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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 June 30, 2004
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.)
33 Knightsbridge Road, Piscataway, NJ 08854
(Address of Principal Executive Office) (Zip Code)
(732) 652-3500
(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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
Common stock outstanding at August 1, 2004: Class A common stock $0.01 par value
43,165,003 shares, and Class B common stock $0.01 par value 1,000,000 shares.
EASYLINK SERVICES CORPORATION
JUNE 30, 2004
FORM 10-Q
INDEX
Page
Number
------
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of June 30,
2004 (unaudited) and December 31, 2003................................................................ 3
Unaudited Condensed Consolidated Statements of Operations for the
three months ended June 30, 2004 and 2003............................................................. 4
Unaudited Condensed Consolidated Statements of Operations for the
six months ended June 30, 2004 and 2003............................................................... 5
Unaudited Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2004 and 2003............................................................... 6
Notes to Unaudited Interim Condensed Consolidated Financial Statements................................ 8
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations................. 13
Item 3: Qualitative and Quantitative Disclosure about Market Risk............................................. 17
Item 4: Controls and Procedures............................................................................... 29
PART II: OTHER INFORMATION
Item 1: Legal Proceedings..................................................................................... 29
Item 2: Changes in Securities and Use of Proceeds............................................................. 30
Item 4: Submission of Matters to a Vote of Security Holders................................................... 30
Item 5: Other Information..................................................................................... 31
Item 6: Exhibits and Reports on Form 8-K...................................................................... 31
Signatures........................................................................................................ 32
-2-
ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Easylink Services Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
June 30 December 31
2004 2003
---- ----
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents........................................................................ $5,761 $6,623
Accounts receivable, net of allowance for doubtful accounts of
$4,176 and $4,824 as of June 30, 2004 and December 31, 2003, respectively........................ 10,949 11,430
Assets held for sale............................................................................. 807 --
Prepaid expenses and other current assets........................................................ 2,243 1,760
----- -----
Total current assets............................................................................. 19,760 19,813
------ ------
Property and equipment, net...................................................................... 8,482 10,641
Goodwill, net.................................................................................... 6,266 6,266
Other intangible assets, net..................................................................... 10,275 11,629
Other assets..................................................................................... 1,255 1,062
----- -----
Total assets..................................................................................... $46,038 $49,411
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................................. $7,898 $9,082
Accrued expenses................................................................................. 12,690 14,336
Restructuring reserves payable................................................................... 1,433 1,894
Current portion of notes payable................................................................. 4,406 2,957
Current portion of capitalized interest on notes payable......................................... 917 1,040
Current portion of capital lease................................................................. 523 89
Other current liabilities........................................................................ 1,047 1,349
Net liabilities of discontinued operations....................................................... 528 828
--- ---
Total current liabilities........................................................................ 29,442 31,575
------ ------
Notes payable, less current portion.............................................................. 7,780 10,511
Capitalized interest on notes payable, less current portion...................................... 563 956
Other long term liabilities...................................................................... 1,173 1,957
----- -----
Total liabilities................................................................................ 38,958 44,999
------ ------
Stockholders' equity:
Common stock, $0.01 par value; 510,000,000 shares authorized at June 30, 2004
and December 31, 2003, respectively:
Class A--500,000,000 shares authorized at June 30, 2004 and December 31, 2003;
43,136,801 and 42,821,500 shares issued and outstanding at June 30,
2004 and December 31, 2003, respectively................................................... 431 428
Class B--10,000,000 shares authorized at June 30, 2004 and December 31, 2003;
1,000,000 issued and outstanding at June 30, 2004 and December 31, 2003.................... 10 10
Additional paid-in capital....................................................................... 553,235 552,589
Accumulated other comprehensive loss............................................................. (409) (272)
Accumulated deficit.............................................................................. (546,187) (548,343)
--------- ---------
Total stockholders' equity....................................................................... 7,080 4,412
----- -----
Total liabilities and stockholders' equity....................................................... $46,038 $49,411
======= =======
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 June 30,
---------------------------
2004 2003
---- ----
Revenues............................................................................ $24,053 $25,802
Cost of revenues.................................................................... 9,764 13,361
----- ------
Gross profit........................................................................ 14,289 12,441
------ ------
Sales and marketing................................................................. 4,749 4,288
General and administrative.......................................................... 5,681 6,275
Product development................................................................. 1,648 1,707
Amortization of intangible assets................................................... 517 517
-------- --------
12,595 12,787
------ ------
Income (loss) from operations....................................................... 1,694 (346)
------- -----
Other income (expense), net:
Interest income..................................................................... 8 6
Interest expense.................................................................... (121) (343)
Gain on debt restructurings and settlements......................................... ---- 47,026
Other, net.......................................................................... (117) 33
---------- -----
Total other income (expense), net................................................... (230) 46,722
---------- ------
Income before income taxes.......................................................... 1,464 46,376
Provision for Federal and state income taxes........................................ 170 ----
---------- ------
Net income ......................................................................... $ 1,294 $46,376
======= =======
Basic and diluted net income per share ............................................. $ 0.03 $1.28
====== =====
Weighted-average basic shares outstanding........................................... 44,063,679 36,126,806
========== ==========
Weighted-average diluted shares outstanding......................................... 45,098,034 36,126,806
========== ==========
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)
Six Months Ended June 30,
-------------------------
2004 2003
---- ----
Revenues............................................................................ $48,390 $51,544
Cost of revenues.................................................................... 20,090 27,068
------ ------
Gross profit........................................................................ 28,300 24,476
------ ------
Sales and marketing................................................................. 9,280 9,671
General and administrative.......................................................... 12,064 13,015
Product development................................................................. 3,358 3,663
Amortization of intangible assets................................................... 1,033 1,033
------- -----
25,735 27,382
------ ------
Income (loss) from operations....................................................... 2,565 (2,906)
------- -------
Other income (expense), net:
Interest income..................................................................... 18 25
Interest expense.................................................................... (251) (1,098)
Gain on debt restructurings and settlements......................................... ---- 53,666
Other, net.......................................................................... 16 (10)
-------- -------
Total other income (expense), net................................................... (217) 52,583
----- ------
Income before income taxes.......................................................... 2,348 49,677
Provision for Federal and state income taxes........................................ 200 ----
--------- ------
Net income ......................................................................... $ 2,148 $49,677
======= =======
Basic and diluted net income per share ............................................. $ 0.05 $ 1.85
========= =========
Weighted-average basic shares outstanding........................................... 43,963,203 26,899,659
========== ==========
Weighted-average diluted shares outstanding......................................... 44,603,688 26,899,659
========== ==========
See accompanying notes to unaudited condensed consolidated
financial statements.
