
common stock and materially adversely affect the trading market and prices for
our Class A common stock and our ability to issue additional securities or to
secure additional financing.
Our stock price has been volatile and we expect that it will continue to be
volatile.
Our stock price has been volatile since our initial public offering and we
expect that it will continue to be volatile. As discussed above, our financial
results are difficult to predict and could fluctuate significantly. In addition,
the market prices of securities of electronic services companies have been
highly volatile. A stock's price is often influenced by rapidly changing
perceptions about the future of electronic services or the results of other
Internet or technology companies, rather than specific developments relating to
the issuer of that particular stock. As a result of volatility in our stock
price, a securities class action may be brought against us. Class-action
litigation could result in substantial costs and divert our management's
attention and resources.
We may have continuing obligations in connection with the sale of our
advertising network business.
On March 30, 2001, we completed the sale of our advertising network business to
Net2Phone, Inc. Included in the sale were our rights to provide e-mail-based
advertising and permission marketing solutions to advertisers, as well as our
rights to provide e-mail services directly to consumers at the www.mail.com Web
site and in partnership with other Web sites. In connection with the sale, we
entered into a hosting agreement under which we agreed to host or arrange to
host the consumer e-mailboxes for Net2Phone for a minimum of one year. During
the second quarter of 2001, we completed the migration of the hosting of these
consumer mailboxes to a third party provider whom we paid for this service. On
November 14, 2001, we entered into an agreement with Net2Phone which terminated
the hosting agreement as of September 30, 2001. Net2Phone has subsequently
transferred this business to a third party.
Notwithstanding the migration of the consumer mailboxes to the third party
provider, the termination of the hosting agreement with Net2Phone and the
assignment to Net2Phone of our Web site contracts with third parties, we may
nonetheless remain liable for obligations under some of such third party Web
site contracts. Accordingly, we may have liability if there is a breach on the
part of the third party to which we have migrated the hosting or on the part of
Net2Phone or its transferee under the third party Web site agreements that were
assigned to them.
Item 4: Controls and Procedures
Based upon their evaluation of the Company's disclosure controls and
procedures (as defined in Rules 13a - 14(c) and 15d -14(c) of the Securities
Exchange Act of 1934, as amended) as of September 30, 2002, Thomas Murawski,
Chief Executive Officer, and Debra McClister, Chief Financial Officer, concluded
that these disclosure controls and procedures were effective as of September 30,
2002.
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
after September 30, 2002.
52
PART II: OTHER INFORMATION
Item 1: Legal Proceedings
From time to time the Company has been, and expects to continue to be, subject
to legal proceedings and claims in the ordinary course of business. These
include claims of alleged infringement of third-party patents, trademarks,
copyrights, domain names and other similar proprietary rights; employment
claims; and contract claims. These claims include pending claims that some of
our services employ technology covered by third party patents. These claims,
even if not meritorious, could require the Company to expend significant
financial and managerial resources. No assurance can be given as to the outcome
of one or more claims of this nature. If an infringement claim were determined
in a manner adverse to the Company, the Company may be required to discontinue
use of any infringing technology, to pay damages and/or to pay ongoing license
fees which would increase the Company's costs of providing the service.
The Company has also received notices or claims from certain third parties for
disputed and unpaid accounts payable. The Company believes that it has
appropriately reserved for the amount of any liability that may arise out of
these matters, and management believes that these matters will be resolved
without a material effect on the Company's financial position or results of
operations.
Item 2: Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
On July 15, August 15, and September 17, 2002, we issued 34,458, 40,396 and
21,407 shares, respectively, of Class A common stock to employees at an exercise
price of $0.85, $0.86 and $1.80, respectively, per share representing the
Company's matching contribution to its 401(k) plan.
On July 15 and September 1, 2002, we issued 92,574 and 110,179 shares,
respectively, of Class A common stock valued at approximately $0.2 million as
payment for interest in lieu of cash.
The issuance of shares representing matching contributions to the Company's
401(k) plan was not subject to the registration requirements of the Securities
Act of 1933, as amended (the "Act"), because the issuance of the shares was not
voluntary and contributory on the part of employees. The other issuances were
exempt from such registration requirements based on the exemption provided under
Section 4(2) of the Act. Such shares were issued in transactions not involving a
public offering to investors capable of evaluating the merits and risks of the
investment and not in need of the protections afforded by registration under the
Act.
Item 5: Other Information
William Donaldson, a member of the Board of Directors of the Company,
resigned from the Board of Directors as of November 12, 2002 for personal
reasons.
Item 6: Exhibits and Reports on Form 8-K
The following exhibits are filed as part of this report:
(10) Employment Agreement between EasyLink Services Corporation and Gerald
Gorman dated November 12, 2002.
Reports on Form 8-K - EasyLink Services Corporation filed the following reports
on Form 8-K during the three months ended September 30, 2002:
Report on Form 8-K filed on August 26, 2002 announcing that Jack Kuehler, a
member of the Board of Directors of EasyLink Services Corporation, resigned as a
director of EasyLink for personal reasons. The resignation became effective
September 30, 2002.
53
ITEM 7
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereto duly authorized.
EasyLink Services Corporation
/s/ DEBRA L. MCCLISTER
-------------------------------
Executive Vice President and
Chief Financial Officer
November 14, 2002
54
Certifications
I, Thomas Murawski, certify that:
1. I have reviewed this quarterly report on Form 10-Q of EasyLink Services
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
By /s/ Thomas Murawski
----------------------
Thomas Murawski
Chief Executive Officer
55
I, Debra McClister, certify that:
1. I have reviewed this quarterly report on Form 10-Q of EasyLink Services
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
By /s/ Debra McClister
----------------------
Debra McClister
Chief Financial Officer
56
Exhibits
(10) Employment Agreement between EasyLink Services Corporation and Gerald
Gorman dated November 12, 2002.
57