-5-
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Six Months Ended June 30,
-------------------------
2004 2003
---- ----
Cash flows from operating activities:
Net income.................................................................................... $2,148 $49,677
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization................................................................. 2,917 4,683
Amortization of intangible assets............................................................. 1,355 1,564
Provision for doubtful accounts............................................................... 278 106
Gain on debt restructuring and settlements.................................................... -- (53,666)
Non-cash interest............................................................................. 26 120
Issuance of shares to employee benefit plans.................................................. 246 232
Other......................................................................................... 166 159
Changes in operating assets and liabilities:
Accounts receivable, net................................................................... 203 (519)
Prepaid expenses and other current assets.................................................. (483) 65
Other assets............................................................................... 2 178
Accounts payable, accrued expenses and other current liabilities........................... (4,314) (318)
----- -----
Net cash provided by operating activities..................................................... 2,544 2,281
----- -----
Cash flows used in investing activities:
Purchases of property and equipment, including capitalized software........................... (1,085) (3,479)
------- -------
Net cash used in investing activities......................................................... (1,085) (3,479)
------- -------
Cash flows used in financing activities:
Payments under capital lease obligations...................................................... (109) (229)
Payments of capitalized interest.............................................................. (516) --
Payments of notes payable..................................................................... (1,289) (3,308)
Proceeds from exercise of employee stock options.............................................. 24 --
Proceeds from issuance of Class A common stock................................................ -- 1,000
----------- -----
Net cash used in financing activities......................................................... (1,890) (2,537)
------- ---------
Effect of foreign exchange rate changes on cash and cash equivalents.......................... (131) 78
-------- ----
Net decrease in cash and cash equivalents..................................................... (562) (3,657)
Cash used in discontinued operations.......................................................... (300) --
Cash and cash equivalents at beginning of the period.......................................... 6,623 9,554
----- -----
Cash and cash equivalents at the end of the period............................................ $5,761 $5,897
====== ======
-6-
Supplemental disclosure of non-cash information:
During the six months ended June 30, 2004 and 2003, the Company paid
approximately $307,223 and $35,000, respectively, for interest.
During the six months ended June 30, 2004, the Company issued shares of Class A
common stock as follows:
The Company issued 19,058 shares of Class A common stock valued at
approximately $26,000 as payment for interest in lieu of cash.
The Company issued 161,243 shares of Class A common stock valued at
approximately $246,000 in connection with matching contributions to
its 401(k) plan.
The Company issued 99,500 shares of Class A common stock valued at
approximately $149,000 to a former employee of the Company pursuant
to the settlement of a commitment to the employee to issue such
shares originally entered into in 2001.
The Company issued 35,500 shares of Class A Common Stock valued at
approximately $24,000 in connection with the exercise of employee
stock options.
During the six months ended June 30, 2003, the Company issued shares of Class A
common stock as follows:
The Company issued 261,178 shares of Class A common stock valued at
approximately $151,000 as payment for interest in lieu of cash. (See
Note 2).
The Company issued 381,696 shares of Class A common stock valued at
approximately $232,000 in connection with matching contributions to
its 401(k) plan.
The Company issued 23,405,037 shares of Class A common stock valued
at approximately $12.7 million in connection with the cancellation of
debt. (See Note 2).
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
The Company offers a broad range of information exchange services to businesses
and service providers, including Transaction Management Services consisting of
integrated desktop messaging services and document capture and management
services such as fax to database, fax to data and data conversion services;
Transaction Delivery Services consisting of electronic data interchange or
"EDI," and production messaging services utilizing email, fax and telex: and,
through July 31, 2004, services that protect corporate e-mail systems such as
virus protection, spam control and content filtering services (the Mailwatch
service line).
The Company operates in a single industry segment, business communication
services. Although the Company provides various major service offerings, many
customers employ multiple services using the same access and network facilities.
Similarly, network operations and customer support services are provided across
various services. Accordingly, allocation of expenses and reporting of operating
results by individual services would be impractical and arbitrary. Services are
provided in the United States and certain other regions in the world
(predominantly in the United Kingdom).
(b) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of June
30, 2004 and for the three and six months ended June 30, 2004 and 2003 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
June 30, 2004 and the consolidated results of operations and cash flows for the
interim periods ended June 30, 2004 and 2003. 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, 2003 has been derived from audited
consolidated financial statements at that date.
For each of the years ended December 31, 2003 and 2002, 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 continued profitable operations.
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, 2003 as included in the Company's Form 10-K filed with
the Securities and Exchange Commission on March 30, 2004.
(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 that the Company does not have the ability to control or
over which it does not 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.
-8-
The net liabilities of WORLD.com, a wholly owned subsidiary, and its majority
owned subsidiaries, are reported as discontinued operations in the consolidated
balance sheets as of June 30, 2004 and December 31, 2003 as a result of the sale
or discontinuance of the operations of this business in 2001.
(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) Revenue Recognition
The Company's services include Transaction Management Services consisting of
integrated desktop messaging services and document capture and management
services such as fax to database, fax to data and data conversion services;
Transaction Delivery Services consisting of electronic data interchange or
"EDI," and production messaging services utilizing email, fax and telex; and,
through July 31, 2004, services that protect corporate e-mail systems such as
virus protection, spam control and content filtering services (the Mailwatch
service line). The Company derives revenues from monthly fees and usage-based
charges for its transaction delivery and management services; from monthly
per-user or per-message fees for its virus protection, spam control and content
filtering services, and from license fees. Revenue from services is recognized
as the services are performed. Facsimile license revenue is recognized over the
average estimated customer life of 3 years.
Other revenues include revenues from (i) the sale of domain names, which are
recognized 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 and (ii) the licensing of domain names wherein
revenue is recognized ratably over the license period. To date, such revenues
have not been material.
(f) 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, accounts receivable, notes payable and convertible notes payable.
At June 30, 2004 and December 31, 2003, the fair value of cash, cash
equivalents, restricted investments 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
$1.4 million at June 30, 2004 and December 31, 2003. However, as these notes are
payable in February 2005, management estimates that their fair value
approximates their carrying value.
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 three and six months periods ended June 30, 2004 and 2003.
Revenues from the Company's five largest customers accounted for an aggregate
12% and 8% of the Company's total revenues for the six months ended June 30,
2004 and 2003, respectively.
-9-
(g) Basic and Diluted Net Income Per Share
Net income 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. Although diluted net income per share for the three and six months
ended June 30, 2004 is equal to basic net income per share, the amounts for the
three month and six month periods include the effect of employee options to
purchase 3.5 million shares of common stock. Diluted net income per share for
the three months ended June 30, 2003 is equal to basic net income per share
since all common stock equivalents are anti-dilutive for that period.
(h) Stock-Based Compensation Plans
As allowed by SFAS No. 123, Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, we have retained the compensation measurement principles of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and its related interpretations for stock options. SFAS No. 148 also
requires more prominent and more frequent disclosures in both interim and annual
financial statements about the method of accounting for stock-based compensation
and the effect of the method used on reporting results. We adopted the
disclosure provisions of SFAS No. 148 as of December 31, 2002 and continue to
apply the measurement provisions of APB 25. Under APB Opinion No. 25,
compensation expense is recognized based upon the difference, if any, at the
measurement date between the market value of the stock and the option exercise
price. The measurement date is the date at which both the number of options and
the exercise price for each option are known. The following table illustrates
the effect on net income and net income per share if we had applied the fair
value recognition provisions of SFAS No. 123 to stock-based employee
compensation.
($in thousands, except per share amounts) For the three months For the six months
ended June 30, ended June 30,
-------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Net income as reported................................. $1,294 $46,375 $2,148 $49,677
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (667) (2,407) (2,437) (5,553)
----- ------- ------- -------
Pro forma net income (loss)............................ $627 $43,968 $(289) $44,124
==== ======= ====== =======
Basic net income (loss) per share:
As reported............................................ $0.03 $1.28 $0.05 $1.85
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... $(0.02) (0.06) $(0.06) (0.21)
------ ------ ------ ------
Pro forma.............................................. $0.01 $1.22 $(0.01) $1.64
===== ===== ======= =====
Diluted net income (loss) per share:
As reported............................................ $0.03 $1.28 $0.05 $1.85
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... $(0.01) (0.06) $(0.05) (0.21)
------ ------ ------- ------
Pro forma ............................................. $0.02 $1.22 $0.00 $1.64
===== ===== ===== =====
The resulting effect on the pro forma net income (loss) disclosed for the three
and six month periods ended June 30, 2004 and 2003 is not likely to be
representative of the effects on the net income (loss) on a pro forma basis in
future years, because the pro forma results include only the impact of grants
issued to date and related vesting, while subsequent years will include
additional grants and vesting. For purposes of pro-forma disclosure, the
estimated fair value of the options is amortized to expense over the options'
vesting period.
-10-
(i) Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46 ("FIN46"), Consolidation
of Variable Interest Entities", and replaced this interpretation with FIN 46(R)
in December 2003. FIN 46 and FIN 46(R) address how a business enterprise should
evaluate whether it has a controlling financial interest in an entity through
means other than voting rights and accordingly should consolidate the entity.
The provisions of FIN46 were effective immediately for all arrangements entered
into with new variable interest entities ("VIEs") after January 31, 2003.
However, the Company had not entered into any arrangements with VIEs after
January 31, 2003. The Company is required to apply FIN46R to variable interests
in VIEs created after December 31, 2003. For any VIEs created on or before
December 31, 2003, the assets, liabilities and non-controlling interests of VIEs
initially would be measured at their carrying amounts with any difference
between the net amount added to the balance sheet and any previously recognized
interest being recognized as the cumulative effect of an accounting change. The
adoption of FIN46R on January 1, 2004 did not have any impact on the Company's
financial position or results of operations.
(2) NOTES PAYABLE
During the quarter ended March 31, 2003, the Company entered into separate
transactions with debt holders eliminating $7.1 million in indebtedness
including $2.0 million of 7% Convertible Subordinated Notes, due February 2005,
$2.6 million of 10% Senior Convertible Notes, due January 2006, $2.0 million of
12% Restructure Notes due in 13 quarterly payments beginning June 2003 and $0.5
million of Restructuring balloon payments due October 2004. The Company paid the
debt holders $786,000 in cash and issued 1.1 million shares of Class A common
stock valued at $501,000 in connection with the transactions. After including
the reversal of $685,000 of previously capitalized interest, $227,000 of accrued
interest and debt issuance costs of $26,000 related to certain of the eliminated
indebtedness, the Company recorded total gains of $6.6 million on the
elimination of debt in the quarter.
During the quarter ended June 30, 2003, the Company entered into separate
transactions with debt holders eliminating $54.7 million in indebtedness
including $19.8 million of 7% Convertible Subordinated Notes, due February 2005,
$28.5 million of 10% Senior Convertible Notes, due January 2006, $2.7 million
note payable to the former shareholder of STI (who is an officer and director of
the Company), $3.3 million of 12% Restructure Notes due in 13 quarterly payments
beginning June 2003 and $0.5 million in other indebtedness. The Company also
entered into agreements to repay an outstanding note in the principal amount of
$115,000 and accrued interest obligations in the aggregate amount of $959,000
over the next three years, this accrued interest includes $284,000 due to George
Abi Zied, a director and officer of the Company and the former sole shareholder
of STI. In addition, after eliminating $5.8 million of previously capitalized
interest, $2.4 million of accrued interest, and $0.2 million of debt issuance
costs on the eliminated notes, these transactions resulted in a gain of $47.0
million. Also the transaction relating to the previous $115,000 note and
$959,000 of accrued interest have been accounted for in accordance with
Financial Accounting Standards Board Statement No. 15, "Accounting by Debtors
and Creditors for Troubled Debt Restructurings."
Notes payable and capitalized interest on notes payable include the following,
in thousands:
June 30, 2004 December 31, 2003
------------- -----------------
Capitalized Capitalized
Interest Principal Interest Principal
-------- --------- -------- ---------
2000 7% Convertible Subordinated Notes due
February 2005 $-- $1,425 $-- $1,425
2001 12% Restructure note: as amended and
restated effective September 2003 1,409 9,520 1,884 10,504
2001 12% Note payable to former shareholder of
STI -- -- 3 118
2001 12% Restructure notes due in 13 quarterly
payments beginning June 2003 71 823 109 1,025
2001 Restructuring balloon payments due October 2004 -- 418 -- 396
------ ----- ------ -----
Total notes payable and capitalized interest 1,480 12,186 1,996 13,468
Less current portion 917 4,406 1,040 2,957
---- ----- ----- -----
Non current portion $563 $7,780 $956 $10,511
==== ====== ==== =======
-11-
(3) INCOME TAXES
The Company recorded a provision for Federal and state income taxes in the three
and six months ended June 30, 2004 based on its anticipated effective tax rates
for the full year 2004. The effective rate varies from standard tax rates
primarily due to the utilization of available net operating loss carry forwards
for Federal and certain state income tax purposes.
The availability of the Company's existing net operating loss carryforwards to
offset income in the current periods and in the future has been determined to be
significantly limited. As a result of numerous historical equity transactions,
the Company has experienced "ownership changes" as defined by Section 382 of the
Internal Revenue Code of 1986, as amended (the "Code") and, accordingly, the
utilization of net operating loss carryforwards is limited under the change in
stock ownership rules of the Code.
The elimination of outstanding debt in the six months ended June 30, 2003 will
result in substantial income from cancellation of debt for income tax purposes.
The Company intends to minimize its income tax payable as a result of the
restructuring by, among other things, offsetting the income with its historical
net operating losses and otherwise reducing the income in accordance with
applicable income tax rules. As a result, the Company does not expect to incur
any material current income tax liability from the elimination of this debt.
However, the relevant tax authorities may challenge the Company's income tax
positions.
(4) COMMITMENTS AND CONTINGENCIES
Master Carrier Agreement
In April 2004, the Company entered into a Data Service Terms and Pricing
attachment ("MCA Attachment") to its Master Carrier Agreement with AT & T for
the purchase of private line and satellite services. Under the MCA Attachment,
the term is for a minimum of 18 months with an option by the Company to extend
the term for an additional 12 months. Under the MCA Attachment, the Company has
a minimum purchase commitment for services equal to $3.6 million during the
initial 18 month period. Similar to the original agreement, if the Company
terminates the MCA Attachment prior to the end of the term or AT&T terminates
the services for the Company's breach, the Company must pay to AT&T a
termination charge equal to 50% of the unsatisfied minimum purchase commitment
for the remaining portion of the term.
(5) SUBSEQUENT EVENT
On July 31, 2004, the Company sold its MailWatch service line to Infocrossing,
Inc. for a total of $5.0 million, including $3.5 million in cash and 123,193
shares of Infocrossing's common stock valued at approximately $1.5 million. The
sale will result in a gain, net of taxes, of approximately $ 2.6 million. In
connection with the Company's decision to sell the Mailwatch service line, the
book value of related equipment and capitalized software is reflected as assets
held for sale in the June 30, 2004 balance sheet.
-12-
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
We are a provider of services that facilitate the electronic exchange of
information between enterprises, their trading communities and their customers.
On an average business day, we handle approximately one million 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 Transaction Management Services consisting of
integrated desktop messaging services and document capture and management
services such as fax to database, fax to data and data conversion services;
Transaction Delivery Services consisting of electronic data interchange or
"EDI," and production messaging services utilizing email, fax and telex; and,
through July 31, 2004, services that protect corporate e-mail systems such as
virus protection, spam control and content filtering services (the Mailwatch
service line).
REVENUES
For the six months ended June 30, 2004, revenues were $48.4 million in
comparison to revenues of $51.5 million for the six months ended June 30, 2003.
The decline in revenue primarily occurred in our production messaging services
as a result of lower volumes, negotiated customer price reductions at the time
of service contract renewals and the loss of certain customers. These services
have been impacted by continuing pricing pressures in the telecommunications
market and by technological factors that replace or reduce the deployment of
such services by our customers. We have offset, and we intend to continue to
offset, this revenue erosion by expanding the use of our services within our
large base of existing customers, by selling our services to new customers and
by offering new transaction management services including Document Capture and
Management services. However, the declines may continue.
Our revenues by quarter for 2004 year-to-date and 2003 were as follows (in
thousands):
2nd Qtr 1st Qtr 4th Qtr 3rd Qtr 2nd Qtr 1st Qtr
2004 2004 2003 2003 2003 2003
---- ---- ---- ---- ---- ----
Transaction Management Services $ 3,077 $ 2,771 $ 2,467 $ 2,119 $ 1,969 $ 1,778
Transaction Delivery Services 19,948 20,552 21,219 21,674 22,555 22,897
MailWatch 1,028 1,014 1,052 1,272 1,278 1,067
------- ------- ------- ------- ------- -------
$24,053 $24,337 $24,738 $25,065 $25,802 $25,742
======= ======= ======= ======= ======= =======
OPERATING RESULTS
Our operating results have improved in the six months ended June 30, 2004 even
though revenues declined in comparison to the same period in 2003. Our income
from operations amounted to $2.6 million in 2004 in comparison to a loss from
operations of $2.9 million in the 2003 period. The improved operations were as a
result of reduced costs of revenues, in total and as a percentage of revenues,
and, to a lesser extent, as a result of reduced operating expenses in all
categories. Net income for the six months ended June 30, 2004 was $2.1 million
as compared to net income for the six months ended June 30, 2003 of $49.7
million. However, the results for 2003 included a gain on debt restructuring and
settlements of $53.7 million.
-13-
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, accounts receivable, impairment of long-lived assets,
contingencies and litigation and restructuring activities. Refer to the
Company's Form 10K for the year ended December 31, 2003 as filed with the SEC on
March 30, 2004 for a description of these critical accounting policies.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003
Revenues
Revenues for the three months ended June 30, 2004 were $24.1 million, as
compared to $25.8 million for the comparable period in 2003. The decrease of
$1.7 million was due primarily to reduced revenues in our production messaging
services, which include fax, telex and email services, as a result of lower
volumes, negotiated individual customer price reductions at the time of service
contract renewals and loss of certain customers. Revenues in the 2004 and 2003
quarters 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;
document capture and management services (in 2004 only); and other services.
Cost of Revenues
Cost of revenues for the three months ended June 30, 2004 decreased to $9.8
million as compared to $13.4 million for the comparable period in 2003 and, as a
percentage of revenues, these costs decreased to 40.6% in the 2004 quarter as
compared to 51.8% of revenues in the comparable 2003 quarter. The decrease in
costs as a percentage of revenue reflects a 3.1% decrease related to
depreciation charges and a total of 8.1% related to all other costs, primarily
in variable telecommunications charges and fixed network facilities as a result
of our cost reduction and network efficiency efforts. We anticipate that the
cost of revenues will approximate the current quarter's level throughout the
balance of 2004.
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 and databases.
Sales and Marketing Expenses
Sales and marketing expenses were $4.7 million and $4.3 million for the three
months ended June 30, 2004 and 2003, respectively. Included in this category are
costs related to salaries and commissions for sales, marketing, and business
development personnel. Also included are costs for promotional programs, trade
shows and marketing materials. The higher costs in the 2004 quarter were the
result of renewed spending for additional sales staff and marketing programs in
the current period. We anticipate that sales and marketing expenses will further
increase in subsequent quarters in 2004.
General and Administrative Expenses
General and administrative expenses were $5.7 million during the three months
ended June 30, 2004 as compared to $6.3 million during the comparable period of
2003. The decrease in these costs is the net impact of various cost components
with the most significant being a $279,000 decrease in bad debt expense as a
result of improved collection of customer receivables and a $258,000 decrease in
customer billing costs. While certain of these costs will vary from period to
period, we anticipate general and administrative expenses in the remaining
quarters of 2004 to be comparable to the second quarter 2004 amount.
-14-
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 relatively comparable in the three months
ended June 30, 2004 and 2003, amounting to $1.6 million and $1.7 million
respectively. We anticipate spending for product development to remain at these
levels in subsequent periods of 2004.
Other Income (Expense), Net
Interest expense: Interest expense was $121,000 for the three months ended June
30, 2004 as compared to $339,000 for the same period in 2003. The decrease was
due to the elimination of indebtedness as a result of the debt restructuring and
settlements completed during the 2003 period.
Gain on debt restructuring and settlements: In the three months ended June 30,
2003, we eliminated $54.7 million of indebtedness in exchange for the payment of
$2.3 million in cash and the issuance of 22.3 million shares of Class A common
stock valued at $12.1 million pursuant to our announced efforts to eliminate
substantially all of our outstanding indebtedness. After reversing $5.8 million
of previously capitalized interest and $2.2 million of accrued interest net of
debt issuance costs, we recorded a gain of $47.0 million on these transactions.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
Revenues
Revenues for the six months ended June 30, 2004 were $48.4 million, as compared
to $51.5 million for the comparable period in 2003. The decrease of $3.1 million
was due primarily to reduced revenues in our production messaging services,
which include fax, telex and email services, as a result of lower volumes,
negotiated individual customer price reductions at the time of service contract
renewals and loss of certain customers. Revenues in the 2004 and 2003 periods
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;
document capture and management services( in 2004 only) and other services.
Cost of Revenues
Cost of revenues for the six months ended June 30, 2004 decreased to $20.1
million as compared to $27.1 million for the comparable period in 2003 and, as a
percentage of revenues, these costs decreased to 41.6% in the 2004 period as
compared to 52.5% of revenues in the comparable 2003 period. The decrease in
costs as a percentage of revenue reflects a 3.1% decrease related to
depreciation charges and a total of 7.9% related to all other costs, primarily
in variable telecommunications charges and fixed network facilities as a result
of our cost reduction and network efficiency efforts.
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 and databases.
Sales and Marketing Expenses
Sales and marketing expenses were $9.3 million and $9.7 million for the six
months ended June 30, 2004 and 2003, respectively. Included in this category are
costs related to salaries and commissions for sales, marketing, and business
development personnel. Also included are costs for promotional programs, trade
shows and marketing materials. The lower costs in the 2004 period were the
result of reduced staffing but we anticipate that sales and marketing expenses
will increase in the remainder of 2004.
-15-
General and Administrative Expenses
General and administrative expenses were $12.1 million during the six months
ended June 30, 2004 as compared to $13.0 million during the comparable period of
2003. The decrease in these costs is the net impact of various cost components
including $277,000 in reduced office facilities expense as a result of the
restructuring activities completed in 2003 and $425,000 in reduced customer
billing costs.
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 $3.4 million for the six months ended June
30, 2004 as compared to $3.7 million in comparable period of 2003. The net
decrease in costs results mainly from lower salary and related expenses
attributable to fewer employees.
Other Income (Expense), Net
Interest expense: Interest expense was $251,000 for the six months ended June
30, 2004 as compared to $1.1 million for the same period in 2003. The decrease
was due to the elimination of indebtedness as a result of the debt restructuring
and settlements completed during 2003.
Gain on debt restructuring and settlements: In the six months ended June 30,
2003, we eliminated $61.3 million of indebtedness in exchange for the payment of
$3.0 million in cash and the issuance of 23.4 million shares of Class A common
stock valued at $12.7 million pursuant to our announced efforts to eliminate
substantially all of our outstanding indebtedness. After reversing $6.5 million
of previously capitalized interest and $2.4 million of accrued interest net of
debt issuance costs, we recorded total gains of $53.7 million on these
transactions.
Liquidity and Capital Resources
Net cash provided by operating activities was $2.5 million for the six months
ended June 30, 2004 in comparison to $2.3 million in cash provided from
operating activities for the same period in 2003.
Net cash used in investing activities, consisting entirely of purchases of
property and equipment, amounted to $1.1 million and $3.5 million for the six
months ended June 30, 2004 and 2003, respectively. The higher expenditures in
the 2003 period included $1.9 million related to the consolidation of our New
Jersey office facilities into a single location.
Net cash used in financing activities was $1.9 million and $2.5 million for the
six months ended June 30, 2004 and 2003, respectively. In 2004 these activities
were comprised of payments of debt principal and interest and payments under
capital lease obligations as compared to $3.5 million in debt service and
capital lease payments in 2003 net of the proceeds of $1.0 million from the
issuance of 1.9 million shares of class A common stock in a private placement.
At June 30, 2004, we had $5.8 million of cash and cash equivalents which
represents a decrease of $862,000 from December 31, 2003. The reduction reflects
a $562,000 net decrease from continuing operations, including cash provided from
operations net of equipment purchases of $1.1 million described above and $1.9
million of debt service included in financing activities. The balance of the
decrease represents cash used in discontinued operations of $300,000 to fund the
escrow requirement of $50,000 per month in connection with our appeal of a
previous $931,000 judgment against the Company.
At June 30, 2004 we had a working capital deficit of $9.7 million which is $2.1
million less than the deficit of $11.8 million at December 31, 2003 and $9.9
million less than the deficit of $19.6 million at December 31, 2002. We intend
to continue our efforts to reduce the working capital deficit through payment of
liabilities with funds generated from operations; through reductions in certain
liabilities by agreeing to settlements and delayed payment arrangements with
vendors and payees; by refinancing our debt obligations to defer payments of
principal, if possible: and by raising funds through the sale of certain assets.
Subsequent to June 30, 2004, we completed the sale of our MailWatch service line
for $3,500,000 in cash and stock valued at approximately $1,500,000. Income
taxes payable on the sale are estimated at approximately $1.6 million and cash
flow from operations will be reduced in future periods as a result of the lost
MailWatch revenues.
-16-
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 receivable 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 excess of the allowance for doubtful accounts.
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 and 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.
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. EasyLink was incorporated under the name Globecomm,
Inc. in 1994 in the State of Delaware. We launched our business by offering a
commercial email service in 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 related transaction management services that automate more
components of our customers' business processes. In 2002, we commercially
introduced our Document Capture and Management Services which began to generate
revenues in 2003. Our success will depend in part upon our ability to maintain
or expand our sales of transaction delivery services , our ability to
successfully develop transaction management services, the development of a
viable market for fee-based 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 FROM OPERATIONS SINCE INCEPTION.
We have not achieved income from operations in any fiscal year, and we may not
be able to achieve or sustain profitability. We incurred a net loss of $85.8
million for the year ended December 31, 2002. We had net income of $50.9 million
for the year ended December 31, 2003; however, the net income for 2003 included
$54.1 million of gains on debt restructuring and settlements. We had an
accumulated deficit of $546.2 million as of June 30, 2004. We intend to upgrade
and enhance our technology and networks, continue our international expansion,
increase our sales and marketing expenditures and improve and expand our
management information and other internal systems. We intend to continue to make
strategic acquisitions and investments where resources permit, 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 intend to make 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
each of the years ended December 31, 2003 and 2002 as compared to the prior
year. See Part II, Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in our Form 10-K for the year
ended December 31, 2003. No assurance can be given that we will be able to
offset or otherwise reduce all or any of the cancellation of debt income
resulting from the elimination of debt pursuant to our debt restructuring. If we
do not succeed in substantially increasing our revenues, our losses may recur.
-17-
WE MAY NEED TO RAISE CAPITAL IN THE FUTURE TO INVEST IN THE GROWTH OF OUR
BUSINESS AND TO FUND NECESSARY EXPENDITURES.
We may need to raise additional capital in the future. See Part II. Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources contained in our Form 10-K filed
March 30, 2004. At June 30, 2004, we had $5.8 million of cash and cash
equivalents. Our principal fixed commitments consist of subordinated convertible
notes, senior convertible notes, notes payable, obligations under capital
leases, obligations under office space leases, accounts payable and other
current obligations, commitments for capital expenditures and commitments for
telecommunications services. For each of the four years ended December 31, 2003,
2002, 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 have incurred
significant indebtedness for money borrowed, and we may be unable to pay debt
service on this indebtedness." 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 significant 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, although we do not anticipate paying any cash
dividends on our stock in the foreseeable future.
WE HAVE INCURRED SIGNIFICANT INDEBTEDNESS FOR MONEY BORROWED, AND WE MAY BE
UNABLE TO PAY DEBT SERVICE ON THIS INDEBTEDNESS.
As of June 30, 2004, we had outstanding $1.4 million in subordinated convertible
notes due in 2005; $10.8 million in principal amount of notes and other
obligations due in installments through June, 2006; obligations under office
space leases; and commitments for telecommunications services. We currently have
$5.8 million in principal and interest payments due during the twelve month
period after June 30, 2004. We had an operating loss and negative cash flow for
each of the years ended December 31, 2003 and 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 principal and interest payable annually on our outstanding
indebtedness and to pay all of 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.
-18-
The elimination of outstanding debt pursuant to our debt restructuring completed
in 2003 and prior years resulted in substantial cancellation of debt income for
income tax purposes. We intend to minimize income tax payable as a result of the
restructuring by, among other things, offsetting the income with our historical
net operating losses and otherwise reducing the income in accordance with
applicable income tax rules. As a result, we do not expect to incur any material
current income tax liability as a result of the elimination of this debt.
However, the relevant tax authorities may challenge our income tax positions,
including the use of our historical net operating losses to offset some or all
of the cancellation of debt income and the application of the income tax rules
reducing the cancellation of debt income. If we are not able to offset or
otherwise reduce the cancellation of debt income, we may incur material income
tax liabilities as a result of the elimination of debt and we may be unable to
pay these liabilities.
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.
WHERE RESOURCES PERMIT, 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 in 1999. For example, we acquired NetMoves Corporation,
a provider of production messaging services and integrated desktop messaging
services to businesses. We also acquired Swift Telecommunications, Inc. and the
EasyLink Services business that it had contemporaneously acquired from AT&T
Corp. Where resources permit, 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:
- - inability to raise the required capital;
- - difficulty in assimilating the acquired operations and personnel;
- - inability to retain any acquired member or customer accounts;
- - disruption of our ongoing business;
- - the need for additional capital to fund losses of acquired businesses;
- - inability to successfully incorporate acquired technology into our service
offerings and maintain uniform standards, controls, procedures and
policies; and
- - 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 incur acquisition expenses or amortize or
depreciate acquired intangible and tangible assets or to incur impairment
charges as a result of the write-off of goodwill recorded as a result of such
acquisition.
WE MAY BE UNABLE TO SUCCESSFULLY COMPLETE THE MIGRATION OF THE NETWORK RELATING
TO OUR BUSINESS ACQUIRED FROM AT&T OFF OF AT&T PREMISES.
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.
-19-
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
successfully transitioned virtually all 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. The Transition Services Agreement expired on
January 31, 2003. However, the network for the portion of this business relating
to EDI, fax and email services continues to reside on AT&T's premises under an
agreement with AT&T, but is being operated and maintained by EasyLink. This
agreement expires on January 31, 2006, and AT&T has informed us that they will
not extend the agreement beyond this date. If we are unable to extend the
agreement, we will need to either migrate the network off of the AT&T premises
to EasyLink's premises or migrate the customers to a replacement network.
We cannot assure you that we will be able to successfully migrate the remaining
EasyLink Services customers or network from AT&T's premises to our own premises,
or successfully integrate them into our operations, in a timely manner or
without incurring substantial unforeseen expense or without service interruption
to our customers. Even if successfully migrated, 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 migrate, 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.
OUTSOURCING OF TRANSACTION MANAGEMENT SERVICES MAY NOT PROVE TO BE VIABLE
BUSINESS.
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 development of viable markets for the outsourcing of
new transaction management services which is somewhat speculative.
There are significant obstacles to the full development of a sizable market for
the outsourcing of 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 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 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. The following are among the factors that could cause significant
fluctuations in our operating results:
-20-
- - 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;
- - 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;
- - gains from the restructuring or settlement of debt and other obligations;
- - non-cash charges associated with repriced stock options, if our stock price
rises above $16.90;
- - system outages, delays in obtaining new equipment or problems with planned
upgrades;
- - disruption or impairment of the Internet;
- - demand for outsourced transaction delivery and transaction management
services;
- - attracting and retaining customers and maintaining customer satisfaction;
- - introduction of new or enhanced services by us or our competitors;
- - changes in our pricing policy or that of our competitors;
- - changes in governmental regulation of the Internet and transaction delivery
and transaction management services in particular; and
- - general economic and market conditions and global political factors.
Other such factors in our non-core assets include:
- - incurrence of additional expenditures without receipt of offsetting
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.
-21-
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" contained in our Form 10-K for the year
ended December 31, 2003 and subsequent reports filed with the Securities and
Exchange Commission.
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.
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 F. Murawski, our
President and Chief Executive Officer, George Abi Zeid, our
President-International Operations, and Michael A. Doyle, our Vice President and
Chief Financial Officer. The loss of the services of Messrs. Gorman, Murawski or
Abi Zeid or of Mr. Doyle, 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, customers 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 service fee rebates
or monetary damages.
-22-
WE MAY NEED TO UPGRADE SOME OF 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.
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. In addition, substantially
all of our computer and communications systems relating to our services are
currently located in Glen Head, New York; Jersey City, New Jersey; Piscataway,
New Jersey; Washington, DC; Bridgeton, Missouri; Dayton, Ohio, and London,
England. 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 customer transaction
documents and other customer files, causing significant customer dissatisfaction
and possibly giving rise to claims for monetary damages. As a result of the
recent 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.
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, message content, stored
email or other personal or business information or similar information relating
to our customer's customers. Our customers or their employees or customers may
assert claims for money damages for any breach in our security and any breach
could harm our reputation.
-23-
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 and 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.
Our customers are subject to, and in turn require that their service providers
meet, increasingly strict guidelines for network and operational security. If we
are unable to meet the security requirements of a customer, we may be unable to
obtain or keep their business. This is particularly the case for customers in
the health insurance and financial services industries, which are subject to
legal requirements governing the security and confidentiality of customer
information.
WE ARE DEPENDENT ON LICENSED TECHNOLOGY AND THIRD PARTY COMMERCIAL PARTNERS.
We license a significant amount of technology from third parties, including
technology related to our virus protection, spam control and content filtering
services, Internet fax services, billing processes and databases. We also rely
on third party commercial partners to provide services for our trading community
enablement services, document capture and management services and some of our
other services. We anticipate that we will need to license additional technology
or to enter into additional commercial relationships to remain competitive. We
may not be able to license these technologies or to enter into arrangements with
prospective commercial partners on commercially reasonable terms or at all.
Third-party licenses and strategic commercial relationships 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 or service fee costs, and the possible termination of or failure to
renew an important license or other agreement by the third-party licensor or
commercial partner.
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., MCI and XO Communications for a variety of
telecommunications and Internet services. The network for the EasyLink Services
business acquired from AT&T continues to reside on AT&T's premises. See "Risk
Factors - We may be unable to successfully complete the migration of the network
relating to our business acquired from AT&T off of AT&T premises" above, "Item
1. Business - Technology" contained in our Form 10-K for the year ended December
31, 2003 and subsequent filings with the Securities and Exchange Commission.
GERALD GORMAN AND GEORGE ABI ZEID COLLECTIVELY BENEFICIALLY OWNED AS OF JULY 31,
2004 APPROXIMATELY 26.4% OF THE TOTAL OUTSTANDING VOTING POWER OF EASYLINK AND
WILL BE ABLE TO EXERT SIGNIFICANT INFLUENCE OVER ANY VOTE OF STOCKHOLDERS.
Gerald Gorman, our Chairman, beneficially owned as of July 31, 2004 Class A and
Class B common stock representing approximately 19.1% 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 July
31, 2004 Class A common stock representing approximately 7.3% of the voting
power of our outstanding common stock. Based on their voting power as of July
31, 2004, Mr. Gorman and Mr. Abi Zeid will likely be able to exert significant
influence over 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 may be in a
position to prevent a change in control of EasyLink even if other stockholders
holding a majority of the voting power of the shares not held by Mr. Gorman and
Mr. Abi Zeid were in favor of the transaction. In addition, 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.
-24-
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 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:
- - uncertain demand in foreign markets for transaction delivery and
transaction management services;
- - difficulties and costs of staffing and managing international operations;
- - differing technology standards;
- - difficulties in collecting accounts receivable and longer collection
periods;
- - economic instability and fluctuations in currency exchange rates and
imposition of currency exchange controls;
- - potentially adverse tax consequences;
- - 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;
- - political instability, unexpected changes in regulatory requirements, and
reduced protection for intellectual property rights in some countries;
- - export restrictions;
- - terrorism; and
- - 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 or the recipients of messages delivered through 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.
-25-
A majority of our services are currently classified by the FCC as "information
services," and therefore are currently exempt from telecommunication services
regulation. 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 telecommunications 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.
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 countries such as Cuba, Iran, Iraq, Libya, and North Korea.
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. 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 and telecommunications services 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.
-26-
The status of United States patent protection for software products and services
is not well defined and will evolve as additional patents are granted. We have
applied for a patent for some of our services, and we do not know if our
application will be issued with the scope of the claims we seek or 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.
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.
In connection with the sale of our consumer-based email and advertising network
business, we transferred to the buyer the rights to direct the "MX" record, or
the right to direct email messages addressed to domain names owned by us and
used in this business. Although we do not operate the service or have any role
in the delivery of messages sent by users of the service, our position as the
registrant of the domain names used as addresses for email accounts maintained
by such service may subject us to claims from time to time. We could face
liability for defamation, copyright, patent or trademark infringement,
harassment, unsolicited commercial e-mail and other claims based on the content
of the messages transmitted over the service of this business. These claims,
even if without merit, can cause us to incur legal expenses and may divert
management time and resources.
WE MAY INCUR EXPENSES AND LIABILITIES AS A RESULT OF PENDING LEGAL PROCEEDINGS.
The Company is involved in legal proceedings that may result in additional
expenses or liability. See "Legal Proceedings" contained in Part I, Item 3 of
our Form 10-K for the year ended December 31, 2003 and "Legal Proceedings"
contained in Part II, Item 1 of this Form 10-Q. These proceedings include a
broker's fee dispute in which the Company is appealing a $931,000 judgment
imposed on it, a claim by a landlord for an unspecified amount of damages
arising out of the termination of a lease and tax assessments relating to our
discontinued India.com business in the amount of approximately $650,000.
Although the Company intends to pursue its defense of these matters vigorously,
no assurance can be given that the Company's efforts will be successful. To the
extent that the Company is not successful in appealing the judgment or defending
the claims, it will be required to pay the judgment in the broker's fee dispute
or to pay any damages or tax assessments that may be found to apply in the lease
termination dispute or the India tax proceedings. The Company has already paid
$400,000 into a trust account to secure the payment of the judgment relating to
the broker fee if the judgment is upheld on appeal. Although we intend to defend
vigorously these matters, we cannot assure you that our ultimate liability, if
any, in connection with these matters will not have a material adverse effect on
our results of operations, financial condition or cash flows.
-27-
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 July
31, 2004, we had an aggregate of 44,165,003 shares of Class A and Class B common
stock outstanding. As of July 31, 2004, we had options to purchase approximately
5.0 million shares of Class A common stock outstanding. As of July 31, 2004, we
had warrants to purchase 798,523 shares of Class A common stock outstanding. As
of July 31, 2004, we had approximately 37,177 shares of Class A common stock
issuable upon conversion of outstanding convertible notes and an indeterminate
number of additional shares of Class A common stock issuable over three years in
payment of interest on $297,000 principal amount of notes.
As of the date of this filing on Form 10-Q, substantially all of the shares of
our outstanding 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. We may issue large amounts of additional Class A common
stock, which may also be sold and which could adversely affect the price of our
stock. Approximately 22.5 million of our outstanding shares were issued in
connection with the elimination of debt during the six months ended June 30,
2003. If the holders of these shares sell large numbers of shares, these holders
could cause the price of our Class A common stock to fall.
As of the date of this filing on Form 10-Q, the holders of approximately 8.2
million shares of outstanding Class A common stock, the holders of 0.8 million
shares of Class A common stock issuable upon exercise of our outstanding
warrants and the holders of approximately 29,657 shares of Class A common stock
issuable upon conversion of our outstanding 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 may face 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 $1. 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. It would
then be afforded a 90-calendar day grace period in which to regain compliance.
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. Alternatively, we can 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. Although our
stock price exceeded the $1 minimum bid price requirement for a period of time
after 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 and from November 18, 2002 until July 11, 2003. Although the
Company regained compliance with the minimum bid price requirement on August 4,
2003 after a hearing before a Nasdaq Listing Qualifications Panel, no assurance
can be given that we will maintain compliance with the minimum bid price
requirement. If we are unable to maintain compliance, we may be subject to
delisting.
We had a total stockholders' equity in the amount of $7.1 million as of June 30,
2004. As a result, we are currently not in compliance with the $10 million
minimum total stockholders' equity requirement. An alternative listing standard
to the minimum total stockholders equity standard requires that we maintain a
minimum market value of our publicly held shares of not less than $15 million.
As of the filing of this Form 10-Q, we were in compliance with the $15 million
minimum market value of publicly held shares alternative standard.
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There can be no assurance that EasyLink will maintain compliance with the
minimum bid price requirement or that it will maintain compliance with the other
listing standards, including the $15 million minimum market value of publicly
held shares requirement.
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.
ITEM 4 CONTROLS AND PROCEDURES
As of the end of the period covered by this Quarterly Report on Form 10-Q, our
management, including our Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of EasyLink's "disclosure controls and procedures,"
as that term is defined in Rule 13a-15(e) and 15d-15(e) promulgated under the
Securities and Exchange Act of 1934, as amended (the "Exchange Act"). Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures are effective to ensure
that information required to be disclosed by EasyLink in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms, and to
ensure that such information is made known to the Chief Executive Officer and
Chief Financial Officer as appropriate to allow timely decisions regarding
required disclosure. During the period covered by this Quarterly Report on Form
10-Q, there were no changes in our internal control over financial reporting
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
In connection with Company's appeal of a $931,000 judgment entered by the court
in a favor of a broker, the Court permitted the Company, in lieu of posting an
appeal bond, to place $50,000 per month for eight months commencing November 7,
2003, for a total of $400,000, into a trust account to provide funds for the
payment of the judgment if upheld on appeal. The broker appealed the Court's
order permitting the Company to place funds in the trust account in lieu of
posting an appeal bond. On April 14, 2004, the United States Court of Appeals
for the Second Circuit denied the broker's motion. The Company has paid in full
the $400,000 into the trust account.
In the lawsuit by DTC against the Company relating to the termination of a
sublease, the Company filed an Answer and Counterclaim against DTC, seeking the
return of all or a substantial portion of the proceeds of the Letter of Credit
received by DTC. DTC has filed an answer to the Company's counterclaim. The
Court has entered a second scheduling order on August 2, 2004 providing, among
other things, for the completion of discovery by January 1, 2005.
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The Company previously reported that the staff of the US Securities and Exchange
Commission is reviewing certain transactions accounting for approximately $3
million of revenue generated by its former advertising network business in 2000,
a year in which the Company reported $61.2 million in total revenue. The staff
has informed the Company that it is also reviewing an additional amount of
approximately $1.8 million of revenue from the former advertising network
business. The Company understands that the staff is in part reviewing whether
and to what extent the revenue under review may be recognized under EITF 99-17,
relating to accounting for advertising barter transactions, which became
effective in January 2000. A substantial majority of the revenue being reviewed
was reported after the Company announced its intention to sell its advertising
network business, which the Company ultimately sold in March 2001. The Company
is engaged in ongoing discussions with the staff regarding the foregoing and has
taken the position that the transactions at issue are not material to the
Company's 2000 financial statements.
See Part I, Item 3 Legal Proceedings contained in our Form 10-K filing for the
year ended December 31, 2003 for a description of the foregoing legal
proceedings and other matters.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the three months ended June 30, 2004, the Company issued shares of Class
A common stock as follows:
The Company issued 11,057 shares of Class A common stock valued at approximately
$13,000 as payment for interest in lieu of cash. The issuance of the shares was
made pursuant to the terms of the underlying notes on which the interest accrued
and not at the election of the holders of the notes. The issuance of the notes
and, therefore, the issuance of the shares in payment of interest were exempt
from registration pursuant to the private placement exemption contained in
Section 4(2) of the Securities Act because the shares were issued in a
transaction 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.
The Company issued 85,651 shares of Class A common stock valued at approximately
$126,000 in connection with matching contributions to its 401(k) plan. These
issuances were not subject to the registration requirements of the Securities
Act because the issuance of the shares was not voluntary and contributory on the
part of employees.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders was held on June 15, 2004.
(b) Each of the persons named in the Proxy Statement as a nominee for Director
was elected.
(c) The following are the voting results on each of the matters that were
submitted to the shareholders:
For Withheld Abstain Broker Non-Votes
Election of Directors
Gerald Gorman 39,872,499 3,137,509 Not Applicable Not Applicable
Thomas Murawski 41,679,132 1,330,876 Not Applicable Not Applicable
George Abi Zeid 39,870,415 3,139,593 Not Applicable Not Applicable
Robert Casale 42,035,410 974,598 Not Applicable Not Applicable
Stephen Duff 40,504,316 2,505,692 Not Applicable Not Applicable
George Knapp 42,035,370 974,638 Not Applicable Not Applicable
Dennis Raney 42,419,336 590,672 Not Applicable Not Applicable
For Against Abstain Broker Non-Votes
Resolutions
To approve the EasyLink 9,939,394 3,464,926 11,826,535 17,779,174
Services Corporation 2004
Stock and Incentive Plan
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Based on the above voting results, the 2004 Stock and Incentive Plan was not
approved at the meeting. The text of the matters referred to under this Item 4
is set forth in the definitive Proxy Statement previously filed with the
Commission and incorporated herein by reference.
ITEM 5 OTHER INFORMATION
Related Party Transaction
Pursuant to the terms of the Agreement and Plan of Merger between Swift
Telecommunications, Inc. ("STI") and the Company dated January 31, 2001 under
which the Company acquired STI (the "Merger Agreement"), George Abi Zeid, a
director and officer of the Company, is entitled to receive, in his capacity as
former sole shareholder of STI, contingent merger consideration consisting of
the net proceeds of the sale or liquidation of Swift Comtext srl, an Italian
subsidiary of STI. Mr. Abi Zeid is also obligated to indemnify the Company for
all liabilities and obligations relating to Swift Comtext srl. Pursuant to this
obligation, the Company paid to Mr. Abi Zeid $320,190 representing additional
proceeds received from the sale of Swift Comtext srl.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits are filed as part of this report:
Exhibit 10.1 Reaffirmation Agreement made as of July 23, 2004, by and among
EasyLink Services Corporation (f/k/a Mail.com, Inc.), a
Delaware corporation, Swift Telecommunications, Inc., a
Delaware corporation, and George Abi Zeid
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial Officer
Reports on Form 8-K - EasyLink Services Corporation filed the following reports
on Form 8-K during the three months ended June 30, 2004:
On April 30, 2004, the Company submitted a Form 8-K to correct errors in its
Form 10K for the year ended December 31, 2003 as filed on March 30, 2004.
On May 6, 2004, the Company submitted a Form 8-K to furnish its first quarter
2004 earnings announcement pursuant to Item 12 of Form 8-K.
On May 28, 2004, the Company submitted a Form 8-K to correct an error in its
Form 10Q for the quarter ended March 31, 2004 as filed on May 14, 2004.
On June 30, 2004, the Company submitted a Form 8-K to disclose that the staff of
the US Securities and Exchange Commission was reviewing certain transactions of
its former advertising network business.
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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/ MICHAEL A. DOYLE
-----------------------
Vice President and
Chief Financial Officer
August 16, 2004
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Exhibit Index
Exhibit 10.1 Reaffirmation Agreement made as of July 23, 2004, by and among
EasyLink Services Corporation (f/k/a Mail.com, Inc.), a
Delaware corporation, Swift Telecommunications, Inc., a
Delaware corporation, and George Abi Zeid
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial Officer